China should be steeling itself for a fall, not boosting output

Nov 13, 2012, 9:29PM EST
No one expects state run businesses to be efficient. But the steel industry in China is taking chronic mismanagement to impressive new levels.

China’s economy is slowing with the GDP figures revised to 7.5 percent by Beijing a couple of months ago. Many banks expect the country to slow even further as industrial output falters and domestic consumption weakens.

Yet incredibly, production this year has hit new heights, according to a great HSBC report titled “China: Steel woes tell a different story. Too much production, too little return.”

The report is too long to cover all aspects, but basically increasing production has seen steel prices falling to 1994 levels this year as record inventory piles up, along with liabilities of US$445 billion (that’s not a typo) for the top 80 steel mills and industry-wide losses topping US$3.3 billion.

Instead of cutting back, and urgently, steel production is actually being ramped up. Local governments depend on the steel industry to increase growth, add jobs and generate tax revenue, and the steel companies have no problem accessing funding for expansion through the banks or bond market.

Even with the global financial crisis and two economic slowdowns, China’s steel production has been steadily rising since 2002.

But as damaging as it is to China, the effect of over-production is regarded as the “principal threat” to Latin American steel producing countries, HSBC says. Prices of iron ore are already at a three-year low, and considering that China accounts for 60 percent of the world’s iron ore imports, shippers of ore such as BHP Billiton, Vale and Rio Tinto can only look on in dismay as their revenue vanishes.

The excessive production and restocking of China’s steel reserves is having an impact on the bulk shipping industry. Chinese demand has soared to a four-year high and the dry bulk market is expecting to reap the rewards in rising freight rates.

DNB analysts expect the daily earnings for capsizes to rise from their current $6,000 per day to $16,000 per day next year. As far as the shipping companies are concerned, life is wonderful and getting better. And who can blame them. Chinese demand for iron ore rose more than 40 percent in October alone.

HSBC, however, believes the current situation in China is unsustainable. In its report, the bank considers the steel industry to be suffering from its worst ever downturn with overproduction, excess capacity and historically high levels of debt, of inventory and of losses, right at the time of the worst global economic downturn ever.

Their recommendation: Cut the steel makers access to credit and production levels will drop. But with deeply embedded vested interests at every level of the industry, one would first have to find the right head of the steel beast before it can be chopped off.

 

 
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