China's 12th Five-Year Plan and What It Means for the Steel Industry – Part Two

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Continued from Part One.

So how does Beijing expect to achieve this consolidation, on which so much of the wider strategy depends?

One tactic is apparently to guide provinces to close the following: blast furnaces of less than 400 cubic meters, converters and electric arc furnaces of less than 30 tons, HR strip mills of less than 1,450-mm (57) width, HDG coil mills of less than 300,000 tons per year and color-coated sheet mills of less than 200,000 tons per year.

The Chinese way will be for smaller players in this category to scrap the old mills and build bigger new ones, so restricting access to investment credit will also have to be part of the coercion. Not that any reduction in the overall level of steel demand is envisaged; the new plan expects the steel sector to continue to grow by 5-6 percent per year, but the growth will come overwhelmingly from the larger producers.

Although not a specific government target, it is also hoped producers will become more profitable. Margins for China’s 77 largest steel companies have apparently declined from 8 percent, seen in the 2001 to 2005 period, to below 3 percent last year. Apart from the competition of over-capacity, many believe the biggest culprit to be the industry’s inability to control input costs.

China imports over 60 percent of iron ore consumed, mostly from the big three of Rio, BHP and Vale. China would like to reduce this to 45 percent by 2015 via the rigorous development of domestic sources, but this may prove challenging as ore grades are of poorer quality and imported material generally proves a lower cost per ton of steel produced.

Despite being the world’s largest buyer, China has been very frustrated by its inability to control the cost of imported ore, a situation CISA perceives as not helped by the small and medium-size steel producers breaking ranks and doing their own thing. Consolidation is therefore seen as a way of regaining buy-side control and countering the major iron ore suppliers’ dominant position.

The new plan contains much to commend it. A much greater emphasis on the industry’s environmental impact will be a good development for both current and future generations. The intent to bring structure to a chaotic industry is to be welcomed, not least if it reduces over-investment in new capacity. As we would expect, the plan is positive and confident about the future of Chinese demand, but it also paints a picture of a behemoth; as consolidation gathers pace, the top ten producers will probably outstrip just about every other producer in the world except for ArcelorMittal — China has four of the top five producers already, and nine of the top 20.

By the middle of this decade, Chinese steel producers will out-gun just about every other Asian or Western mill when competing for raw materials and potentially in export markets. Let’s hope Chinese demand holds up; we would hate to see a significant share of that capacity turn up on the global stage.

–Stuart Burns

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