China

The great and good (and the not so good) will meet in Davos this month and no doubt we will hear various proclamations both before and during that event so we at MetalMiner thought we would get in early with details of the World Economic Forum’s Global Risk Report because it contains some interesting issues regarding the risks the global economy faces in the year ahead that may be preoccupying attendees minds.

As an article in the FT explains, the report has been successful in identifying the big risks in the past few years, having flagged up in 2006-2008 issues such as asset-price overvaluations, consumer over-indebtedness, oil and food price jumps and the destabilizing effects of the US current account deficit. Unfortunately it pointedly avoids saying when these risks will manifest themselves as a crisis which is a bit like saying one day it will rain, I just can’t say when. However China is highlighted as one of the biggest concerns in this year’s report, partly because of the way it has responded to the global financial crisis and partly because it is one of the only risks yet to be realized from those consistently identified in the report’s five-year history i.e. all the others have happened but this one hasn’t so it’s only a matter of time is how the theory appears to go. The report says the chances of a serious economic slowdown in China are above 20% and would lead to economic losses of between $250bn and $1,000bn. In total of course the repercussions would be greater than this because of the country’s central role in funding developed country deficits and consuming the majority of exports from its south-east Asian neighbors whose economies would catch a cold if China sneezed.

Of particular concern was high credit growth in China which the report suggested risked mimicking the asset price bubbles and unbalanced growth of the west before the crisis. Commercial lending by Chinese banks grew more than 45% between July 2008 and July 2009, according to data from Swiss Re in the article. To their credit, the Chinese government appears to recognize this risk and is taking steps to reign in further lending.

The other major concern, equally earning a >20% probability of occurrence is asset price collapse in addition to or beyond the asset price destruction we have already seen in western property, commodity and equity values.

Not surprisingly a fiscal crisis is ranked about third in terms of a combination of financial impact and probability of occurrence. Daniel Hofmann, group chief economist at Zurich Financial Services, the global insurance group said that the risks of fiscal crises faced by western countries particularly were not based mainly on “exploding budget deficits but about the current models for health, education and unemployment protection, which in the US and UK especially “are clearly not sustainable. Interestingly he did not mention Japan in that reference yet in a Telegraph article, Japan’s dire financial position was examined in scary detail last week. With the population in outright demographic decline since 2005, the IMF says Japan’s gross public debt will reach 227% of GDP this year. This is compounding at ever faster speeds towards 250% by mid-decade. Yet every year there are less and less taxpayers to fund the government debts while the savings rate will soon crash below zero. The only reason why this has not yet blown up is because investors (mostly Japanese) have not yet had the leap in imagination required to understand their predicament, and act on it says the article. If the analysis is anywhere near correct the risk of another financial crisis is most acute in Japan, and don’t forget they currently hold $750bn or 10% of the entire stock of US Treasury debt, as well as a lot of UK Gilts and Belgian bonds. What will they do with those if they get short of cash?

–Stuart Burns

So how does a finished goods manufacturer go about understanding the carbon footprint of their product? Well it isn’t easy is the simple answer. The question is where do you stop? Let’s take the toothbrush. We all love cars but the toothbrush has fewer parts and this will be complicated enough as it is. There are a number of components and metals involved – the plastic molding including the removable head, the rechargeable battery pack composed of nickel cadmium, a small amount of copper wiring for the inductive coil, motor and circuitry, and a central steel pin connecting the body to the brush head. To understand the carbon content a company should drill the whole way down the supply chain to the source of the ore from the ground. Of course the primary smelter will probably have purchased ore from several sources and so the average of those sources would have to be ascertained. Transport, energy and manufacturing energy inputs would have to be collated, averaged and a per lb or per ton figures developed for each of the metals in each of the components sound impractical? The reality is it is already happening, a whole industry is springing up with tools and technologies some better than others to measure and monitor the carbon footprint of materials in the supply chain. To play the game, the manufacturer doesn’t have to measure the carbon footprint of all the materials all the way back to source even if he did what would it prove, unless all his competitors were doing the same thing he would have nothing to compare it against. A simpler and no less effective message is to take one key component, the plastic maybe or the copper, or in the case of the car the steel, and illustrate that the combined carbon input for that product is the lowest in the industry or has been actively managed and reduced over time.

