Calm after the storm in ferrous markets?

The past three years have witnessed incredible volatility in global ferrous markets due to the pandemic and its impact on economic growth, compounded by the Russian invasion of Ukraine. Steel end-users in Europe and the US are battling inflationary pressures and a lack of demand, while China's growth engine has stalled. Will things get worse before they get better in 2023, or are there reasons for optimism?

Forecasting is challenging enough at the best of times – and these certainly aren't the best of times.

Just as much of the world was starting to return to a semblance of normality after two-years of COVID-related lockdowns, Russia invaded Ukraine. All the well-researched, erudite market outlook pieces written for 2022 were out of date by Feb. 24. So, in a world where "black swans" seem to land with increasing regularity, let's look ahead to 2023.

A good place to start, and where there is perhaps a bit more certainty, is China. As expected, this year, the Chinese government endorsed President Xi Jinping as leader for a further five years. In December, the government surprised many by moving away from its strict zero-COVID policy, which saw cities locked down based on relatively few cases. Cases subsequently surged and some schooling moved back online.

Earlier this year, extended lockdowns in key manufacturing hubs and cities, most notably Shanghai, meant the usually strong Spring second quarter was a non-event. This was followed by a severe heat wave which saw electricity in parts of the country prioritized for consumers at the expense of steelmakers and other industrial producers. With the winter slowdown underway, 2022 is the year that never got going.

Analysts at S&P Global Commodity Insights expect the Chinese government to maintain its policy of keeping a tight rein on industrial output in 2023 and think crude steel production will fall by around 1.5% compared with 2022. Importantly, we do not expect China to reverse its approach to the deleveraging the country's housing sector, having squeezed developer financing over the past two years.

S&P Global Ratings thinks China's house sales will fall by 28%-33% this year, before a potentially "L-shaped" recovery of 3% growth in 2023. But the endless lockdowns and falling house prices have severely undermined sentiment in the property market. Chinese homebuyers are highly leveraged, and the job situation is fragile. Almost 20% of 16- to 24-year-olds are unemployed.

Property stimulus has lost its impact

S&P Global analysts expect that there will be little positive traction even if the Chinese government were to try and stimulate housing again. This means that a longtime "tried-and-trusted" growth engine for steel and raw materials demand may no longer exist to the same extent as previously. S&P Global estimates steel consumption from the property sector will fall by up to 8% in 2022 and expect another decrease next year.

Our latest quarterly China Steel & Iron Ore Market View, found that 53% of respondents expected government stimulus in infrastructure to drive steel demand in the October-December quarter. It's true that China is lifting investment in infrastructure, but growth in the sector is unlikely to offset falling demand in housing and manufacturing.

On the upside, strong pent-up demand could flow through to steel and other metals prices if COVID outbreaks and subsequent lockdowns can be controlled. Knowing how transmissible the Omicron variant is, however, means it is a big "if." Overall, S&P Global analysts think Chinese finished steel prices next year will be at a similar level to the second half of 2022, with potentially a stronger second calendar quarter. Construction steel will perform better than coil used in manufacturing.

While China is still trying to control COVID outbreaks, other countries, and regions, such as Europe and the US, are dealing with the after-effects of the pandemic: inflation, rising interest rates, worker shortages, and logistical constraints. What they all share is a palpable lack of end-user demand.

At the start of 2022, there was optimism that the semiconductor shortage would ease and demand from auto makers would rebound. That led to steel restocking in Northern Europe, which was added to when Russia invaded Ukraine as buyers feared supply shortages. Record high prices for hot-rolled coil in March preceded a huge crash, though market prices remain well above pre-pandemic levels. It is higher input costs, especially for energy, and some steel production cuts, that are largely supporting finished steel price levels.

Demand side of the equation needs to recover

S&P Global's manufacturing purchasing managers' indices found that manufacturing in both Europe and the US has fallen to a two-year low. New orders and production have been receding, while work backlogs and delivery times have been lengthening. Uncertainty, bearish sentiment, and a lack of market direction, are the prevailing moods of the moment. The higher dollar has stymied export demand for manufactured goods from the US.

Most economists, including S&P Global, have US and EU growth decelerating in 2023. Muted downstream demand for steel and wafer-thin mill margins are likely to result in deeper production cuts. The question then is where the steel price support level is. It is very difficult to call when the demand side of the equation is so weak, but it could be closer to early 2020 rather than current levels.

Turning to steelmaking raw materials, S&P Global analysts believe the 62% Fe Platts iron ore benchmark will average around $100/mt CFR China in 2023. There will be some additional tons out of Australia as new mines at BHP, Rio Tinto and Fortescue Metals Group ramp up production. But the demand side will be muted on softer Chinese steel production.

Coking coal markets could see trade flows shift back to where they were before the unofficial Chinese ban on Australian coal imports if the restrictions are overturned. Around a third of market participants believe imports will resume, according to our Market View survey, and the two governments appear to be speaking at a ministerial level again.

India will become a larger importer of coking coal as it lifts steel capacity, whereas Japan is reducing blast furnace production, while South Korea will be largely stable.

Everyone is hoping there will be no more nasty surprises in 2023 and markets will continue dealing with the current range of challenges.

A version of this article was first published in the October 2022 edition of Commodity Insights magazine