Steel seems poised to keep on runnin’, keep on hidin’

So say the lyrics immortalized by Spencer Davis, which to some degree show what is wrong with the global steel market — it keeps on running and hiding from its overcapacity.

For global producers to return to 85% utilization rates, 170 million mt of global capacity has to disappear, according to Macquarie Research. To reach headier rates of 90% utilization rates, at which mills can make decent money, the equivalent of Western European and Japanese production (275 million mt) needs to exit the market.

China is the subject of much criticism in the steel market for its surplus production and rising exports, rightly or wrongly. Exports look set to surpass 100 million mt this year, and China is really the only country in the world that can cause a real supply-side squeeze as it represents half of global production.

China’s problems are perennially well-publicized these days: steel being cheaper than cabbage and all that jazz, yada yada yada. Given the rationalization we are seeing in other countries, such as the UK, the former titan and now minnow of the global market, such talk is very much the zeitgeist.

The China Iron & Steel Association and the government in Beijing say it is their job to address the country’s clear overcapacity and upgrade the industry. Indeed, as part of its transition to a consumer-led economy, Beijing, via banks, is deliberately throttling back credit to loss-making and oversupplied industries such as steel. Once the era of global cheap money ends, as seems to be the case in China, and with strong potential for US interest rate rises, the pain point will surely be tantalizingly close. Some companies have come close to breaching financial covenants of late. Once they are too indebted to make repayments on their financing, the game is well and truly up.

Somewhere out there, I think, exists the John Paulson of the ferrous world, shorting the trousers out of any company unfortunate enough to be producing or selling steel in today’s market. The short won’t only pertain to steel companies or derivatives, but builders, fabricators and the like, whole swathes of the supply chain.

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The signs are pretty clear — steel prices at multi-year lows; demand falling globally; raw materials prices tanking, not aided by booming supply moderating demand and the strength of the greenback and plummeting oil prices. Some would say current raw material costs in the steel industry are a mere function, or derivative, of oil price weakness.

Many people on the ground doubt the extent to which China can address its overcapacity.

Data seen by Platts suggests the worker/million ton of crude steel rate in China is around 2,000. Eliminating even 100 million mt, which would not be sufficient to properly normalize conditions, looks nigh on impossible. In a command economy, this wholesale job eradication would surely be tinder to the fire of social unrest.

While much of China’s production is centralized in Hebei province in the north, it isn’t all there. So CISA and Beijing are reliant on provincial governments — many of which are saddled with huge debts that will become more expensive as US interest rates rise (not to mention US dollar capital outflows, but that’s another story) — to eliminate outdated and uneconomic capacity.

Maybe there is light at the end of a dark and fairly scary tunnel, in the form of India. Modi’s reforms have really been a boon for domestic demand. And Indian mills — that don’t have assets in Europe — are sounding more upbeat these days. But there’s still bureaucratic red-tape aplenty to scythe through, and India isn’t likely to see urbanization to the extent China did.

Maybe, just maybe, many years down the line, parts of Africa will see urbanization and infrastructure spending that would really change the game. But you’d have to be a very big contrarian to be betting on that (if you can bet on that) right now.

Like they say, you can make the right trade at the wrong time and still lose your pants — as did some who foresaw the US housing market slowdown even before Paulson.