The impact could be quite profound for metals manufacturers. It is entirely possible such a differentiation would give manufacturers of metal products from scrap a distinct advantage over those working from primary ore, or those producers consuming iron ore from domestic sources could have advantages over those importing from the other side of the world, or finished goods manufacturers using domestically sourced components could have advantages over those importing components from say China. Trade bodies may see a need to collaboratively work with their members to measure and manage the carbon footprint of the industry as a non tariff barrier against imported goods and materials.

Marketing has always been about the need to sell on more than price. The environment is for many a cost blind or at least cost normalizing factor in making purchase decisions, meaning many buyers are willing to pay more for environmentally friendlier products. Those metals manufacturers that grasp the challenge of measuring and selling on the strength of their carbon footprint will be the early adopters and steal a march on the competition, if they have the vision to see it.

–Stuart Burns

We may, as this decade unfolds, find out. The internal combustion engine is far from dead. In fact, the competition of alternative propulsion systems and the spur of higher fuel costs has created a quiet revolution in engine design and economy. New diesel and even petrol engines are coming onto the market with fuel economy figures that would have been considered phenomenal just ten years ago. And not just fuel economy, levels of refinement in modern diesel engines and small four cylinder petrol engines are the equivalent of smooth six or eight cylinder engines of the late 90’s.

The industry has yet to decide where it is heading. Some 2.2 million Prius Hybrids have been built since their launch by Toyota in 1997 and the trend is rising (with the exception of last year’s recession inducing contraction in the US market). Toyota sold nearly 473,000 hybrid cars globally in the January to November period last year so while numbers are currently small compared to regular autos the numbers are rising fast according to the FT. But while some other majors like Ford, GM and Honda have all brought out their own hybrid cars with mixed reviews the question remains how big will this market become when the primary objective of greater fuel efficiency in large part calculated on gas per mile is constantly being raised by conventional engine design?

Some car manufacturers are by-passing the hybrid model and going straight into electric vehicles. Renault has cut back on research and development spending in the face of the industry crisis but they have continued to invest in all electric vehicles. In China, manufacturers are coming at it from the other end of the supply chain. Battery manufacturer BYD makes both plug in hybrids and all electric vehicles and may launch a car in the US this year with superior electric range to the GM Volt. In China they already sell a plug in hybrid for half the price of a Volt and while a few years ago Chinese cars would have been considered a joke in the US from a quality standpoint standards are now rising fast. The move to electric vehicles is also making car makers re-think their whole approach to the market, driving some unusual alliances. Because their fixed costs are considerably higher than those of traditional vehicles while their running costs are significantly lower, Renault believes electric vehicles will be leased rather than sold and battery supply could be part of that lease package possibly in a four way relationship between car maker, battery supplier, user and finance organization. And where finance is often provided for traditional vehicles by a purely financial company, we may see the entrance of different types of companies into the electric vehicle market. Renault for example is forging links with EDF, the French state owned energy group, in what could be a whole new market for both energy suppliers and other businesses with shared interests. McDonald’s for example could install charging points at its restaurants and sell power at the same time it sells Big Macs.

Of course widespread adoption of electric vehicles is still a long way off, if it will ever happen. Many car makers, including Toyota, believe electric vehicles will only ever be small urban commuter vehicles. Nevertheless the company is investing in next generation Lithium ion battery technology for its next generation of Prius hybrids due in 2012. Working with Panasonic, Toyota has 50 engineers working solely on battery technologies in recognition that the key to both hybrids and all electric vehicles is the range and power provided by the battery.

–Stuart Burns

BHP should be a good stock buy in spite of the strength of the mining sector and stock gains it has made last year. If you thought last year’s iron ore negotiations were protracted and in the end rather acrimonious they will be nothing to this year. For a start China can’t get its act together as to who will represent them. Officially Baosteel is taking back the mantle from CISA who made such a mess of it last year. In practice they have yet to engage the big three BHP, Vale and Rio, in discussions and risk being left behind by more fleet of foot Asian and European mills keen to settle their contract prices for the year ahead before the spot price goes any higher. According to the Financial Times, since the 1960’s, representatives of the world’s largest mining companies have held secretive negotiations to set prices for contracts with the big steel producers. Traditionally, the first deal between a miner and a major steelmaker set a “benchmark which was followed by the rest of the industry.

