This CRU Insight is the second in a series of five that look at China's capacity reduction programme and its key implications.

In this paper we examine the impact of improving capacity utilisation on domestic steel prices. Prices and margins improve, but why?

Part of the answer lies in changes in marginal cost of production. This relationship is independent of any change in steelmaking raw materials costs, and any other input cost for that matter. When capacity utilisation is sustained above 85-90%, the pricing regime begins to shift, disassociating from costs and carrying potential to build margins beyond levels changes in marginal costs alone would imply. Our latest view of capacity utilisation implies that China is approaching this threshold.

Higher capacity utilisation offers fundamental support to domestic steel prices
CRU forecasts ongoing increases in Chinese crude steel capacity utilisation as spare capacity is cut further. Our domestic steel price forecasts have been upgraded, and with them, expectations of industry profitability. But why should this be the case - why is there any relationship between capacity utilisation and steel price in the first place?

Impact beyond costs hikes

Rising Chinese capacity utilisation rates imply higher marginal cost of production for domestic steelmakers. Increasing carbon crude steel capacity utilisation, from 84.7% in 2017 to 89.4% in 2020/21 in our latest data, implies an increase of up to $10 /t in marginal costs over this period.

This will provide support domestic steel prices, above and beyond any movement in input costs. In addition, Chinese steel prices have the potential to disassociate from costs, providing further price and margin upside.

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Source:prnewswire.com

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