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ARTICLE: Will steelmakers’ margins outside China also fall? November 2016

Metal Bulletin Research (MBR) looks at how rising raw materials costs have affected producers in China, and how the rest of the world will cope, should Chinese price rises spread.

Over recent weeks, steel producers have been observing how Chinese steelmakers and resellers have coped with the sudden surge in the costs of raw materials in the country.

The answer – as far as MBR is concerned, and as revealed by the graph below – is “not very well”. And this is despite the high demand for products in China so far this year.

The graph looks at the performance of hot rolled coil (HRC), apparent consumption of which rose by more than 4% year-on-year through the first three quarters of 2016. HRC is among the most commonly consumed products in China, and demand for the material over those nine months was surpassed only by related welded pipe products.

As we have revealed in earlier Outlook articles, Chinese steel consumption overall rose by less than 1% over the same period, held back by construction steels such as wire rod and rebar, as well as rail.

The large rise in average coking coal prices since September has not yet been passed on to steel prices in China, which have merely stabilised over recent months. As a result, nominal metal price spreads or margins over raw materials have fallen backward.

There can be little doubt, in our view, that Chinese margins will improve overall in 2016, following the unprecedented lows in 2015.

By MBR’s calculation, taking into account the difference between output (HRC) and input (iron ore and coking coal) prices, the basic margin has risen by the equivalent of $30 per tonne this year, to $162 per tonne from $133 per tonne.

By international standards, this margin is still terrible (see below) and is lower than the $186 per tonne figure we recorded for China in 2014, the latest year in which Chinese steel producers recorded profits. But the future, unfortunately for the Chinese, is not looking so bright.

As Metal Bulletin readers will know, raw materials prices in China have risen more quickly so far in November, and MBR continues to doubt that downward corrections will be seen until the industries have a chance to rebalance.

As inevitable as this rebalancing appears, to industry observers and to miners themselves, demand for raw materials – especially in China – continues to surpass expectations. Indeed, according to the country’s National Bureau of Statistics (NBS), Chinese coke production volumes rose more quickly than for any other steel or steelmaking raw material in the most recently recorded month of September, gaining by 7.3% year-on-year.

Coke has struggled to keep up with pig iron production so far this year, as shown in the graph below – just as pig iron, to a lesser extent, has struggled to keep pace with steel production.

As a result, as long as steel production volumes continue to rise – which seems likely, given the provisional data and estimates provided recently by member-mills of the China Iron & Steel Assn (Cisa) – the tightness in raw materials markets can only continue.

Clearly, the high prices of coke and related coking coal are encouraging steelmakers to seek alternative raw material supplies, which include scrap but also higher quality iron ores.

The higher ore quality in the popular 62% Fe Metal Bulletin Iron Ore Index, for example, limits the high use of coke in China, although it is also underpinning higher iron ore prices, while the greater use of scrap in basic oxygen furnaces (BOFs) reduces the hot metal or primary iron required to make steel.

But then, understandably, Chinese scrap prices are also rising, with scrap consumers having to return to the US export market to secure sufficient supplies.

While Chinese steelmakers are clearly running out of cheap options, developments in November suggest that they are at least managing to maintain the margins they recorded in October. What is encouraging for steelmakers elsewhere is that they are managing to do that while their costs, so far in November, have been averaging nearly $40 per tonne higher than in October.

We know, from the experience of a year ago, the level of margin that encourages steel production cuts in China. In the fourth quarter last year, the gap between the HRC and hot metal proxy slipped to just $100 per tonne, in China as in the EU (see graph below). MBR believes that it was because of these poor margins that production cuts accelerated from December 2015 to February this year.

Those margins are now just $40 per tonne below the level the industry was at in October, and has been at so far in November.

In these circumstances, MBR suspects that it is still unlikely that there will be significant production cuts in China any time soon, but can mills continue to raise prices and sustain higher output rates? In our opinion, the answer is “no”, although it will be interesting to see how successful the European integrated producers will be in pushing through their own targeted rises in the short term.

The effects of rising raw materials costs have yet to be seen by EU steelmakers, so their margins remain relatively high. In addition, seasonal conditions should soon improve in most northern hemisphere markets, other than China.

However, as in China, we suspect that European producers will also be taking a margin hit in the short term.

This article was written by Metal Bulletin Research’s steel raw materials analysts. For a free sample of their regular analyses, click here.
This content is provided by Metal Bulletin Events for informational purposes only, and it reflects the market and industry conditions and presenter’s opinions and affiliations available at the time of the presentation.