As if the social cost of the coronavirus Covid-19 were not bad enough, some sectors of China’s industrial economy are suffering growing pain despite a supposed return to work last week.
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The property sector, which accounts for about 40% of China’s steel consumption, is stagnant, a Reuters report states, while other steel-consuming industries are likely to be operating far below full capacity.
Nonetheless, steel mills have continued to produce product through January and February, such that mill and trader inventories are overflowing.
Steel stocks held by Chinese traders hit 23.74 million metric tons as of Feb. 27, the highest level since at least May 2006, Reuters reported, quoting data compiled by consultancy Mysteel.
Meanwhile, an SPG Global report suggests total inventories across the supply chain were expected to have reached around 60 million tons in late February — three times as high as normal levels for the time of year.
Not surprisingly, this is putting immense strain on cash flow, particularly among traders and distributors who typically have to pay cash for metal and then have to finance stocks until they are sold.
Traders face a double whammy of financing record stocks as sales prices ease, squeezing margins and causing difficulty for some.
The question is: when will steel mills start to reduce output?
Demand is not expected to pick up fast enough to soak up the massive inventory build.
Only around 30% of real estate projects and 40% of infrastructure projects have resumed work, according to Argus Media, suggesting demand is not going to come to the rescue. Mills are already being squeezed by rising raw material costs and falling sales prices in an environment that has seen falling capacity utilization from late last year.
Raw material prices have risen. Coking coal prices are up nearly $30/ton to about $170/ton as Mongolia halted shipments last month. Iron ore prices have remained robust following supply disruptions from Brazil and Australia.
Yet, finished steel sales prices have been falling — and with them, mill margins.
Blast furnace-based steel mills’ average gross profit margin for rebar sales was around 100-200 yuan/t ($14-29) compared with 500-700 yuan/t in late November, according to Argus. Gross profit margins for hot-rolled coil fell to 100 yuan/t from 400 yuan/t in November.
Some mills have pulled forward maintenance to slow production, while a few others have reduced output.
In the case of Dazhou Iron & Steel (Dagang), an integrated long steel producer in Sichuan province in southeast China with a crude steel capacity of 3.2 million tons per year, it suspended all of its iron and steel production, according to Reuters. “Frozen end-user demand has led to soaring finished steel inventories and brought great pressure on our cash flow,” the paper quoted an unnamed mill source as saying. Quoting official channels, Reuters adds Dagang has built up around 140,000 tons of finished steel inventories, creating a crippling capital requirement of nearly 500 million yuan ($71.5 million).
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Producers have been hoping for the promised bounce back, but it has become apparent that it isn’t going to happen in the short term. April is cited as the beginning of a return to some degree of normality, providing there isn’t a resurgence of Covid-19 infection rates (now that travel restrictions have been lifted).
Meanwhile, the temptation to cut prices to shift inventory will build, potentially setting producers and traders up for significant losses.