September 28, 2018 / 10:44 AM / in a month

COLUMN-China's shift on winter smog rules rattles steel markets: Andy Home

(The opinions expressed here are those of the author, a columnist for Reuters.)

* Chinese steel production: tmsnrt.rs/2Im1vV3

* Chinese steel exports: tmsnrt.rs/2Ior2ga

By Andy Home

LONDON, Sept 28 (Reuters) - China will not repeat last year’s blanket production cuts in heavy industries such as steel this winter.

Rather, local governments will be given the power to decide how to meet emission targets during the smog-prone winter heating season which runs from November to March.

The steel market didn’t much like the news.

Shanghai rebar futures dropped to two month lows on Friday with hot rolled coil and coking coal prices sliding in sympathy.

The fear is that China’s steel mills, already operating at elevated run rates, will keep churning out metal over a seasonally weak time for demand.

That risks flooding the domestic market, with the ensuing danger of more Chinese steel spilling out to the rest of the world.

Falling exports from China, the world’s largest steel producer, have underpinned a global steel revival.

U.S. steel tariffs and European Union “safeguard measures” against Chinese steel are now starting to play their part but China’s exports have been falling since late 2016.

They have done so in response to Beijing’s simultaneous mass closure of steel capacity and rebooting of demand from the construction sector — and its war on smog.

Which is why the apparent loosening of the winter heating season rules has rattled the steel pricing chain.

Is the market right to be worried? And should the rest of the world’s producers start worrying?

Graphic on Chinese steel production: tmsnrt.rs/2Im1vV3

WHAT’S CHANGED?

There’s no doubt that last year’s forced curtailments in the 26 cities surrounding Beijing and Tianjin hit national steel output.

Production contracted year-on-year in November and December, according to the National Bureau of Statistics. The official numbers come with the usual caveats but the slowdown from super-charged run rates in the middle of the year was clear.

Compliance was mandatory and there was a demonstrable reduction in particulate pollution across the affected area.

Things will change this coming winter.

“Local authorities should carry out production cuts based on their individual situation and refrain from adopting blanket cuts,” the Ministry of Environment and Economy (MEE) said in its finalised plan released on Thursday.

Each plant will be judged on its merits. Those that comply with emissions standards will not have to cut production at all.

It looks at first glance as if economics has trumped environmental concerns at a time when Beijing is fighting to ward off a tariff-induced growth slowdown.

However, the shift in policy is more nuanced than it might initially appear.

Firstly, there is no suggestion that the war on smog is in any way over.

The MEE has set itself a target of reducing average particulate emissions by about 3 percent over the coming winter. Local authorities will be held accountable for delivering that target in their jurisdictions.

Given the goal, it makes no sense closing steel or any other capacity that meets environmental standards. Last year’s blanket cuts were not only unfair on compliant producers but meant sacrificing economic growth for no environmental benefit.

This time around some steel production will be spared but it is equally possible some might be hit with even tougher restrictions than last year.

Moreover, the focus on what happens in the winter heating season may be misplaced.

Smog in the industrialised north of China is particularly bad in winter but it is not as if the rest of the year is characterised by clear blue skies.

Emissions-related cutbacks have been taking place over the summer months as well.

The city of Tangshan, China’s No.1 steelmaking hub, ordered steel mills to cut output capacity by 30 percent to 50 percent over six weeks from July 20 to Aug. 31.

It’s noticeable that Chinese annual production growth braked sharply in August from more than 7 percent to 2.7 percent.

This is clearly the broader direction of travel, emissions restrictions becoming a year-round event and, eventually, being expanded to encompass ever more regions.

The war on smog is by no means won. And until it is, steel production will continue to be impacted by rolling curtailments.

REFORM AND STIMULUS

The other two core components of China’s buoyant domestic steel market have been capacity cuts and robust demand.

Both are evolving as well.

Chinese steel capacity fell from a peak of 1.15 billion tonnes in 2015 to 1.05 million tonnes in 2017, according to the Organisation of Economic Cooperation and Development (OECD).

Not included in those figures are 140 million tonnes of “illegal” production closed by the Chinese authorities.

Arguably, it was the forced removal of this “ghost” production that more than anything else transformed the global steel sector’s fortunes.

As this low-cost and reputedly low-quality production stream was closed, China’s official producers reaped the rewards in terms of sales and profit margins. That in turn reduced the flood of product into global markets.

The days of wholesale capacity closures are now over but Beijing is forging ahead with its broader reform of the steel sector. Industry consolidation looks set to be phase two of the programme, witness reports that China’s largest steel-maker Baowu is in talks to take over rival Magang Group. China aims to put 60 percent of its national steel capacity in the hands of its top 10 producers by 2020, up from a third currently.

It’s another, more targeted way of controlling capacity.

Steel demand, meanwhile, is also shifting as the construction sector loses steam.

Beijing is now doing what it always does when it wants to inject a bit of oomph to a flagging growth rate, namely lifting infrastructure spending.

This one won’t be a blanket spree either.

Rather, it will target specific projects such as the expansion of subway networks across a string of major Chinese cities, an investment that could consume around 80 million tonnes of steel.

Graphic on Chinese steel exports: tmsnrt.rs/2Ior2ga

EXPORT PROOF

Beijing’s ambitions to clean its air and clean up its massive steel sector are undiminished. It’s just that the policies are evolving.

However, this is still a series of giant experiments, any of which could disrupt the internal balance of the domestic market.

Exports will be the litmus test of whether things are working.

Cumulative exports totalled 47.2 million tonnes in the first eight months of this year, down 13 percent on 2017 and 38 percent lower than 2016 levels.

The rest of the world has benefited from that retreat. Production in every one of the world’s next 10 largest producers has been growing this year.

And Chinese producers have benefitted most of all.

Beijing wants to keep it that way. Everyone else should hope it succeeds.

Editing by Edmund Blair

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