The relentless rapid economic development in China is a well-documented story. Nevertheless, what has been less understood, until recently, is the explosive impact of this growth on metal and mineral demand. One such industry that is experiencing the full impact and which has yet to come to grips with the changing landscape is the steel industry. By taking a closer look at the 'China Factor' and its immediate and longer-term impact on the industry, one can better gauge the effect and impact, beneficial or otherwise, on local steel producers and downstream manufacturers.
Part 1 : The 'China Factor' - Her Role in the Changing Landscape of the Global Steel Industry
(A) Driver of Production and Consumption
From a mere production of 148,000 tonnes (MT) of crude steel in 1949, China is now easily the world's largest producer (see figure 1), melting in excess of 272 mln MT in 2004. Such is its size and dominance that the next largest producer, Japan, trails far behind with only 112.7 mln MT of crude steel. Between 1998 and 2004, although world raw steel production grew 36% to 1,057 mln MT (see figure 2), China's output jumped 137% from 115 mln MT in 1998 to 272 mln MT in 2004. In other words, more than half of the global production increase was attributable to China.
Figure 1: World Crude Steel Production (2004)
Figure 2: World Crude Steel Production
Unknown to the masses, the rate of growth of China's steel production has been accelerating, with the period for breaking through 100 mln MT becoming shorter and shorter. In 1980, steel output was a mere 36 mln MT and it took 16 years before it reached 100 mln MT. By 2003, crude steel production rose to 222 mln MT, requiring just 7 years to achieve its second 100 mln MT. Based on 160 mln MT output for the first half of 2005, raw steel production in China is poised to exceed 300 mln MT this year. At such a break-neck pace (less than 2 years to achieve an output increase of 100 mln MT), China's melting capacity is overwhelming its global peers. No wonder it is the major determining factor in deciphering the cyclical gyrations of global steel prices.
On the demand side, a similar scenario is unfolding. During that same 6-year period, China's increase in steel consumption from 110.6 mln MT in 1998 to 265 mln MT in 2004 accounted for more than half of the 41% rise or 284 mln MT in global consumption (see figure 3). In 2004, China's demand for steel was approximately 27% of global consumption. Such phenomenal growth was paralleled by developments in other industries, particularly those that consume significant amounts of steel, notably automobile, electric appliances, shipbuilding and construction in relation to infrastructure and housing. Hence, it is of no surprise that China's role in the global steel industry has taken an influential form.
Figure 3: Change in Steel Comsumption
(B) Causes of Raw Material Shortages
China's voracious appetite for steel and its primary raw materials, namely iron-ore, coking coal, scrap iron, pig iron, etc. has triggered an unprecedented boom in the minerals industry. For instance, last year, seaborne traded iron ore volumes rose 13% or 70 mln MT, nearly all of which is attributable to China. It was not long ago in 2000 that such volumes represented China's total consumption of imported iron-ore. Within a short period, imports of the key ingredient in the production of high-grade steel sheets in blast furnaces have grown to 208 mln MT in 2004 (see figure 4 and 5). This tonnage itself accounted for more than a third of the global seaborne market. In fact, China has overtaken Japan as the largest iron ore importer. Supplies from Australia, India and Brazil formed 36%, 25% and 22% of its total imports respectively. Not surprisingly, contract prices for iron-ore have risen in tandem with the rapid growth of China's imports, adding US$35-40 per MT to the cost of making steel for integrated mills over the past 3 years. The unprecedented and controversial 71.5% increase from last year was a clear reflection of the acute tightness in the current iron-ore market and the structural changes that are presently taking place.
