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China's supply-side reform roiling metals markets

Some commentators and participants still question the extent of China's supply-side reforms, but the effects — or the perception of the effects — are undoubtedly reverberating throughout the global steel and metals market right now.

China's net steel exports over January-July were down almost a third year on year at 40.16 million mt, aiding profitability for global producers.

The elimination of induction furnace capacity and government-mandated plans to halve blast furnace production at some mills in northern China during winter — alongside other factors such as a strong property sector — are also pushing the domestic market sharply higher. Hot rolled coil prices have increased $123.50/mt since the start of May, to be assessed at $546/mt FOB August 10, the highest level since early September 2013. Margins on hot rolled are galloping. Rebar prices also hit a four-year high of $535/mt FOB.

Steel stocks are stable at comparatively low levels despite increased production from the mills reporting to CISA, suggesting the increases are based on actual consumption.

China has even looked to import billet, a stark reversal from a few years ago when it was exporting "square bar" all over the globe at such competitive levels it displaced scrap charging to a large extent: Turkish mills booked 16.25 million mt of scrap imports in 2015, down almost 15% year on year as output via electric arc furnaces sagged 13.8%, culminating in a third year of lower crude steel production. Since then scrap has once again become a competitive alternative, and Turkish imports and output have recovered.

Other inputs to steel are also being affected by the reforms. Prices of graphite electrodes, used in electric arc furnace steelmaking and also ladle furnaces, are rocketing on curtailed supply, especially from China; its electrode exports will fall from around 200,000 mt last year to 100,000 in 2017, as a sharper focus on pollution constrains output. China’s production of needle coke, the key raw material for graphite electrodes, has also reduced markedly, according to producers.

There is also concern that supply-side reforms will hit the refractories sector, as China is a large producer of raw material used in the bricks, according to Turkish mill executives.

One bank's commodities research team told S&P Global Platts it was contemplating increasing its price forecasts for steel and raw materials given the bull-run and seeming lack of bearish factors, bar hefty port stocks of iron ore.

The impact of Xi Jinping's reform program has not just been confined to steel — aluminum and copper both topped two-and-half-year highs on the London Metal Exchange this week, supported by news of capacity cuts in China amid the pollution crackdown.

China's Shandong province, the largest aluminum region, said Tuesday it had ordered the closure of 3.2 million mt of unlicensed smelting capacity, and this was expected to be rolled out to other regions. Some steel mills in Tangshan will also be forced to cut blast furnace production up to 50% during winter.

"Many industrial furnaces, most of which are open to the atmosphere, will have to be shut and the worst of these may never reopen despite price rises in a number of industrial commodities," SP Angel said in a note this week referring to China's Environmental Protection Tax Law, due to start January 1.

"We expect China to order further cuts in capacity and production of a range of metals through the winter and to permanently close the worst polluters," it said.

There have been large speculative build-ups on both aluminum and copper in recent weeks, on both LME and COMEX, which point to heavy investor support for the rally.

Some consumers do not expect supply-demand to be affected by the Chinese smelter closures, as they are running around 85%, meaning there is sufficient idle capacity already. Chinese primary production also hit record highs in H1, and there is a stock build on SHFE, where prices hit a near five-year high in the week ending August 11.

Chinese aluminum stocks stand close to 1.4 million mt, up substantially from around 450,000 mt at the beginning of this year. And the actual production cut in aluminum for this year is estimated to be around 370,000 mt, accounting for 1.2% of national annual output last year, according to S&P Global Ratings.

"Today’s aluminum price reflects a future metal shortfall that is yet to emerge," Morgan Stanley research said in a note Thursday.

And CISA recently warned the steel price increase was overplayed. "The recent steel price surge is not through increased demand or decreased supply but just the exaggeration — or even misinterpretation — of a few matters such as excess steel capacity cuts, induction furnace stoppages and pollution control efforts," the association said on its social media account Thursday.

Given the current protectionist bent that seems to span the globe, it will be interesting to see how China's metal exports will be perceived in a few years' time. In the US, for example, there is not enough steel capacity to deliver upon the infra-build being promised by President Trump, should Section 232 be imposed, and the build go ahead.