LONDON (Reuters) - Chinese steel output fell by 1.3 percent in the first half of the year.
This is self-evidently not good news for the iron ore market, given China is the single biggest buyer of seaborne ore.
A surge in supply on the back of expansions by the world’s largest producers was always going to pose hard questions of the iron ore price.
The adjustment process gets a whole lot messier if demand from Chinese steel-mills is contracting exactly at the same time as new supply is looking to find a home.
Which is why the iron ore price, as assessed by The Steel Index, is struggling to stay above the $50-per-tonne level, just shy of the all-time low of $44.10 registered at the start of this month.
However, the real problem for iron ore, indeed for the whole ferrous supply chain, is not that Chinese steel production is falling, but that it is not falling fast enough.
The first-half drop in China’s steel production may look marginal, equivalent as it was to just 5 million tonnes less output than in the first half of last year.
But it’s hard to overstate just what a step-change this represents for a country that has registered nothing other than production growth, often double-digit growth at that, for many years.
The slowdown has been evolving since October last year, when year-on-year growth first turned negative. It has remained negative in every month since but one (December), fuelling a debate as to whether China’s steel output has peaked well ahead of original expectations.
The more pertinent question, however, is whether China’s steel demand has peaked.
China’s own steel association, CISA, thinks it has. “It is obvious that China’s apparent steel consumption has already entered the peak period and big rises in market demand have already passed into history,” it said.
Demand in what was, until very recently, the driver of global steel demand growth, has taken multiple hits this year.
The biggest has come from the residential construction sector, which is now undergoing a painful adjustment as a previous boom turns to something close to bust.
Investment in real estate grew by 4.6 percent in the first half of this year. A year ago it was running at just over 14 percent.
It’s just one part of a broader slowdown in fixed asset investment (FAI) in China. Despite all the talk of government infrastructure spending, FAI growth has decelerated to 11.4 percent from 17.3 percent over the same period.
Moreover, previous non-construction bulwarks of the country’s steel demand, such as the automotive sector, are also showing signs of weakening.
Vehicle sales have been falling year-on-year for several months, with passenger vehicle sales falling faster than commercial vehicle sales.
The clearest indication of the current mismatch between Chinese production and demand for steel is the boom in exports of products.
These totaled 52.4 million tonnes in the first half of 2015, up by almost 28 percent, or around 11.4 million tonnes, on the same period of 2014.
To understand the scale of this outbound flood, consider the fact that monthly exports are running at an annualized pace of around 107 million tonnes. That’s more than last year’s production in the United States. It is, in fact, close to the combined output of the whole of North America.
Trade tensions are inevitably rising, particularly since demand just about everywhere else is also fading.
Indeed, analysts at Macquarie Bank suggest that the global steel outlook is so negative that “we are probably not too far off a global industrial recession (though not an economic one)”. (“Steel under pressure from all angles,” July 23, 2015).
And yet even with exports acting as a powerful lifeline for China’s steel mills, CISA says 43 of its 100 or so members lost money in the first half of this year.
And that also despite the massive drop in input costs resulting from bombed-out iron ore and coking coal prices.
Steel-making margins are still at best razor-thin and at worst negative.
Chinese overproduction and excess capacity have been steel market themes for a long time but there is a sense that sectoral instability is rising.
CISA notes its members are “struggling with credit line cuts and difficulties in rolling over loans” as banks tighten their lending against the sector.
Previous periods of credit stress in China’s steel leviathan have sent shockwaves along the entire supply chain, triggering sudden, vicious destocking and sharp falls in the iron ore price.
The irony is that such financial pressures are likely to lead to steel producers maintaining run rates at unsustainable levels as they try to generate cash flow.
Some short-term relief might come from the forced shuttering of capacity around Beijing on environmental grounds ahead of planned celebrations to mark the 70th anniversary of the victory in World War Two in September.
But such temporary measures will not alter the current dangerous dynamic of Chinese overproduction in a context of weakening local and international demand.
At some stage something must give and the longer the adjustment is deferred, the stronger the possibility that it will happen in a disorderly way.
The iron ore market is already ugly, even with Chinese steel production falling only marginally.
With no sign of the supply surge ending any time soon, the instability in China’s steel supply chain means there may yet be worse to come.
A lot worse unless the juggernaut starts braking harder.
Editing by Dale Hudson