Signs of Chinese steel recovery as stimulus starts to bear fruit

China’s steel mills, the most important consumers of Australian iron ore, are showing signs of recovery.

China GDP

China’s steel mills, the most important consumers of Australian iron ore, are showing signs of recovery as a result of the Chinese government’s huge stimulus ­program and Beijing’s efforts to curb excess capacity.

The move comes as the Chinese economy continues to defy the sceptics, with GDP growth ­remaining at an enviable 6.7 per cent pace and industrial production, retail sales and fixed-­asset investment growing more than expected.

Data shows money supply and lending also accelerated last month, with economists noting a pick-up in the manufacturing and construction sectors. But weaker housing starts and investment in the economy suggest construction will ease back in the second half, and risks are still weighted to the downside.

But for Australian miners, much of the attention remains on iron ore, with prices surging back to around $US59 a tonne on Thursday.

At a recent conference representing the country’s biggest steel producers, the China Iron & Steel Association said the industry made a collective profit of 8.7 billion yuan ($1.7bn) during the first five months of 2016, a sevenfold increase from the same period last year.

The proportion of loss-making steel mills has also been reduced from 41.41 per cent to 28.28 per cent, although the collective profit for the industry remains below 0.83 per cent, significantly below the national average for other ­industrial sectors. According to Chinese experts, 5 per cent profit is considered to be “healthy” for ­industrial firms.

Last year was certainly an annus horribilis for the Chinese steel industry due to overcapacity. The Chinese government significantly expanded its steel industry after the global financial crisis, and state-owned banks funnelled more than 10 trillion yuan of credits to the steel, coal and real estate industries. Steel production surged from 512 million tonnes in 2008 to 803 million tonnes in 2015, according to the World Steel Association, accounting for about half of the world’s production.

The expansion of the Chinese steel sector created financial ­bonanzas for the federal government and mining companies, but the sharp slowdown in the Chinese economy has rendered much of the newly added steel production capacity idle.

The utilisation rate of steel production facilities is about 67 per cent and perhaps as low as 40 per cent for underdeveloped western regions of China.

In 2015, seven of the 10 worst-performing listed companies were in the steel sector. Wuhan Steel, which has invested in Australian iron ore mines, topped the worst-performing list and made a loss of 7.5 billion yuan that year.

The Chinese government has made reducing steel and coal production two of its most important objectives in its so-called supply-side reform. So far, it has made slow progress in reducing over­capacity in these sectors.

“Though we have seen some modest price recovery in steel and coal, the overall problem of overcapacity will not change in the short term,” said a spokesman for the National Development and Reform Commission, China’s powerful economic planning agency.

In fact, Chinese steel production rebounded in several key provinces including Hebei, Jiangsu and Shandong, rising 0.3 per cent, 2.19 per cent and 5.47 per cent respectively during the first five months of 2016. Blast furnaces have been reopened since March.

Many in China — including the country’s most influential business journalist, Hu Shuli — were concerned about the slowness in implementing an over­capacity reduction strategy. They lobbied the government to rein in loose monetary policy and reconfirm its commitment to address the overcapacity issue.

News of a possible restructure in the Chinese steel industry has pushed up steel prices in recent months, according to ANZ Bank.

Last month, Baosteel and Wuhan Iron & Steel announced they would undergo a joint strategic restructuring, giving hope the overcapacity plaguing the ­industry for the past few years could be alleviated.

News reports this week said Hebei was restricting output of steel in July, resulting in steel rebar prices in China climbing nearly 5 per cent this week, and more than 15 per cent since the start of June.

“We can’t see iron ore prices ­remaining at these levels for too long,” ANZ commodity strategist Daniel Hynes said. “Con­solidation in the steel market is ultimately bearish for the iron ore demand, and supply growth in iron ore also remains relatively high. We recommend that producers use the current rally to forward sell some production.”

Overall, the ability of the Chinese government to deal with the problem of overcapacity will be crucial to its economic reform agenda, as overleveraged state-owned firms in industries with problems of overcapacity are sucking up vital resources such as credit, land and raw materials.

More importantly they are threatening the health of the Chinese banking system.