Despite Beijing's attempts to impose tough environmental standards on the country's steelmakers, the specter of overcapacity continues to loom large in China, and could put pressure on steel prices in 2014. Coupled with an expected surge in new seaborne iron ore supply from the second half of next year, weaker steel prices could contribute to softer global iron ore prices.
China's new leadership knows it must address environmental concerns but tackling the notoriously fragmented steel sector has always proved a challenge. Any initiative to curb capacity takes time and is unlikely to show any palpable effect in 2014.
A much-trumpeted closure of steelmaking facilities in the northern Hebei province in late November removed less than 7 million mt/year of steelmaking capacity from a total estimated capacity of around 1 billion mt/year.
The most important policy announcement to emerge from the recent plenary session in Beijing was the central government's plan to move toward a more market-based economy. This will see policy support for state-owned enterprises withdrawn, which could eventually help curb capacity.
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But both Chinese Academy Social Sciences executive Jiang Feitao and China Metallurgical Industry Planning & Research Institute Secretary General Li Xinchuang said at Platts' Steel Markets Asia conference in Hong Kong in November that it would be several years before China started reducing excess steel capacity in any meaningful way.
STRONG PRODUCTION
Steel production has remained belligerently strong in 2013 despite domestic hot rolled coil prices having by early December fallen 18.5% from a peak of $702/mt in February, according to Platts data.
A pick-up in construction demand from the second quarter of this year as Beijing eased lending restrictions, supported long steel prices, which have fallen just 4% since the start of January.
Some analysts have attributed the strong output this year in part to provincial governments pushing hard to meet revenue targets. Equity brokerage CLSA in a November 29 report warned of the effect of China's habitual under-reporting of steel production as mills hide real output levels to show compliance with environmental targets.
China's crude steel production over November 11-20 reached 2.13 million mt/day, or 777 million mt/year, China Iron & Steel Association data show. This was down just 0.6% from early November despite finished steel stocks held by CISA members climbing 1 million mt in the period to 14 million mt and prices staying fairly flat.
Platts' latest China Steel Sentiment Survey found a big increase in the number of traders who expected their inventories to climb in December -- from 33.84 in October to 60.77 in November.
Of the long steel products traders surveyed, more than 70% expected a build-up of stocks in December. About a third of flats traders, however, said they expected inventories to fall.
Platts' China Steel Sentiment Survey questions steelmakers and traders at the end of each month about prices, demand and inventory for the coming month. The methodology is similar to a purchasing managers' index, where a figure over 50 indicates expansion and under 50, a contraction.
The mid-November crude steel output rate is in line with CISA's prediction that production will reach 776 million mt in 2013, up 5% from 740 million mt in 2012. CISA forecasts a 4.1% increase to 808 million mt in 2014 on strong demand from the auto and rail sectors in particular, and to a lesser extent from machinery and appliances.
MANUFACTURING STABLE
China's two manufacturing PMIs in November suggests the country's manufacturing sector, which largely uses flat steel to make its products, remains stable. The HSBC PMI, which typically canvasses smaller and private businesses, deteriorated slightly in November to 50.8 from 50.9 in October.
China's official PMI, which picks up the views of larger and state-owned enterprises, was flat from October at 51.5 in November. Both should improve in 2014 if CISA's demand outlook holds.
CISA estimates that average steelmaking capacity utilization in China is less than 75% currently, with 95% of the output consumed domestically and the rest exported.
The export route has eased some of the overcapacity tension, but how much longer this will continue remains doubtful. Southeast Asian steelmakers blame Chinese exports for stifling development of their own industry. Trade barriers that may be put in place as a result could shut some of the outlets for Chinese steel exports in the next few years and curb output of HRC in particular. But again, this is unlikely to happen in 2014.
CISA said profits earned by its 86 member mills plunged 47.5% in October to Yuan 1.72 billion ($282 million) from September's Yuan 3.27 billion, after three consecutive months of profit. As well as impacting the bottom lines of steelmakers, weaker steel prices have slowed the winter restocking activity by traders and end-users, who do not anticipate that prices will rise before the Lunar New Year at the end of January.
Some analysts expect rising capacity utilization to boost profit margins next year, but it simply means there will be more steel, which could push down prices.
Given this outlook, it is not surprising that the Platts Steel Sentiment Survey for November found participants expecting prices to remain soft in the near term on weak orders.