Fitch: China’s Steel Curbs to Hit Smaller Producers Hardest
The Chinese authorities’ winter curbs on steel production in the north-east and broader efforts to contain carbon emissions will temporarily lower steelmakers’ sales volumes, but the impact on profits will be partially offset by higher prices and margins, says Fitch Ratings in association with CRU. Smaller steelmakers are likely to be the most negatively affected due to their relatively high fixed costs and the large capex burden they already face in meeting new environment standards for equipment.
The production cuts are being imposed to help meet emissions targets during the winter months, which extend from around mid-November to mid-March, and usually involve heavy pollution from coal-fire heating. The cuts will fall most heavily on sinter and ironmaking facilities in Hebei, Henan, Shanxi, Shandong and Tianjin, which together account for around half of Chinese iron and steel output. Plants in these regions may need to cut production by 50% on average during the heating season. Smaller steel producers have generally invested less in emissions control equipment and could be required to make larger cuts than producers with better emissions histories. So far, production cuts have been in line with expectations at the start of the winter, according to estimates by CRU (see chart).
The production cuts are likely to cause steel prices to rise. Other heavy industries that consume large amounts of steel – such as construction – will also be constrained by the emissions targets, but steel supply is likely to fall more sharply than demand. Meanwhile, weak iron ore prices are likely to contain costs and support profits.
Large producers, including most of those rated by Fitch, should be relatively well placed to cope with the production cuts and any temporary hit to profitability. Their large scale, market dominance and access to cheap raw materials mean they are generally starting from more profitable positions than smaller players. Some may also have stockpiled inventory in anticipation of the production cuts, which will help them continue to meet orders. That said, larger players with operations concentrated in the north-east, such as HBIS, will be more affected than those located primarily in the south, such as Baowu, which are likely to run their unaffected steel facilities at above-average capacity utilisation during the winter months.
There could be a period of market tightness at the end of the winter, as it will take up to two months for steel companies to restart idle blast furnaces and ramp up production. Steel inventory is also likely to be low. This raises the possibility that demand will initially recover more quickly than supply, which would further support prices and margins.
The winter disruptions are unlikely to have a significant impact on our full-year 2018 steel market outlook. We still expect apparent consumption to remain flat compared with 2017. Prices are likely to be slightly lower on average than in 2017, but profitability should be supported by lower raw material costs.
The government’s focus on environmental targets is likely to continue to create pressures for Chinese steel producers in the medium term. In particular, they will need to continue to invest in new equipment that meets the latest environmental standards. Larger steelmakers should find it easier to support this capex. Indeed, some of the large state-owned producers are already compliant with the latest policies. Smaller, less profitable producers could be gradually squeezed out of the market as they struggle to cope with the additional required capex.
Source: Fitch Ratings