What’s the big deal this year and why should the rest of us worry you may ask? Well the big deal is that 95% of all the metal used in the world is steel and steel is made from iron ore. Iron ore is the world’s second largest commodity market by value, after crude oil, so it represents billions of dollars by value and just about everything metallic we come into contact with contains some (if it is not wholly made from) steel. So the price of the raw materials is a pretty big deal for the global economy and for us as individuals and businesses. Why is it a big deal this year? Well for the much of the last decade the iron ore market has been in rapid transition. Back in 2000, iron ore was mined and consumed in a more diverse fashion but as China’s demand has risen the country has come to dominate representing 52% of the buying market and importing three times more than Europe the next closest trading block. At the same time, the supply side has consolidated, invested and grown such that now just three producers Vale (240mt) Rio Tinto (188mt) and BHP Billiton (138mt) dominate the seaborne trade market of 849 million metric tons (2008 figures from the Financial Times). Read more

Yesterday I had an opportunity to talk metals with Tracy Brynes and Chris Cotter on FoxBusiness.com. Back in my broadcast journalism days (well, that was one of my college majors if truth be told), every comment and every item was heavily scripted. Today, these internet interviews are a bit more refreshing as you have longer than 10 seconds to make a point. Of course no metal discussion would be complete without talking about the headliners: steel, copper, China, gold and of course rhodium.

Rhodium you may ask? Well, we have spent a good part of 2009 tracking various rare earth metals so rather than talk about neodymium (my other rare earth metal option for this year or lithium), I thought we’d give the low down on Rhodium.  The interview runs about 6 minutes. I’d welcome your feedback:

In the coming weeks, MetalMiner will be rolling out two versions of price predictions. We’ll cover the high level directional trends on the blog and then integrate detailed price forecasts including data from our own proprietary MetalMiner IndX(SM) and specific sourcing strategies via a premium content section.

If you have a metal you would like to see covered, drop us a line at info (at) agmetalminer (dot) com.

–Lisa Reisman

China looks like it will be going through its own kind of post cash for clunkers hangover in 2010 that Europe and the US has experienced in the 4th quarter of 2009. Sales surged in 2009 by an average of 40% to some 13.6 million cars and trucks boosted by a halving of the tax on vehicles with engine sizes less than 1.6 liters. Sales of car with sub 1.6 liter engines made up 85% of the growth in the overall vehicle market according to the China Association of Automobile Manufacturers quoted in Bloomberg. But such sales growth cannot continue forever and the government’s plans to withdraw the stimulus have already had a profound effect on projections for 2010. Miao Wei, vice minister of industry and information technology said China’s vehicle sales growth may slow to 15% this year although some analysts are forecasting even lower growth of 5-6% according to Marketwatch.

SAIC Motor Corp’s. stock price, China’s biggest automaker, has tumbled 12% this year, (after the stock more than quadrupled in 2009) when the car-maker forecast an increase for 2010 of less than 15% in industry wide sales this year. Ford seems to agree. After seeing sales at their passenger vehicle joint venture, Changan Ford Mazda Automobile Co., rise 55% to 315,791 units in 2009 and sales at their commercial vehicle joint venture, Jiangling Motors Corp., total 114,688 units, a 21% rise in 2009, Ford is only predicting an industry-wide rise of 10% according to Nigel Harris, general manager of Changan Ford Mazda. Even so, Ford is predicting their share of the market will rise and following the introduction of new models is predicting double digit growth for the company in 2010.

Growth of 5 to 15% depending on who turns out to be correct is still respectable for what should remain the largest auto market in the world. At 10.6 million in the US and 13.6 million in China, growth in both markets of this magnitude will only increase the gulf between them. Good news for GM and Ford’s Chinese subsidiaries but let’s hope the phenomenal growth in sales during 2009 hasn’t spurred excessive investment in domestic component suppliers. Such dramatic swings in growth have lead in the past to over-investment in other industries. After such a surge in growth and filled with confidence for the future the last thing the Chinese auto industry needs is to follow so many other Chinese industry segments into over investment.

–Stuart Burns

Though we spend quite a bit of time discussing semi-finished metals and raw materials, we like to keep tabs on what happens further down the supply chain. In a recent article from Chaina Online, (yes, I spelled it correctly), Monica Liau uncovers a growing problem with key part shortages in China particularly for the automotive and graphics processing industries. Liau quotes several individuals who have their own theories as to why the part shortages exist, despite sluggish demand.

The first reason for part shortages relates to, “The deliberate compromise on quality of service and high focus on cost reduction, according to a supply chain director based in India. Capacity cutbacks and staff layoffs made sense in order to keep businesses afloat but this limited the suppliers’ ability to quickly respond to orders. Cost reduction, which often goes hand in hand with restructuring meant less people available to fill fast turnaround orders.

