The China factor in global steel

China’s increased demand for steel will be met largely by domestic producers, leaving multinational ones to fight for the scraps.

China’s soaring demand for steel is raising hopes of a new and profitable era for this long-suffering global industry. Aided by regional consolidation among European and US producers, the worldwide outlook for profits is positive. Moreover, steel companies listed on the world’s major stock exchanges started 2004 with a total market value that was up 77 percent from the levels of the previous year.

Celebrations may be premature, however. Our analysis suggests that most of China’s flat-steel demand will eventually be satisfied by additional domestic capacity—hardly a long-term solution to the fundamental problem of worldwide overcapacity. In fact, chances are that the high-cost steelmakers of Japan, the United States, and Western Europe, will be worse off if they maintain their capacity or expand to take advantage of the Chinese boom. Moreover, if China’s economic growth slows, the country could become a net exporter, with devastating effects.

Our study examined the impact of Chinese trends on the global $200 billion-a-year flat-steel industry through 2010. Its general conclusions apply not only to flat steel (used to make car bodies, among other things) but also to the industry’s other segment, long steel (used, for instance, in construction). Flat steel is increasingly traded on global markets, and China has become a huge net importer.

Over the past five years, China’s demand for flat steel has risen by an average of 17 percent annually, compared with just 2 percent for the rest of the world. Indeed, the country is this segment’s sole growth engine. The expansion of China’s GDP and its likely impact on the domestic consumption of finished steel products suggest that demand for flat steel could rise at an average annual rate of 8 percent from 2003 to 2010. By the latter year, China may need 170 million tons of flat-steel products annually—30 to 40 percent of the global market—compared with just over 80 million tons in 2002.

Currently, the global flat-steel industry has at least 100 million tons of overcapacity. Still, our economic models indicate that most of the increase in China’s demand will be met not by foreign producers but by domestic ones, which intend to build new factories with a cumulative estimated capacity of 60 million to 80 million tons a year. We also expect domestic producers to expand the overall capacity of their existing plants by 10 million tons a year through 2010; improved operations could contribute another 10 million. These developments may leave foreign producers competing for, at best, just 20 million tons a year of imports. Competition for commodity steel will probably come from the former Soviet republics and from South America (mainly Brazil), the regions with clear global cost advantages. European and Japanese producers will likely continue to export high-quality steel. Thus China’s emergence as the biggest steel consumer will reduce global overcapacity just marginally by 2010 (Exhibit 1).

Only the former Soviet republics and South America (mainly Brazil) can compete with new Chinese capacity in the full range of costs, including the cost of capital, fixed and variable operating costs, and logistics. Nonetheless, at current price levels, producers in the world’s high-cost areas—particularly Japan, Western Europe, and, to some extent, the United States—could direct a significant part of their overcapacity to China by selling steel there at variable cost. Ultimately, they couldn’t cover their total fixed costs, especially once major reinvestment was needed (Exhibit 2). But though exports at variable cost would be unsustainable in the long term, such companies could sell an additional 50 million tons annually in the next few years, before new Chinese capacity came on line. Of course, China could reduce imports by invoking antidumping tariffs, as it has recently done for some steel imports from Russia.

Steelmakers also realize that China might suffer a severe economic slowdown brought on, for example, by a banking crisis. Stalled or slowly growing domestic demand for steel would make the country’s producers attempt to sell low-cost steel abroad, thereby depressing global prices and increasing global overcapacity. But pressure to address the overcapacity of Japanese, US, and Western European operators might fall in the event of continued economic growth, which currently seems more likely. These steelmakers must recognize, however, that any increase in Chinese imports will be short-term. In the longer term, producers in the developed world must continue to consolidate and rationalize. To profit from the growing Chinese market, they should consider moves in China or in the world’s other low-cost steel-producing regions rather than at home.

Exclusively for Member Importers and Suppliers