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Shai Heffetz

Chinese steel output shrinks amid declining local demand


Chinese steel mills, responsible for 50% of the world’s supply, reported the sharpest reduction in output capacity in 25 years in 2015. The decline was brought about by plunging domestic demand resulting in falling prices and skyrocketing inventory levels. According to the China Statistics Bureau, steel production contracted to 803.83 million metric tons (-2.3%), with December production figures plunging 5.2% from December 2014.
China’s macroeconomic policy is now focused on developing the domestic economy, in contrast to the past few decades’ focus on exports. The economy has shifted from investment-led growth to consumption-led growth, an about-turn which largely accounts for China’s slowdown in recent months.
In fact, 2015’s 6.9% annual GDP growth is the lowest reading in 25 years, and it is also expected that steel production will decline by 2.6% over 2016. This compounds concerns about iron ore production which has been characterised recently by excess capacity.
Production cuts to the Chinese steel industry will continue unabated in 2016, though at a slower pace than in 2015. The situation is a tenuous one given that steel mills in China want to retain market share by continuing to oversupply, irrespective of demand.
This is much the same as the crude oil industry where OPEC countries and non-OPEC countries are determined to protect their share of the market regardless of how low the price of crude oil drops. In the 24 years from 1990 to 2014 steel output in China increased 1200%, exemplifying the rise to dominance of China as a global economic powerhouse.

Steel consumption surged with infrastructure growth

The rapid escalation in steel production and utilisation in China facilitated massive infrastructure development and the widespread urbanisation of China’s burgeoning middle class. The increase in the consumption of luxury goods such as vehicles, machinery and equipment also contributed to rising demand for iron ore and steel.
Since the slowdown began the Communist authorities in Beijing have attempted to intervene in the currency markets and the financial markets on almost every level, with little or no success. They devalued the renminbi to make Chinese exports cheaper, and established mega-funds to purchase blue-chip shares to prop up the Shanghai Composite Index.
However, Chinese stocks are heavily overvalued and both domestic and international investors are convinced that the bubble is quickly deflating.

Domestic steel demand at record lows

Since local consumption of steel is at record low levels, steel mills are attempting to export even greater amounts to maintain production capacity. Exports increased by 20% in 2015 to 112.4m tonnes. This has resulted in various tariffs and trade restrictions being imposed on Chinese steel by foreign governments to protect their own industries.
With slack local demand, additional production cuts are warranted and the opposition that Chinese steel producers are facing in foreign markets is placing further pressure on the industry. According to a spokesman from the CISA (China Iron & Steel Association) production capacity may decline to 783m tonnes in 2016.
As a result of declining production, as many as 400,000 jobs could be lost. There are concerns that rampant social instability will result as production capacity declines to 150m tonnes. The government has pledged to support the retrenched employees with the proceeds from an emergency fund.
The domino effect resulting from the loss of so many jobs will also bring about social instability in related industries. During 2015, the industry shed $12 billion in profits, and the road ahead is long with as many as 300m tonnes of excess capacity available.
While this appears to be a negative sign for China, it is merely a rebalancing act designed to streamline an overheated economy now focused on domestic rather than export-driven growth. Bear in mind that the 400,000 possible job losses are but a fraction (just 3%) of the 13 million new jobs that China created in 2015.
The restructuring of the steel industry will allow for greater profitability in developing new enterprises across China, so the big picture is not as gloomy as the headlines suggest. China may be in the midst of a speed wobble, but the economy will quickly find its feet as it focuses on moving in a new direction.
Brett Chatz
Intertrader.com
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The content of this article is the personal opinion of the author and not Intertrader.com. The information and comments provided herein under no circumstances are to be considered an offer or solicitation to invest. Nothing herein should be construed as investment advice. The information provided is believed to be accurate at the date the information is produced.

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