Another main reason for part shortages involves the move toward more “leaner sourcing practices. Buying organizations have shifted their buying from less frequent larger orders to more frequent smaller orders. Though a good practice from the buyer’s perspective, without a means of sharing forecasting and demand data, Lean Sourcing â„¢ can create uncertainty in the supply base. Perhaps the most controversial reason for part shortages accuses the larger companies based in Europe, the US and Japan of squeezing margins so much that overseas suppliers internally debate as to whether or not they want to take the business at all. One CEO of a parts supplier doesn’t even believe there is a part shortage at all but believes Asian suppliers have become much more cautious because of the margin squeeze.

Defining market equilibrium in which just enough capacity comes on stream to meet demand remains challenging in a volatile economic environment. And though many of the economic indicators look quite positive, we think buying organizations will remain cautious with their purchases so as not to create too much inventory. A bumpy economic recovery that moves in fits and starts will likely continue for the next 12-18 months so expect supply constraints along the way. From a metals perspective, we expect producers will continue to watch demand so as to manage capacity coming on stream. The steel industry in particular, has learned that lesson the hard way.

–Lisa Reisman

What the global steel industry has gone through over the last 18 months is nothing to what it will go through over the next five years. To say the turmoil of the last 18 months has been good for the steel industry sounds ridiculous when the hardships it has created among steel communities and the losses in share values for investors is taken into account, but it has acted as a catalyst to hasten changes that otherwise would have taken the next decade to achieve. Increasingly, steel will only be made in high cost locations like North America or Western Europe by the most efficient of producers. The last 12 months has seen plants that were idled in late 2008 closed permanently by steel companies who have come to the realization that new investment should be focused on where the new demand is coming from. ArcelorMittal, the world’s largest steel producer and arguably one of the most dynamic in terms of its strategic thinking and long term ambitions has just permanently closed plants in Lackawana, N.Y. and Hennepin, IL while shifting investments to Brazil, India and eastern Europe. Arcelor sees growth in the next decade coming from these markets.  Demand in India alone is growing at 9%, with the prospect of yet higher growth in the years ahead as long term infrastructure investments are rolled out. The steel company is planning to team up with the iron ore producer Vale in a US$5bn steel mill investment as its sees long term growth in Brazil as a better bet than established western markets. Both Arcelor and the India home grown steel giants like Tata are increasingly focusing investment decisions on the  domestic Indian  market rather than looking to take on more old world producers. Indeed old world facilities like Corus’ Teeside steel plant in the UK had closed in early December as applications for new plants in India were being submitted.

Not all emerging markets make solid investments though. China has benefited if that is the right word from massive state supported investment in their steel industry during the current decade. Business Standard reported China is now sitting on steel capacity of 610 million tons and will be commissioning another 50 million tons next year. A spokesperson for China Iron & Steel Association said at a recent conference in Beijing that the country would end the year with production of 565 million tons of crude steel. That will be a lot more than China’s domestic requirements, and because of the fragmented nature of China’s steel industry, difficult to control. This and a desire to clean up more polluting and less efficient steel plants is leading to ever more strident attempts by the authorities to effect in China what is happening elsewhere in the world namely the consolidation of production under a small number of ever larger steel companies. The Chinese Ministry of Industry and Information Technology (MIIT) published details of a new scheme this month for the restructuring and upgrading of raw-material industries in central China in the 2010-2011 period. The scheme is to cover nonferrous metals, steel, building materials, coal and chemical industries. The program requires forming several “super-large-scale and “large-scale enterprises in central China through mergers and acquisitions. MIIT is to encourage Wuhan Iron and Steel Corp., the parent company of Wu Steel to acquire the production capacities of smaller rivals in the central areas of China and Ma Steel, Taiyuan Iron & Steel Co., and Hunan VALIN are also encouraged to conduct mergers and to acquire smaller rivals to form one or two super sized steel companies able to operate on the world stage. As with Arcelor’s long term investment plans, the convulsions of the last 12-18 months have driven steel mills everywhere to look much more aggressively at where the growth in the coming decade is going to come from and divert investments to those markets at the expense of the old.

–Stuart Burns

Last Wednesday, the US ITC (International Trade Commission) in a 6-0 vote, ruled against Chinese OCTG producers and exporters slapping a 10.5% – 16% countervailing duty on this category of imports starting mid-month. On April 1, the anti-dumping portion of the case will also come up for a vote. Preliminary duties of 96% have already gone into effect. Whether the economy or the trade case has caused the steep drop in OCTG imports, we don’t know but check out this link from Panjiva to see the steep drop in OCTG imports.

