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China's steel cuts are a market-moving mirage: Analytics

Highlights

China's plan to cut steel output in 2021 showing few signs of success

Iron ore prices are soaring on the back of elevated steel prices

But demand could start to falter in H2 as downstream segments soften

Melbourne — The Chinese government's efforts to get on top of crude steel production in 2021 appear to be bearing little fruit. Despite the capacity utilization reductions in Tangshan in Hebei province, and in other cities and regions, crude steel production jumped almost 20% year on year in March to 94 million mt. This took January-March output to 271.04 million mt, up 16% from Q1 last year. Further, April output has started strongly, rising 13% on year over April 1-10, according to the China Iron & Steel Association.

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S&P Global Platts Analytics forecasts that China's crude steel production will rise by 2% this year. Expectations were that last year's incredibly strong year for output -- which rose 5.2% year on year -- was unlikely to be repeated, and that downstream demand in a tighter credit environment would not justify so much production. Beijing's plans outlined at the start of 2021 to reduce steel output in a bid to lower carbon emissions – and the subsequent cuts in Tangshan from early March – seemed to endorse that view. However, Q1 results and current trends indicate that a 2% increase could be a conservative forecast.

The challenge for the Chinese government is getting mills to lower production when they are enjoying extremely healthy profit margins, notwithstanding high raw materials prices. Platts Analytics data shows that domestic Chinese hot-rolled coil margins were in the high $140s/mt range in the second week of April, while rebar margins hit a two-year high in the month, peaking at $130/mt mid-April.

Mills ramp up output while prices are high

Elevated steel price and margin levels have incentivized mills unaffected by reduction cuts to lift their utilization rates, thereby more than offsetting any losses.

HRC prices have risen by Yuan 1,000/mt ($154/mt) since the start of 2021 to Yuan 5,500/mt ($847/mt) on April 15. Domestic rebar prices rose 27% over the same period to Yuan 5,255/mt.

The Tangshan cuts were priced in and the market may look at the output data and realize fears of steel supply shortages were unfounded. Steel inventories have softened slightly since late March but are higher than at the start of the year. Stocks of hot-rolled products in major cities stood at 3.57 million mt April 15, up from around 2 million mt at the turn of the year, according to CEIC data.

Iron ore prices softened in the wake of the Tangshan cut announcements on the basis there would be less demand for raw materials. But this was short-lived, and iron ore prices are now fully aligned to higher finished steel prices. On April 20, the 62% (IODEX) benchmark hit a year-to-date high of $187.75/mt CFR China. Weak Q1 iron ore exports from Australia and Brazil indicate supply tightness will prevail this year, keeping prices well above consensus forecasts.

Downstream demand could start to wane

However, steel prices and margins could come under pressure from around mid-year if the recovery in China's key domestic steel consumption sectors, such as property and manufacturing, starts to falter.

China's floor space (housing) starts were up around 7% on year in March, while sales were up 38%, indicating a sell-off of properties as developers tried to generate cash amid tighter credit conditions. Overall, property in Q1 was weaker than in Q1 2019 (a better comparison than with virus-impacted 2020), and housing inventories in smaller cities have started to soar. Manufacturing investment was also weaker than in 2019, though infrastructure in March increased 11% from the same period of 2019, generating decent steel demand.

A recovering global manufacturing sector could dent demand for China's exports, while a crackdown on shadow banking may make it harder for provincial governments to move forward on infrastructure projects. Manufacturers are also struggling to pass on the full extent of rising steel input costs and may start to show resistance to higher prices. Unlike in the US, Europe and India, where a lack of spot availability means buyers have no choice but to pay higher prices, strong steel output in China means supply is not a pressing issue.

Platts Analytics projects China's GDP will expand by 8% in 2021; after 2.3% growth in 2020, the average annual growth in 2020-2021 is expected to be around 5%. However, Q1 macro data shows coronavirus still has the potential to disrupt growth momentum, and the deployment of vaccines will have to progress further before China's economy will be able to return to normal.