As China attempts to
shift from an “old economy” anchored in heavy industry and manufacturing to a
“new economy” that is more efficient, light and service-based, the steel sector
is facing full-on restructuring in order to become consistently profitable. At
present, China’s steel sector, which produces over 50% of global steel output,
is suffering from overcapacity due to a decline in construction demand and
inefficiencies. This has resulted in large losses for the industry, as it seeks
to find sources of demand domestically and abroad.
Chinese authorities have
directed provinces to reduce capacity to pick up the slack between oversupply
and dwindling demand and falling prices. According to the State Council, crude
steel production capacity is to be slashed by 100 to 150 million tons by 2020.
This appears to be a tall order for some provinces, which rely heavily on the
steel industry for employment and revenue. Data from the National Development
and Reform Commission (NDRC) has shown that in some provinces, including Hebei,
Liaoning, Jiangsu and Jiangxi provinces, little has been done to reduce
overproduction. Less than half of the estimated steel overcapacity of 45
million tons has been slashed so far this year, and the NDRC has ordered local
governments to meet the target or face severe punishment. High levels of
production, as seen in the figure below, are unsustainable.
While profits rose 4.27
times in the steel industry in the first half of 2016 to 12.6 billion RMB as a
result of somewhat rising steel prices, the profit margin of less than 1%
remains low in comparison to other industries, and firms are often subsidized
through low interest rate loans and low energy charges. Low profitability can
be attributed mainly to glaring inefficiencies in production, as well as to
declining domestic demand and prices. Furthermore, a recent study by Renmin
University found that over half of China’s steel firms are zombie companies.
China’s steel industry
is extremely inefficient in terms of output per worker, requiring three times
as many workers per ton of steel produced than the US or Japan. State owned
enterprises (SOEs) are particularly inefficient in use of labor and
energy. Nielsen (2016) shows that China’s state-owned steel production
bases have declined in energy efficiency since 2003 while privately owned steel
production bases are as efficient as possible. Less efficient enterprises can
profit from laying off redundant workers, producing higher value-added products,
and making use of advanced, energy-efficient technology.
Mergers have been a
focus for SOE reform, for their capacity to improve efficiency. Baosteel Group
and Wuhan Iron and Steel Group are in talks for a merger, subject to regulatory
approval. Baosteel is already highly energy efficient, making use of the most
advanced technology available. Wuhan Iron and Steel has laid off thousands of
workers, streamlining its labor force. It is also rumored that authorities are
considering merging steel firms into two major producers, one in the north and
one in the south. However, there is no guarantee that mergers will result in
improved operations. While mergers may improve scale efficiency by increasing
the size of firms, they do not guarantee the efficient use of labor, energy or
materials. Firms must sufficiently restructure operations and strive to improve
the bottom line.
Small and medium-sized
steel producers are also extremely inefficient due to production beyond the
minimum efficient scale. Somewhat higher prices this year have induced many
small and medium-sized steel mills to maintain existing capacity against state
directives.
Declining demand for
steel in China’s slowing economy and declining domestic prices have forced
steel producers to sell their goods on the global market. Steel exports have
risen to almost record levels, inducing the US and EU to accuse China of
dumping steel on world markets. Despite this outcry, however, the increase in
exports has helped reduce the stock of steel. By the end of June, the steel
stock was down by 24.63%.
Steel Price
Going forward, state
directives and environmental inspections may force some firms to improve
efficiency and raise profit margins. So far this year, thousands of workers
have been laid off, and there are many more to go. In addition, environmental
inspections of the steel industry began in June, and will be carried out
through October. Requirements to improve energy efficiency will not only reduce
carbon emissions, but improve profitability.
Still, it will likely
take some time to really see profits in this industry. Overcapacity and
inefficiencies in the sector have dwindled for years, despite previous state
directives to consolidate. Therefore, it is quite unlikely that China’s steel
industry will show much promise for investors in the short to medium run.
Source: forbes.com