Figure 4: Steel Production & Iron-ore Imports
Figure 5: Monthly Imports of Iron-ore (3-months moving avg)
The next question is, will this trend of rising imports and prices continue? What are the implications to the global steel industry in the longer term? To answer them, one needs to understand the production and consumption of iron-ore in China. Domestic iron-ore mines comprise a small number of large mines owned by steel mills, a larger number of small and medium sized independent mines and many small local mines. In the early 1990s, iron-ore was predominantly sourced from these operations but as growth in domestic steel production picked up over the last decade, most of the needs were met by rising imports as domestic production failed to keep up pace. Not that it is lacking in size, as China's production, at 370 mln MT in 2004, is one of the largest. But in terms of the quality of its ores, unlike the ores from major producers like Brazil, Australia and Canada, which contain 60% iron content, ores from China only contain about 30% iron and this inhibits its usage for the production of higher-grade steel. Furthermore, domestic ore grades have been deteriorating and future growth in output is likely to be constrained by resources and cost issues. Hence, as the country progressively steps up the value chain and shifts its production and emphasis to sheets used for shipbuilding and automotive sectors, as opposed to the cheap construction steel, its heavy reliance on imported iron ores will be greater.
In view of this, the government has set in place measures to reduce and rationalise unfettered imports of iron ore. One of these was the recent introduction of an automatic licensing system that allows more effective monitoring of imports and limits the number of iron-ore importers. Only steel companies that produce more than 1.0 mln MT of crude steel and trading companies with capital of 10 mln Renminbi and an import volume of 300,000 MT can apply for these licenses. This effectively scaled down the number of qualified enterprises from 500 to 118, comprising 70 iron and steel companies and 48 trade corporations. Whilst this may go a long way in curtailing speculative trading of iron-ore in the spot market and hence, the manipulation of prices, it may not solve the bigger problem - its reliance on imports. As it is, China's iron ore imports have grown by another 33% in the first eight months of 2005 and this is despite the 30% growth in domestic iron ore production over the same period.
As for the price trend, much of it depends on the growth in steel production and consumption, matched against the growth in mining of ore deposits. On the supply side, there are significant multi-billion dollar expansions in mines owned by the world's 3 largest iron-ore companies (CVRD, Rio Tinto and BHP Billiton), with Rio Tinto aiming to lift its annual capacity to 170 mln MT by 2006 and BHP Billiton planning to increase its capacity to more than 150 mln MT by 2008. Combined with the ramping up of production by the smaller iron-ore companies to ride on the recent surge in prices, these may well tip the finely balanced market into a possible global iron-ore glut. However, unlike the highly fragmented steel industry, the top three iron-ore companies control 75% of the seaborne market. Hence, because of their clout, these companies are better able to adjust production levels to avoid oversupply and consequently, dictate the direction of prices. Furthermore, India, the world's third largest iron-ore exporter, is facing difficulties matching the ore export growth achieved last year as its stocks have been drawn down and domestic steel lobbyists have been exerting pressure on the government to keep as much iron ore in the country as possible. Nonetheless, as the planned expansions will take some time to come on-stream, China and the rest of the world, for now, have to accept the situation of tight supply and high price levels for iron-ore.
Coking coal and coke
Like iron-ore, China's consumption growth has completely altered the dynamics of the seaborne trade in coking coal. Coking coal or 'coke making coal' is the raw material used to make coke. Coke is used in various industries such as foundry, lead and zinc smelting and ferrochrome production but the vast majority is consumed in the steel industry as reducing agents or as a source of carbon in blast furnaces. Out of the 4.8 bln MT of coal produced globally, metallurgical coal (hard-coking, semi-soft coking, PCI and thermal) accounts for approximately 530 mln MT, with seaborne trade at slightly more than a third of that amount (190 mln MT). From that, approximately 63% comprise the much-in-demand hard-coking coal. Similar to the iron-ore industry, a handful of hard coking coal suppliers (BHP Billiton, Fording Canadian Coal Trust, Xstrata, Anglo American, etc.) control more than 80% of the global trade, with long-term contracts and annual price negotiations being the norm.
