China is frantically trying to apply the brakes to its runaway steel juggernaut.
Targets are being set for capacity closures, 45 million tons nationally this year and 100-150 million tons over the next three to five years.
Regional governments are heeding Beijing’s call. Yunnan province, for example, has committed to eliminate 4.5 million tons of capacity by 2018.
Local authorities are being urged to crack down on energy usage in the sector with those that fail to meet efficiency targets facing forced closure if they cannot improve.
A drive to consolidate the country’s fractured steel production landscape has begun with Baosteel, the second-largest Chinese operator, being pushed into a forced marriage with its smaller and financially weaker peer Wuhan Iron and Steel.
Beijing, in other words, is using all of its centrally-controlled levers to try and reform the sector.
It has good reasons to do so. Steel and coal, another sector earmarked for “supply-side reform”, are not only littered with non-performing “zombie” operators but major obstacles on the path toward a greener future.
But the palpable sense of urgency is being dictated by the growing international pressure on China to halt its surging steel exports.
A failure to produce results is going to ignite an already smoldering trade war with other global powers.
But can Beijing deliver? It’s going to help if it stops pressing the accelerator and the brake pedals at the same time. Even if does, though, it may be too little too late.
RAISING THE POLITICAL TEMPERATURE
Reform of the steel and coal sectors has been moving steadily toward the top of China’s national policy agenda ever since the 2009 shock-and-awe infrastructure boom started to lose momentum a couple of years ago.
Left to its own devices Beijing would have preferred a more gradualist process, not least because of the high social costs of weeding out excess steel capacity and loss-making production. An estimated 400,000 jobs would be lost if the full 150-million-ton target is met.
But time is no longer on Beijing’s side.
The trade walls are rapidly being erected.
The U.S. International Trade Commission (ITC) last week ruled that imports of both Chinese cold-rolled and corrosion-resistant steel products were hurting local producers, paving the way for hefty anti-dumping duties.
That just adds to a growing list of punitive U.S. tariffs against Chinese steel-makers.
More may be on their way, including the nuclear option of halting just about all imports proposed by U.S. Steel, which alleges Chinese competitors stole its secrets and fixed prices. Those claims are now being investigated by the ITC.
China has reacted with predictable anger, threatening to take the United States to the World Trade Organisation.
But it is not just the United States that is piling on the pressure.
Any failure by China to curtail its output and exports could prompt the European Union also to take retaliatory action, not only in steel but in other sectors.
“If the problem is not properly remedied, trade defense measures may proliferate, spreading beyond steel to other sectors such as aluminum, ceramics and wood-based products,” warned the European Commission.
Aluminum in particular is another hot-button issue, especially in the United States, where the ITC in April opened an investigation into the domestic production sector and global (read “Chinese”) trade flows.
Looming even larger for Beijing policy-makers is the prospect of seeing China’s bid for market economy status at the WTO founder on the rising protectionist waves.
OUTPUT UP, EXPORTS UP
In trying to react fast enough to head off a full-blown trade war with the both the United States and Europe, China faces two big challenges.
The first is the sheer scale of excess capacity in the country. The most commonly cited figure is 300 million tons which comes from the China Iron and Steel Association (CISA).
Not only is it a suspiciously round figure, suggesting as it does an element of back-of-the-envelope calculation, but even if true, Beijing’s official target of eliminating around half of it over several years will not be enough to satisfy its critics.
The European Commission, for example, explicitly noted that the pledge was insufficient, a point underlined by German Chancellor Angela Merkel, who used a trip to Shenyang this month to warn that as the world’s biggest steel producer, China “bears a greater responsibility” for addressing global market imbalances.
The second more pressing problem is the fact that both Chinese steel production and exports are rising again.
National production has risen year-on-year in the last three months after falling over the course of 2015 and January-February 2016. Cumulative year-to-date output of 330 million tonnes is still down by 1.4 percent on last year but the gap is fast closing.
Exports of steel products have risen by six percent so far this year to 46 million tons and are on course to at least match last year’s massive 112 million tons.
Higher production is a direct reaction to improved steel pricing in China’s domestic market.
The speculative bull bubble of April has been burst but the price of Shanghai rebar has picked itself off the ensuing lows of 1,900 yuan per ton to a current 2,241 yuan. There are no signs that the retail crowd that fueled the spring frenzy has returned.
Rather, the steel price and steel producers are riding the tail-winds of China’s mini stimulus at the start of the year, which like all recent Beijing-designed economic boosters has been focused on accelerated infrastructure spending.
This is the government foot that is still on the steel accelerator, albeit with less force than in the past.
CLOCKS TICKING
Even assuming the effects of mini-stimulus wane over the coming months, there is another, even more problematic dynamic behind buoyant Chinese steel prices.
They are in part reacting to Beijing’s very targeting of excess capacity. After all, less excess capacity promises better profitability for those that survive the coming “supply side” reform package.
Again, it’s a very rational market reaction to government policy but one that promises higher output and, in all probability, higher exports over the coming period.
That wouldn’t matter over a medium-term time frame, if it’s the price to be paid for a leaner, cleaner Chinese steel sector.
But with the clock ticking on more steel sanctions, the potential spread of “defense measures” to other sectors and an end-year deadline for that much-coveted market economy status, time is what China doesn’t have right now.