The case has created strong opinions (arguments?) both pro and con. Here is a quote from a recent Washington Post article, suggesting that China, “asserted that the global economic slowdown was the real reason for lower demand for U.S.-made steel pipe. Personally, I think that argument is hogwash. Though the end result of this case will be an increase in price for US buyers, the reality is that China has a distorted export tax and VAT scheme which incents Chinese producers to over-produce these products and export them to the US. The second factor leading to the flood of imports involves an undervalued RMB. Both create the net effect of making Chinese goods much cheaper then they would have otherwise been. We have written about both of these points previously here and here, among many other posts.

Many will claim this case as an example of protectionist US trade policies. And ordinarily, we might concur but the facts of this case suggest the ITC made a good decision. Let’s look at this a bit differently shall we?

As a buying organization, we all want to see maximum price competition and therefore would advocate policies that support imports. But if the US allows a flood of OCTG imports (which it did¦the case at $2.8b represents the largest trade case ever and the trade case documentation along with Panjiva data all show massive imports of OCTG), the downward price pressure could force domestic producers to shut down lines (we should add that OCTG has a lengthy supply chain including iron ore and coking coal producers to flat rolled steel producers who produce for this end application) and in some cases, shut down those lines permanently which would ultimately result in higher prices for domestic manufacturers. A buying industry such as oil and gas always has an interest in trying to preserve as many supply options as possible, despite aggregating company specific demand with fewer suppliers to achieve price leverage.

Let’s borrow an example from the world of rare earth metals. Once upon a time, the US produced neodymium and had a supply chain that could process, refine and make neodymium into magnets. But that part of the market went by way of China as they (the Chinese) undercut US producers and flooded the market with their magnets. The domestic neodymium industry also lacked the powerhouse lobbying organizations of the domestic steel industry. Today, to my knowledge, only 1-2 neodymium players exist in the US. Buying organizations around the country all rely on Chinese producers. It would be a tragedy for the US oil and gas industry to have to depend upon China OCTG because we killed our own domestic industry.

Does this case represent a good decision on the part of the ITC? I don’t buy the steel industry’s arguments in every case but I do on this one. Buying organizations what do you think?

–Lisa Reisman

China’s relentless growth continues and looks set to push the country from being the number three economy in the world, overtaking Japan to take second place behind the US. China’s National Bureau of Statistics has upgraded the 2008 figure to $4.6 trillion and with growth generally acknowledged as more than 9% for 2009 and while Japan contracts, that should put China above Japan in 2010. According to the World Bank, Japan’s annual output was the equivalent of $4.9 trillion last year, but it is expected to shrink by 6.6% this year said a post in the Telegraph newspaper.

“The big underlying factor propelling China’s growth is the continued migration of people from the agricultural sector to the more modern economy — industry and services,” said David Cohen, an economist at Action Economics in Singapore reported in the Washington Post. In the longer term that is no doubt correct but in the short term growth has been fueled by a massive stimulus program both in terms of infrastructure investment and bank lending estimated to have doubled from a year ago and dangerously set to continue. According to another Telegraph article, Chinese banks pumped 10 trillion Yuan ($1450bn) into the economy this year and they are expected to inject another 8 trillion Yuan in 2010. This might appear like retrenchment, but that is still nearly twice the 4.6 trillion Yuan of the loans disbursed in 2008 according to the article.

As exports have slumped of course the authorities have had to keep the financial tap turned wide open in order to keep growth going and  markets hungry for all the massive capacity investments that have come on stream. Steel, cement, aluminum are all running at close to capacity with limited export markets. So an early curtailment of stimulus measures would result in massive over production and widespread unemployment. Which is why the stimulus program will continue well into 2010 and why the risk of inflation will become a more entrenched problem for China over the next two years. There is not much doubt that China is going to overcome Japan as the second largest economy next year, or that once that milestone is passed China will not continue to expand for the rest of the decade. Although global growth is slow and export markets remain weak, China is going to be stoking the fires of internal inflation with its domestic stimulus programs and some day there will be a reckoning. Phenomenal as the last decade has been it is hard to see how a China less reliant on exports can continue to grow at near double digit rates and not fuel an inflationary bubble that is going to be painful to solve.

–Stuart Burns

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