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China Commodities Watch: Steel Mills Move House

Highlights

China's steel-mill relocations should enhance industry clustering and logistics.

Large capex requirements will force some mills to sell out or merge, increasing market concentration.

Relocations will focus more on upgrading output than reducing capacity.

Jul. 16 2019 — Chinese steel mills are relocating to reduce urban pollution and improve industrial clustering. S&P Global Ratings anticipates the process will help streamline the industry and boost efficiency. The cost of moving house could put strain on some steel companies' financials, however this should further the consolidation trend in the country's steel sector.

Led by China's top steel-producing provinces--Hebei, Shandong and Jiangsu--many regions have announced relocation plans for steel mills within their reign. Since late 2017, announced plans amount to at least 100 million tons per annum (mtpa) covering various cities in different provinces, or about 10% of national total capacity.

Relocating steel mills will help but not complete reform guidelines set by state planners. Under a plan devised by the Ministry of Industry and Information Technology (MIIT), the overriding targets to be reached by 2025 are: (1) structural adjustments with reduced capacity; (2) increased market concentration led by several large groups; (3) improved efficiency and profitability.

Clustering Takes Precedence Over Reducing Capacity

In our view, the key objective of relocation is to improve logistics and geographic layout by moving facilities out of populated cities and clustering them in coastal areas near ports. These objectives take precedence at this juncture because other goals, such as de-capacity, are already ahead of schedule. China has reduced crude steel capacity by 150 mtpa since 2016, according to China Iron and Steel Association. This exceeds timeline targets set by the MIIT's planning targets of reducing 100-150 mtpa by 2020 (see chart 1).

We also believe that urban pollution is no longer the headline issue for relocation. Steel production is less polluting than in the past, due to large investments into monitoring and controlling pollution. Whether located in urban areas or elsewhere, the mills still need to meet new, tighter emissions standards.

Mills will focus on improving logistics and location by moving from inland to coastal areas. In our view, coastal areas have geographic advantages due to the China steel sector's heavy reliance on imported iron ore. We note that many steel mills have started to expand their presence near deep-water ports that can berth large ore carriers from Australia and Brazil. These include Qingdao Port and Rizhao Port in Shandong province; Caofeidian Port and Jingtang Port in Hebei; and Zhanjiang Port in Guangdong.

We also see moves to industrial parks, which facilitates consolidation and industry clustery. Shandong province recently announced a plan to consolidate steel capacity spread over 12 cities to the coastal regions of Rizhao-Linyi and to inland industrial parks around Laiwu-Taizhou by 2023. Jiangsu province has designated a range of coastal industrial parks to harbor steel capacity relocated from other cities. These moves are influential because Jiangsu and Shandong produced 106 and 74 million tons of crude steel in 2018, ranking the second and third after Hebei, accounting for 11% and 8% of the national total, respectively.

We believe the Chinese government will try to prevent steel mills from increasing capacity in the name of relocation. Still mills are supposed to adhere to the principle of "replacement at reduced capacity," usually 80% of original capacity. We note however that overall steel capacity began creeping up again in 2018, and that China's crude steel output set a record in 2018 and again in the first half of 2019. There seems to be no clear penalty for building more capacity, and good profitability could boost tax income for local governments, encouraging them to loosen their grips. Crude steel capacity is estimated to reach 1,150-1,200 mtpa by end of 2019, according to S&P Global Platts. 

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