China Creates Global Steel Champion As Doubts Deepen On Output Cuts

20 September 2016

China has backed the creation of a giant national steel champion with continental reach, calling into question the country's pledge at the G20 summit to slash over-production.

Caixin Magazine said regulators have approved the merger of Baosteel and the loss-making group Wuhan Iron and Steel, calling it the birth of a strategic “behemoth” with a capacity of over 60 million tonnes a year.

The move is touted as part of a restructuring plan to slash 100-150 million tonnes of excess capacity in China by 2020, with the loss of 180,000 steel jobs. But the evidence so far  shows that output is still rising.

An internal document from the German steel federation Stahl alleges that China has added 9m tonnes of extra capacity so far this year and there is no chance whatsoever that the country will meet its commitment to eliminate 45m tonnes of plant in 2016.  

Stahl said China’s capacity has been increasing every year for the last four years, reaching 1,105m tonnes at a time when internal demand in China has slumped to 686m tonnes.

Over-capacity has in effect doubled to 419m tonnes since 2012, more than twice the entire steel output of the European Union.

The Baosteel takeover of Wuhan is not necessarily a threat. Mergers can be part of the slow process of consolidation, and in this case the two state-owned companies have vowed to cut capacity by 13.4m tonnes between them.

The nagging doubt is that steel is deemed a "strategic" industry by Beijing, a term with specific meaning in Communist Party ideology. The normal reflex of the authorities – especially regional party bosses – is to keep ailing steel mills alive by rolling over bad debts or forcing debt-equity swaps.

A study by Duke University concluded that the whole steel sector in China is underpinned by a nexus of distortions and opaque subsidies, from cheap energy and credit to free land. Foreigners are effectively shut out of the $1 trillion market for government procurement. “China’s ‘state capitalism’ model is at the core of the current over-capacity problem,” it said.

Baosteel in particular has played a pivotal role over the last three decades as the “national champion of national champions”, leader of China’s industrial shock-troops and able to tap deep into the pockets of the state on preferential terms.

Professor Jeffrey Wilson from Murdoch University in Perth says it has been under “particularly tight party supervision”. It was established as a policy instrument from the outset and has been used over the years to drive state industrial goals.

The merger would create the world’s second biggest steel group, chasing hard on the heels of Mittal. Together Baosteel and Wuhan would control 70pc of China’s silicon steel and 60pc of the quality steel used in the car industry.

For now the global steel crisis is in remission. The glut has been masked by China’s own policies over recent months,  chiefly a fresh blast of infrastructure spending and a 20pc surge in new construction driven by easier credit. This looks like a cyclical bounce, now a routine feature of China’s stop-go economic management.

The latest property boom is highly unstable. House prices rose 9.2pc in August from a year earlier, reaching 40pc in Hefei, 37pc in Shenzhen, 37pc in Nanjing, and 31pc in Shanghai. Once the new bubble deflates, a slowdown in building is likely to expose the immense scale of the steel glut once again.

Steel prices in the US have risen by half since the start of the year, supported in part by anti-dumping sanctions of up to 500pc on hot-rolled and cold products.

Punitive measures in the EU have been far gentler - in part due to Britain's objections - but this may change as UK influence fades in Brussels.

Jean-Claude Juncker, the European Commission’s president, has  warned China that it would be frozen out of the global trade club unless it curbs steel output, and called for tougher defence measures in his State of the Union speech last week. “We should not be naïve free traders, but be able to respond as forcefully to dumping as the United States,” he said.

The G20 has agreed to create a Global Forum on excess steel capacity but it will not report back until well into 2017, and there were no binding commitments.

OECD’s Steel Committee said last week that “urgent structural challenges remain unaddressed”, warning that excess capacity would reach 800m tonnes this year with little chance of any change by 2018. It is a grim prospect for those at the Port Talbot steel works hanging on by their finger tips.

It is never easy to tackle excess capacity. Efforts to slim down Europe’s steel foundries in 1970s with the ‘Davignon 1’ reforms achieved little, and voluntary curbs had to be followed by more painful measures.

The steel dispute with China goes to the heart of the raging debate over globalisation. It is a litmus test of whether  Beijing is willing to purge of endemic excess capacity across swaths of industry, given the risks of social protest and the threat to Communist party control.

The fear is that Beijing will play for time with cosmetic measures and with a stealth devaluation, exporting its deflationary woes until the global trading system snaps.


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