No Stimulus for Chinese Steel as Consumption Hits First Slump in 31 Years

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Written by Richard Finlayson, Senior International Editor for Industrial Info Resources (Sugar Land)--Estimates of China's current steel industry capacity stand at 850 million tons a year. However, the country only produced about 683 million tons in 2011, according to Raja Mukherji, the head of Asian credit research for Pacific Investment Management Company Asia PTE Limited (PIMCO).

China consumed only 631 million tons of the 2011 production, leaving an excess of 52 million tons, which was carried over as surplus inventory in 2012. Even if consumption remains flat in 2012, there should only be "true" expected demand for new production of about 580 million tons for 2012.

Demand is not likely to rise, in PIMCO's view, because stimulus plans have resulted in an estimated consumption of an additional 120 million to 140 million tons of infrastructure-related steel from 2008 to 2012. New stimulus programs are not expected to be announced in the coming years.

For investors, the biggest risk is that iron ore prices may falter (since iron ore is one of the main ingredients in steel production), as new iron ore supply ramps up by 2014 and Chinese steel demand weakens. The consultant says that the Australian dollar could be vulnerable, since it has traditionally been closely aligned to the price of iron ore, one of the country's main export commodities; with other natural resources, iron ore is a major driver of Australia's trade with China. Housing construction and heavy machinery represent about 70% of steel demand.

The greatest probable risk to this forecast for Chinese steel consumption is that a faster-than-expected slowdown in China prompts another round of investment-intensive stimulus by Chinese policy makers. This may not be the base line path, but it is a possible scenario. A second major new commitment to social housing could potentially be a larger demand source for steel, if a social-oriented program is made a higher government priority.

The Australian Financial Review (AFR) reported that China's steel production fell by as much a 10% in the first weeks of August. A sluggish construction market and a lack of additional stimulus by the Chinese government has seen the Chinese steel mills stockpile product to record levels. China looks to record its first annual slump in steel production in 31 years, AFR reported.

China's state-controlled China Iron and Steel Association (CISA) sees zero or negative growth in the country's steel production for 2012 as "highly probable" because a significant decline in the second half of the year is assumed. Profits for China's iron and steel industry fell more than 95% year-over-year for the first six months of 2012--but, reported CISA, despite the weakening outlook, mills continued to forge steel at a record-breaking rate of nearly 2 million tons a day.

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