Steel prices depend on ‘supply discipline’

World steel prices are languishing at multi-year lows amid a supply glut, further exacerbated by Chinese steel dumping.

Data from the World Steel Association (WSA) shows crude steel production among its 66 affiliate countries fell 3.1% year-on-year to 134 million tonnes (Mt) in October. More importantly, this marks the ninth consecutive month of declines in annual output. But it wasn’t enough to give prices some much needed support. According to consultancy firm MEPS International, global steel prices fell 26% year-on-year in October. At the same time, the supply overhang drove the WSA’s steel capacity utilisation ratio (see chart below) down 3.4% year-on-year to a low of 68.3%.

According to Colin Hamilton, global head of commodities research at Macquarie, in order to reach 90% capacity utilisation, the point around which steelmakers would have ‘decent pricing power’, about 275Mt of production would have to be mothballed. Noting that this is equivalent to the entire production in Japan and Western Europe, “This highlights the scale of the problem facing global steel,” he said.

Despite the recent spate of curtailments in output and, in some cases the mothballing of steel mills in some countries, supply is still set to continue exceeding demand.

So, is there any upside for steel in the short-term?

It all seems to depend on China, the world’s largest producer and consumer of steel. Slowing economic growth has tempered the country’s demand for steel – its monthly steel PMI fell from 43.7 to 42.2 in October, marking its 18th consecutive month of contraction – resulting in its steelmakers offloading their stockpiles at rock-bottom prices in other countries.

According to Fitch Ratings, this is likely to continue. “Fitch expects Chinese steel producers to continue to enjoy cost advantages stemming from further depreciation in the Chinese yuan and lower material prices, which will help drive exports,” Lauren Zhai and Charles Li of Fitch’s Industrial Team said in a note.

The ratings agency says the country will add about 16Mt of annual new capacity in 2016 and 2017 from 2015’s expected total production capacity of around 1.17 billion tonnes (Bt). This will be offset by the shutdown of plants with a total capacity of 75Mt to 85Mt, resulting in peak steel production capacity in 2016.

At the same time, CISA, China’s Iron and Steel Association forecasts a 3% annual reduction in steel production to 783Mt in 2016. That’s still above its expected steel demand of 654Mt.

According to BHP Billiton, China’s steel production will only peak in the middle of the next decade, coming in between 935Mt and 985Mt while Rio Tinto expects production to peak at around 1Bt within the next 15 years.

In the meantime, governments the world over are coming under increasing pressure by steelmakers and trade unions alike to tackle Chinese steel dumping by instituting trade barriers. But China is lobbying to be granted market economy status under the World Trade Organisations rules, which would make it difficult for tariffs to be imposed on Chinese imports.  A November 2015 report sponsored by 6 North American steel industry groups argues against this: “China is a state-run economy and does not operate on market principles… granting China market economy status is premature and would lead to significant job losses in our sector, and in steel communities where plants are being idled and jobs are already being decimated. This is unacceptable”.

According to MEPS International, steel mills will “Almost certainly initiate unfair trade cases against producers in China”, which could give prices a shot in the arm. “The combination of a slight improvement in the global economy, a leaner raw materials supply industry and rationalisation in the steel sector, should lead to a modest upturn in steel selling values in 2017 and beyond,” it said. At the same time, Capital Economics senior commodities economist John Kovacs says “The global steel market is forecast to remain oversupplied and this should keep prices low”. Following its China Commodities Tour, JP Morgan Asia’s Metals and Mining team said the prospects for the steel industry would depend on “supply discipline” emerging.

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