Why China can’t get rid of all those steel mills

The steel in­dus­try suf­fers from a se­vere glut—but will re­sist cuts “Steel­work­ers are pretty feisty peo­ple when it comes to protests”

Bloomberg Businessweek (Europe) - - CONTENTS - −Dex­ter Roberts

China has had an over­ca­pac­ity prob­lem in its alu­minum, chem­i­cal, ce­ment, and steel in­dus­tries for years. Now it’s reach­ing cri­sis lev­els. “The sit­u­a­tion has gone so dra­mat­i­cally bad that ac­tion has to hap­pen very soon,” said Jörg Wut­tke, pres­i­dent

of the Euro­pean Union Cham­ber of Com­merce in China, at a press con­fer­ence in Bei­jing on Feb. 22, where a cham­ber re­port on ex­cess ca­pac­ity was re­leased. That re­port’s con­clu­sion: “The Chi­nese govern­ment’s cur­rent role in the econ­omy is part of the prob­lem,” while over­ca­pac­ity has be­come “an im­ped­i­ment to the party’s re­form agenda.”

Many of the un­needed mills, smelters, and plants were built or ex­panded af­ter China’s pol­i­cy­mak­ers un­leashed cheap credit dur­ing the global fi­nan­cial cri­sis in 2009. The sit­u­a­tion in steel is es­pe­cially dire. China pro­duces more than dou­ble the steel of Ja­pan, In­dia, the U.S., and Rus­sia— the four next-largest pro­duc­ers— com­bined, ac­cord­ing to the Euro­pean Union Cham­ber of Com­merce. That’s caus­ing trade fric­tions as China cuts prices. On Feb. 12 the EU an­nounced it would charge an­tidump­ing du­ties of as much as 26.2 per­cent on im­ports of Chi­nese non-stain­less steel.

Steel mills are run­ning at about 70 per­cent ca­pac­ity, well below the 80 per­cent needed to make the

op­er­a­tions prof­itable. Roughly half of China’s 500 or so steel pro­duc­ers lost money last year as prices fell about 30 per­cent, ac­cord­ing to Fitch Rat­ings. Even so, ca­pac­ity reached 1.17 bil­lion tons, up from 1.15 bil­lion tons the year be­fore.

With about one-quar­ter of China’s steel pro­duc­tion com­ing from Bei­jing’s neigh­bor­ing prov­ince of He­bei, ex­cess pro­duc­tion is a ma­jor con­trib­u­tor to the cap­i­tal’s smoggy skies. And with av­er­age steel prices likely to fall an ad­di­tional 10 per­cent in 2016, fears of spi­ral­ing bad debts are grow­ing. A sur­vey re­leased in Jan­uary by the China Bank­ing As­so­ci­a­tion and con­sult­ing firm PwC China found that more than four-fifths of Chi­nese banks see a height­ened risk that loans to in­dus­tries with over­ca­pac­ity may sour.

In De­cem­ber, Premier Li Ke­qiang warned that money-los­ing in­dus­trial “zom­bie com­pa­nies” are wast­ing scarce re­sources and must be shut­tered. In Fe­bru­ary, China’s State Coun­cil an­nounced plans to elim­i­nate up to 150 mil­lion tons of steel pro­duc­tion in five years and said

reg­u­la­tions will be loos­ened to speed up merg­ers and ac­qui­si­tions in steel and other in­dus­tries. China will “ac­tively and steadily push for­ward in­dus­try and re­solve ex­cess ca­pac­ity and in­ven­tory,” the Peo­ple’s Bank of China said on Feb. 16 af­ter a meet­ing with the Na­tional De­vel­op­ment and Re­form Com­mis­sion, the bank­ing reg­u­la­tory com­mis­sion, and other agen­cies.

The govern­ment may find it hard to achieve that goal. The steel in­dus­try will lose as many as 400,000 jobs as ex­cess pro­duc­tion is shut­tered, Li Xinchuang, head of the China Met­al­lur­gi­cal In­dus­try Plan­ning and Re­search In­sti­tute, pre­dicted in Jan­uary. He­bei and the in­dus­trial north­east­ern provinces of Hei­longjiang, Jilin, and Liaon­ing, home to much of China’s steel pro­duc­tion, don’t have lots of jobcre­at­ing com­pa­nies to ab­sorb un­em­ployed steel­work­ers. “They are con­cerned about the pos­si­bil­ity of so­cial un­rest with work­ers’ lay­offs,” says Peter Markey, Shang­hai-based China and Mon­go­lia min­ing and me­tals leader at con­sul­tants Ernst &

Young. “As you can see around the world, steel­work­ers are pretty feisty peo­ple when it comes to protests.”

Pro­vin­cial and city gov­ern­ments, which con­trol the lo­cal branches of China’s state-owned banks, are likely to re­sist the man­date to down­size. Of­fi­cials are of­ten pro­moted based on the eco­nomic per­for­mance of their re­gions. And cities rely on lo­cal com­pa­nies for much of their tax rev­enue. The cen­tral govern­ment “will re­ally have to push hard” to make a dent in ex­cess pro­duc­tion, says May Zhong of Stan­dard & Poor’s Rat­ings Ser­vices. “Re­duc­ing over­ca­pac­ity will take time be­cause of push­back.”

While cen­tral govern­ment of­fi­cials claim 90 mil­lion tons of steel pro­duc­tion ca­pac­ity was shut down for good over the past five years, that fig­ure doesn’t count newly built mills, says Se­bas­tian Lewis, Shang­hai-based edi­to­rial di­rec­tor for China at Platts, the com­modi­ties re­search firm. And steel­mak­ers have de­vel­oped elab­o­rate strate­gies to avoid Bei­jing’s or­ders. Com­mon ploys in­clude turn­ing off one blast fur­nace while in­creas­ing pro­duc­tion in the re­main­ing ones, or tem­po­rar­ily idling a fa­cil­ity and claim­ing the shut­down is per­ma­nent. How many real closings there will be “is al­ways un­clear,” says Lewis. “It is re­ally hard to get a sense of when ca­pac­ity re­ally is be­ing re­tired.”

The bot­tom line Steel­mak­ing ca­pac­ity in China keeps ris­ing de­spite govern­ment pledges to cut pro­duc­tion and end easy credit.

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