Volatility Bites Back.
What China giveth, China taketh away. Steel prices are down some 5-10% globally due not so much to a slowing of economic growth in China, but due to worries of slowing. The next big question the global steel industry will be addressing will clearly be production cuts; in the first six months of the post crisis world in 2008 the global steel industry cut production by 30%, an unprecedented response. The argument for cuts in China in particular is compelling given China’s higher cash cost position and the coming cost increases locked in for 3Q.
In the past week there have been dozens of reports from Chinese “establishment press” calling for production cuts, culminating in a high profile Bloomberg interview with the Chairman of Baosteel earlier this week calling for production cuts by “smaller mills” . We view this as a clear challenge to Beijing and CISA to allow market forces to drive production cuts by the higher cost provincial mills and avoid the past export subsidies that become the industry’s lifeline during prior periods of economic slowing.
Production Cuts in the West.
The profound production cuts early in this recession were, in our view, not so much a result of so-called “discipline” but reflected the new economics where cash costs dominate steel production, as compared to the high fixed cost environment of a decade ago where producers maximized profits by running flat-out. With steel prices peaking only weeks ago, there are already numerous press reports of idlings; in the US we’ve already seen Severstal’s giant Sparrows Point facility – at 3mtpy about 6% of the domestic sheet market – scheduled for market-related closure; ArcelorMittal (NYSE:MT) has already talked about idling 3 blast furnaces in Europe.
Outlook – Chinese Production Cuts Will Accelerate Quickly.
We expect to see meaningful production cuts coming out of China in the coming weeks. In the prior decline, Chinese production had declined in the months ahead of the crisis due to the Olympics; so China actually did very little cutting in late 2008 and, in fact, was raising production from December 2008 onwards. This time the slowing is coming from China, so there will be no choice but to cut production or ramp up exports into the West – and there are very few places in the world today that will be tolerant of a temporary surge in high cost steel from China. So we expect to see China bring the globe back to equilibrium in the next quarter through a combination of production cuts and continued strong economic growth.
Disclosure: No positions