Baosteel Closes Production Plant – The First of Many?

Finally, Chinese steelmakers may be facing up to reality and following their Western brethren in cutting capacity.

Reuters reports that China’s Baoshan Iron & Steel Co. (Baosteel), the country’s biggest listed steelmaker, said it has suspended production at a loss-making plant in Luojing district, Shanghai, in a sign of the intense pressure on the sector as steel prices trade near three-year lows.

To be fair, Luojing has a lot counting against it. The plant bought by Baosteel in 2008 for $2.22 billion was producing 3 million tons per year of steel plates used for shipbuilding, oil rigs and construction, but with sales falling, prices have collapsed.

In addition, the Loujing plant was costly to run because of its technology – the furnaces use the Corex smelting process of gasifying non-coking coal to produce pig iron.

Baosteel has been losing 100 million yuan per month at the plant, but others are expected to follow with Angang Steel also said to be under pressure. Baosteel posted a 53 percent drop in profits during the first half of this year with the second half not expected to be any better.

Meanwhile ArcelorMittal has formalized the permanent closure of two blast furnaces at Florange in northern France. The furnaces were originally idled in July and October 2011 amid falling sales and faced with high costs.

Faced with falling sales and overcapacity, China will likely face further closures over coming months. Bringing supply into balance with demand is the only way the industry will bring stability to prices and an improvement in margins.

As the global and domestic economies slowed this year, Chinese steelmakers continued to produce at or near capacity, maintaining high raw material imports and building finished steel inventory. With export markets even more depressed than the domestic market, this has built a sizeable inventory that will take until well into next year to work through.

Until then, the industry is saddled with $400 billion of debts built up during breakneck growth over the last decade – debt that was proving a drain on resources even under healthier margins.

Unfortunately steel producers are continuing to produce at near-full capacity, extending the timescale over which a recovery is possible. If more were to bite the bullet like Baosteel, some short-term pain could be followed by longer-term gain.

China’s steel demand is expected to continue to increase through to 2025, according to Standard Chartered, but the industry will go through a structural change with the product mix evolving to meet the rising demands of the manufacturing sector relative to the falling demand of the construction sector.

Seen in the light of the product mix and older technology, Baosteel’s closure of Loujing is consistent with this trend and is likely the first of many closures, both for them and other steelmakers.

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