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A Breath Of Fresh Air — China's Steel Suspensions

China plans to reduce crude steel production by approximately 33 million tonnes over the winter in an attempt to balance the spike in pollution during the country's winter heating season. However, reports from Tangshan are that the air quality is bleak, and the provincial government has responded by commencing capacity suspensions October 12, 2017, ahead of mid-November as originally planned.

The cuts in utilization rates at Chinese crude steel plants ordered by the country's central and provincial governments during the winter heating season are expected to impact the "2+26" steel producing cities of Beijing and Tianjin, plus major cities across the provinces of Hebei, Shandong, Henan, and Shanxi. These cuts have been communicated on an individual basis to mills, with reductions in production from the individual furnaces set at either 30% or 50% (see map for details).

S&P Global Market Intelligence views these cuts in output as a necessary reform to China's producers, with output increasingly being rationalized via direct intervention and microeconomic control. While the key driver for these suspensions is the environment, the industry will improve its cost-basis as smaller, less efficient producers are removed from China's stock of steelmaking capacity.

The temporary reduction in production includes the blast furnaces and sinter plants, although only the former has been clearly defined. S&P Global Platts calculated that the cuts could impact approximately 33 million tonnes of annual production based on provincial steel capacity figures.

ESTIMATED STEEL MILL PRODUCTION CUTS OF 17 CITIES DURING HEATING SEASON

Structural capacity cuts continue

These steel-related measures, among others, are to make sure that the spike seen in 2016 will not reoccur to the same extent this year. Data from the U.S. Embassy in Beijing shows that particulate matter with diameter less than 2.5 mm is low for October, yet other steelmaking areas continue to grapple with pollution.

China’s crackdown on pollution is having the intended effect

The Chinese central government has committed to 140 Mt/y of steel capacity reduction in the five years commencing 2016. In 2016, much of the capacity removed was already idled and the reduction target was reportedly overachieved at 65 Mt against a target of 45 Mt. The capacity reduction target for 2017 is approximately 50 Mt, and in May, the National Development and Reform Commission, or NDRC, announced that 42 Mt had already been mothballed. Not included in this figure is the closure of the illegal induction furnaces, or IFs.

China plans to reduce crude steel production by approximately 33 million tonnes over the winter

China's NDRC announced that 120 Mt of IF capacity has been removed in 2017 so far; however, the actual amount is difficult to quantify due to the nature of the underground, unlicensed IFs. The IF plants are fed with scrap and produced mainly rebar.

Steel mill margins remain strong

Downstream demand data indicates that strong growth is still being experienced for those products that consume finished steel on a large scale. Demand from the residential construction and general machinery sectors have been especially strong. Residential housing starts grew by 11.1%, while general machinery growth was 10.6% in September compared with 2016. We expect this robust demand will continue in the near term due to accommodative credit, ongoing accommodation insufficiencies and strong replacement demand.

Steel mill margins have remained strong throughout most of 2017, buoyed by construction and new infrastructure projects. A reversal of the typical trend between rebar and hot-rolled coil, or HRC, margins was observed in the June and September quarters this year, with rebar margins increasing above those of HRC. The rebar market tightened due to the closure of the illegal induction furnaces, which supported higher prices. A market for cheap scrap became available and led to other, legal steel mills increasing the volume of scrap they used in the blast furnace from an estimated average of 8% up to 15%, based on Platts' research across northern coastal China.

S&P Global Platts MVS Steel mill margins for both rebar and HRC have soared during 2017

The elevated margins have resulted in steel mills across China increasing the utilization of the furnaces to lift production and take advantage of the elevated rebar and HRC steel prices. The attractive economics of short-term production have led to many mills delaying maintenance periods that have typically been observed in the hotter months of July and August. This decision came at a cost to some mills where, for example, a fire at one of Benxi Steel's furnaces September 1 shut down approximately 9,000 tonnes per day of production for at least 16 days. Delaying maintenance was thought to be the cause of the fire at the relatively new furnace. As many mills expected winter capacity cuts to be imposed, it made sense for them to hold off on scheduled maintenance until later in the year.

Steel mill margins have recently reverted to the typical trend seen at the beginning of 2017, with HRC commanding higher margins than margins for rebar. A slowdown in construction is the driver, as this winter a number of cities such as Beijing, Tangshan, and Ji'nan have announced a total ban on construction activities in a bid to reduce dust pollution during the heating season. Should more of the 2+26 cities follow suit, demand for rebar could soften.

Impact of cuts on CISA member mills

China Iron and Steel Association, or CISA, member mills comprise approximately 80% of total Chinese crude steel production. Figure three shows that the composition of Chinese production has changed since 2015, with large (>10 Mt/y) and medium mills (3-10 Mt/y) increased by 17.9 Mt and 10.8 Mt, respectively. Production from smaller mills (≤3 Mt/y) has reduced by 12.1 Mt. While the number of mills included in the large and medium mills category has remained constant, smaller mills have seen a reduction in their numbers from 52 to 42. While there are fewer smaller mills, the mills that remain are more productive.

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This increase in productivity is in line with what has been observed during the closure of the illegal IF mills. Typical blast furnaces have been able to fill the production gap left by the shuttered IFs and have increased their utilization and production volumes. While this data covers approximately 80% of production, it is important to note that the non-CISA members could be impacted by the cuts to a greater extent.

CISA Members Mills annual production (Mt/y) and number of mills by size of mill

2+26 cuts in a world context

This demand will have to be, at least in part, satiated from other sources. The cuts to production are not expected to result in the full-scale production slowdown that the market priced in at prices of US$58/t in early October. This is likely is due to the large-scale profit margins steel mills are enjoying and the fact that these 33-Mt cuts only represent 3.2% of China's steelmaking capacity. Despite these curtailments to crude steel production, China remains on track to produce 844 Mt of crude steel in 2017. Only 8 Mt of annual capacity reduction are required by the end of the year to achieve the 50 Mt target set for this year. This is necessary for the affected 2+26 region as Beijing seeks to push for further improvements in its air quality over this political period.

The cuts are not insignificant but dwarfed by the world’s overall steelmaking capacity     China still has room to remove excess capacity past 2019

What do these cuts mean for seaborne prices?

S&P Market Intelligence expects 62% iron seaborne prices of iron ore to fall gradually throughout the rest of the fourth quarter of 2017 and into 2018 and 2019. These winter suspensions to Chinese steelmaking facilities will increase the amplitude and duration of volatility in seaborne prices as market participants struggle to clarify the impact on demand. The impact is further obscured by potential policy changes in the wake of the recent 19th Communist Party Congress.

This divergent thinking is observed in the wide range of consensus price forecasts that are skewed to the downside. Market Intelligence expect 62% prices to average US$64.1/t in the fourth quarter of 2017, albeit with prominent volatility and with continued environmental pressures to enact stronger downward forces on 58% iron prices. Premiums on direct charge material are expected to remain at elevated levels. The 58% to 62% iron differential has been widening once more to an assessment of US$28.9/t on October 17.

The consensus view on pricing is wide for 2017 given uncertainty

This article is a collaborative analysis by S&P Global Platts and S&P Global Market Intelligence, which are owned by S&P Global Inc.

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