China’s steel industry is looking back at a bleak 2012. A year portrayed drearily by the secretary general of the China Iron & Steel Association (CISA) as being characterized by “two lows and two highs”: low growth and low efficiency combined with high costs and high (over-)capacities. After long years of exponential growth the Chinese steel industry now appears to have finally reached a plateau. Crude steel production for 2012 is expected to have increased by no more than 3%, while apparent consumption probably grew only a meager 1.8%. On top of this disappointing development, cost/price relations turned bad. With steel prices imploding and sales price levels approaching those of 1994 as steel makers tried to defend their market shares by aggressively throwing their production on the market, profits were eaten up. But while this constellation may have come as a shock to an industry spoiled by success, the fourth characteristic highlighted by CISA, the phenomenon of high and excessive overcapacities has accompanied the industry for many years.
The phenomenon of excessive overcapacities epitomizes the substantial gap between Beijing’s macroeconomic control aspirations on the one hand and local implementation on the other, where evasive behavior of self-interested local actors defuses national regulation ambitions and prevents the establishment of sustainable and really market oriented industry structures. The case of Hebei province is a case in point. In late summer 2012 it became known that Hebei authorities had deliberately under-reported the province’s 2011 crude steel output data by 50 million tons (equivalent to more than the total German steel production in 2011), thereby demonstrating the complete failure of the central government’s project approval system as well as CISA’s inability to ensure regulatory compliance and industry discipline. It cannot be expected that the Chinese steel industry as a whole will overcome its present structural weaknesses and especially its inclination to exacerbate the effects of market (demand) shocks if the capacity of central government organizations to enforce macroeconomic regulation on the local level is not significantly increased.
Seen in perspective, there seems to be no easy way out. Until today, higher and ever higher powered central government initiatives to dismantle the environmentally most hazardous and economically least viable production capacities have eventually all been blocked at the local level. The urgency to achieve results, however, has now increased massively. The Lehman-crisis stimulus programs have resulted in a shift of future steel consumption into the years 2009 to 2012. As a consequence the post stimulus package era is characterized by sluggish demand, which will remain flat until current demand once again catches up with its long-term growth trajectory. Furthermore the natural limits to growth for the domestic steel market are clearly discernible at the horizon. Given the already very significant steel endowment of the Chinese economy, there exist strong arguments that the steel intensity measured in kg steel per citizen will level out soon. If this scenario materializes, a further expansion of the domestic market by no more than 125 million tons in the run of this decade appears to be a sensible estimate. These 125 million tons, however, are more or less equivalent to the overcapacities already existing in the market. Growth will have to come from a substitution of inefficient by modern facilities and a general upgrading of the product structure towards higher qualities and complexities.
The strategies recently employed by Wuhan Steel (WISCO) may indicate in which direction the industry will have to develop. In its core business the steel maker has lobbied strongly for permission to build a new state of the art plant in Guangxi Autonomous Region – and shut down sizable sub-standard facilities on the way. The final go ahead came in 2012 after seven years of negotiations. In addition. Last year the company has acquired the Thyssen Krupp tailored blanks business, thereby positioning itself as a lead player in a technology segment that will remain crucial for the Chinese mass market for years to come. But this is not the complete story, Wuhan Steel is today moving beyond steel. As proclaimed by its CEO Deng Qilin the company will diversify and increase its investments in related industries, especially in the tertiary sector – as well as begin to breed pigs and chicken and plant vegetables (sic!).
The way taken by Wuhan Steel is certainly not paradigmatic for the development trends in the industry as a whole. On the one hand, the process of industry consolidation is intensifying. Especially the large state-owned steel mills are continuing to strengthen their business models with the acquisition of complementary assets. At the same time these very companies are striking strategic co-operation agreements with their customers down the value chain. All in all, these players seem to be right on track towards strengthened competitiveness and market oriented development. On the other hand, the prevalence of smaller, sub-standard mills in the market is not being reduced. In contrast, in 2012 small, non-state-owned mills have invested heavily and for the first time accounted for more than 50% of total domestic crude steel production. Mostly serving local niche markets these smaller mills are often profiting from the protection of local governments and are a key factor to the structural weaknesses of the industry in general and its excessive overcapacities in particular. It may sound heretically for a Western economist, but what the Chinese steel industry really needs today is not more (small-scale) private sector contenders, but rather a consequential market adjustment and weeding out of players who exist at the mercy of local governments only.
As such the outlook for the Chinese steel industry in general has become a lot less optimistic than it used to be. But – unlike in the past – a cautious outlook for the steel sector is no longer pointing at a general downturn of economic activity in the Chinese economy in general. The growth dynamics have changed.
As indicated above, the steel intensity of the Chinese economy has already reached significant levels. The infrastructure build up to be observed in recent years has laid a solid foundation for economic development in the years to come. As such the massive steel demand stemming from the need for a catching-up type infrastructure build up in the past does no longer exist. The development of manufacturing output has therefore – at least for the time being – become decoupled from developments in the steel industry itself. Growth in one sector does not depend on growth in the other. Furthermore, the next stage of economic development will (have to) to be much less based on steel absorbing fixed asset investment and manufacturing activities, but rather rely on the expansion of service industries and the satisfaction of domestic consumer needs. These however, feature only low steel contents.
Seen in a nutshell, the Chinese economy seems to be headed for a consolidation of its overall steel consumption in the coming years. Having witnessed 15 years of exponential growth, now a period of stagnation seems to lie ahead. Paradoxically, for the Chinese economy as whole, such stagnation may become an indicator for its success to change course and initiate a new development and growth pattern. And such a new – much less steel reliant – growth pattern will be needed in order to allow China to escape the looming middle income trap and propel it to the elite circle of the OECD industrialized economies.
(Markus Taube, 28. Februar 2013)