China's Steelmakers Set Record as Profits Slump

An analysis by Michael Lelyveld
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china-steel-production-april-2019.jpg A worker pours molten steel at a factory in Jinjiang, in China's eastern Fujian province, April 10, 2019.

Signs of trouble have re-emerged in China's steel industry with surging production and plunging profits, renewing doubts about the effectiveness of government policies.

In March, China's output of crude steel jumped 10 percent from a year earlier to 80.3 million metric tons, pushing first-quarter production to a record 231 million tons, Bloomberg News reported, citing data from the National Bureau of Statistics (NBS).

The 9.9-percent growth for the quarter set off alarms in April as Baoshan Iron and Steel Co. (Baosteel) reported that net profits of 2.7 billion yuan (U.S. $401 million) fell 45.7 percent from a year before.

Other steelmakers recorded declines for the period. Net profits dropped 75.8 percent from a year earlier at Shandong Iron and Steel Co., the official Xinhua news agency said.

On April 28, the China Iron and Steel Association (CISA) said quarterly profits among its monitored manufacturers dipped 30.2 percent to 37.5 billion yuan (U.S. $5.5 billion), Xinhua reported.

Iron and steel industry profits slid 36.7 percent to 54.8 billion yuan (U.S. $8 billion), despite a 10.5-percent rise in revenue, the Ministry of Industry and Information Technology (MIIT) said.

Gross profits of steel producers rebounded in March on renewed demand for construction and manufactured products, but average margins remained only about half of 2018 levels, Argus Media said.

The implication that China was once again making more steel for less increased the risk of a global price slide, since the country produces and consumes about half of the world's steel.

"The possibility of output exceeding domestic demand in China ... raises the prospect of the country again using exports as a pressure valve, flooding international markets with excess material and suppressing prices and profit margins for producers elsewhere," the London-based Financial Times said.

The first-quarter production record came despite government curbs in China's northern region during the winter heating season to guard against smog in Beijing and other population centers.

Production may rise even more, now that seasonal restrictions have come to an end.

Effects on competitors

Overcapacity and overproduction have been chronic problems for China's steel industry with devastating ripple effects for competitors in the rest of the world.

Chinese steel exports have been a primary concern for the administration of U.S. President Donald Trump, who announced a 25-percent tariff on steel imports in March 2018.

But tariff barriers and anti-dumping duties have only partially protected competitors from pricing pressures as a result of China's huge market share and support from state bank loans.

In the first four months of this year, China's steel exports rose 8.3 percent to 23.35 million tons, according to customs figures cited by the industry website last week.

While world market pressures are cyclical, China tends to ignore them, producing more steel when prices are low to crowd out competitors, and producing even more when prices are high to make up for lost profits during previous slumps.

Last year, steel industry profits of 470.4 billion yuan (U.S. $69.8 billion) jumped 39.3 percent as output climbed 6.6 percent to a record 928.2 million tons, according to official data cited by Xinhua.

In 2018, China made nearly 60 percent more steel than the rest of the top 10 manufacturing countries combined, based on World Steel Association data.

In the first quarter, Chinese steel accounted for 52 percent of the world total from the 64 countries that report to the association.

Overproduction problems

The latest quarterly results are a sign that government policies aimed at reducing production overcapacity have failed to break the cycle because the excess has left ample room to overproduce.

"That firms listen to the government in China should never have been in doubt; the problem is that they still do not pay sufficient heed to the market," The Economist of London said in 2017.

The profit plunge this year has been blamed on higher iron ore prices following the Jan. 25 collapse of a dam operated by top Brazilian ore producer Vale SA that left nearly 300 people dead or missing.

The output increase in March suggests that Chinese mills continued to pump out more steel despite warnings of higher costs and lower demand.

Analysts cited reliance on local governments in China to boost spending on infrastructure and increase domestic consumption, Bloomberg reported.

But in its statement, Baoshan warned of lower demand from the auto and property sectors this year. China's exports of steel products rose 12.6 percent in the first quarter, Xinhua reported, citing CISA data.

The quarterly figures suggest that the government's plan to cut overcapacity has not solved the overproduction problem.

In 2016, Premier Li Keqiang set a target of cutting production capacity by 100 million to 150 million tons by 2020, which the government claims was reached ahead of time last year.

The government has also tried to rein in capacity with "swap" formulas that require steelmakers to replace outmoded lines with more efficient production at a ratio of less than 1 to 1 in provinces with high manufacturing.

On March 30, the MIIT announced a new enforcement crackdown, implying recognition that the capacity curbs have not worked.

The ministry plans to conduct random inspections in provincial regions that are prone to "illegal steel production activities," Xinhua reported. Officials will check for "unwanted" production by using satellite remote sensing technology and monitoring electricity use, an MIIT inspector said.

Last week, the National Development and Reform Commission (NDRC) and other government agencies issued a circular requiring inspections to "avoid the resurgence of eliminated capacity."

The NDRC, China's top planning agency, said it would tighten approvals for capacity swapping and "ban all new steel capacity in any form," Reuters reported.

Consolidation efforts

The government also plans to issue guidelines for consolidation by promoting mergers and restructuring in the steel industry, the official Economic Information Daily said last month.

The guidelines will "encourage cross-region and cross-ownership mergers," according to the report.

The government has used similar strategies in the coal industry to consolidate operations as part of a push to eliminate smaller and more dangerous mines. But here, too, production has been increasing and the number of mines actually operating is in doubt.

Derek Scissors, an Asia economist and resident scholar at the American Enterprise Institute in Washington, said that China's steelmakers overproduced in the first quarter on the strength of the high profits they enjoyed last year, ignoring signs of slower demand.

"The firms making this mistake should be punished by sharp contraction or bankruptcy, but they won't be," Scissors said. "They are sheltered by local and national governments, even during periods of capacity reduction."

"When there are no serious consequences for overinvesting and overproducing, the pattern inevitably repeats," he said.

Scissors pointed particularly to protections for steelmaking at the provincial level.

"The obvious solution is for the state to abandon half of the steel industry to fend for itself," he said. "The reason that the obvious solution is never implemented is that the provinces all think it should be someone else's half."


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