Figure 6: Average Price of Metallurgical Coal
However, not reflected in this statistic is the increasingly significant role of China as both a producer and consumer, especially with its cheap and abundant supply of coal. Last year, China alone produced one-third of the global coal production at 1.9 bln MT and nearly half of the global metallurgic coke supply at 209 mln MT. The bulk of the coke produced is consumed locally with 15.0 mln MT set aside for exports, which itself equates to 60% of the international trade volume. At present, China's coke is mainly destined for the EU, Japan, the US and India, which together, account for 83% of its exports. Despite its huge production volume, China had to import 6.7 mln MT of hard coking coal to feed its domestic coke oven batteries. For every 100 MT rise in steel production, assuming the present ratio of crude steel production using basic oxygen furnaces remains unchanged, about 30 MT of coke and 46 MT of coking coal are needed. As such, if global raw steel production does hit 1.2 bln MT by 2006 as predicted by some, as much as 50 mln MT of coke and 76 mln MT of coking coal would have to come on stream. This is also based on the premise that existing production levels are kept unchanged and running smoothly - a rare occurrence considering the numerous problems faced in 2004. Hence, it is not surprising that there is a mad rush by producers to boost production capacities and raise export prices (as much as 120% year-on-year). So, will this be a precursor to further price increases (see figure 6) or will the industry revisit the pre-2003 years of oversupply and low coking coal prices?
Frankly, it is hard to gauge as it depends on a whole host of factors. For one, China is presently an importer of coking coal but a major exporter of coke. This is because the coal produced locally has a high content of ash and sulphur, rendering it unsuitable for conversion into coke. In addition, more than a quarter of China's total coke production is from inefficient, obsolete, and polluting beehive coke ovens, which waste precious coal resources, as opposed to advanced slot ovens. This inefficient use of coking coal is further exacerbated by the rapid expansion in capacities and new investments in coke batteries in view of the lucrative export markets. At present, 183 coke ovens, with a combined capacity of 68 mln MT, are being constructed, accounting for nearly a third of China's current production capacity. As its steel production grows and gradually switches to the higher grades made via the basic oxygen furnace route, demand for coke will correspondingly increase and this will heighten its exposure to imports of coking coal.
Furthermore, one has to also factor in the demand/supply dynamics of the power generation sector in determining the supply of coking coal to steel mills, as coal-fired power plants presently account for 75% of the country's power generation capability. This is because whilst coking coal can be burnt in suitably designed power plants to generate electricity, not all bituminous steam coal can be converted into coke. If China's domestic power requirements continue to surge, more coal may be diverted away from the coking ovens and into power stations, further squeezing domestic supply of coking coal. That being the case, the global trade of coking coal may tilt into a sellers' market before new supply can come on board.
It is with this scenario in mind that China is taking swift actions to cool the overheating investment in the coke industry and avoid a surge in production costs. In May 2004, it scrapped the 5% tax rebates for coke and coking coal after previously reducing them from 15% and 13% respectively in Jan. The abolition of the subsidy is mainly geared towards lessening exports. The government also cut coke export quota from 15 mln MT in 2004 to 14 mln MT this year. The spike in international spot prices for coke early last year was partly due to its decision to momentarily halt exports of coke, which surged following supply disruptions in the US, in order to stabilise domestic supply. There are also signs that the government is contemplating imposing additional charges on coke exports.
On the supply side, the government imposed stricter standards for entry, suspended approvals for construction of new coke plants and cracked down on obsolete and inefficient beehive ovens. Over the next couple of years, when coke capacity exceeds domestic consumption and exports are restricted to a large degree, the too dispersed industry is likely to undergo a healthy large-scale consolidation process. From a broader point of view, if the government is successful in reducing over-investment and improving efficiencies, chances are that the spikes in prices witnessed early last year (from under US$100/MT to over US$400/MT) will not recur and fears of a global coke glut can be allayed. What this means is an environment of gradual increase and decrease as opposed to a sudden surge and crash in coking coal and coke prices.