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China's steel embracing a new age
By Judy Zhu, Koun-Ken Lee and Ouyang Wei |
October 9, 2012, Tuesday
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Print Edition
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OVER the last five decades, China's steel industry was part of the North East Asian miracle: its steel consumption surged from 3 percent of the world's total in the late 1960s to 42 percent in 2010, while its steel production rose from 3 percent to 44 percent of the global total over the same period.
The highest growth in steel consumption and production has come in the last decade, when the country's annual gross domestic product growth stabilized above 8 percent and urban growth created strong demand for the infrastructure development in rural areas.
While no market can grow forever, we think the Chinese steel demand growth will continue up to 2025 - a good five years beyond the general market consensus of 2020. We use per-capita consumption as a benchmark to help forecast the peak. Steel consumption in large countries over the course of their development - specifically, the relationship between per-capita steel consumption and per-capita GDP in real terms - follows a similar trend.
Steel intensive
Although we expect infrastructure to contribute less to GDP growth over the long term, and the contribution from domestic consumption to gradually increase, infrastructure will remain one of the most important economic growth drivers. A higher standard of living requires development of infrastructure and manufactured products. This includes building new houses, roads, railways, airports and bridges, as well as producing cars, white goods and more pipelines for energy transmission. All of these are steel-intensive.
In the last 10 years China's urban population has increased rapidly, from less than 40 percent to 51 percent of the total population, generating huge demand for infrastructure and manufactured goods. Urban population growth should slow from here, contributing less to per-capita use of steel.
Development in Japan and the US shows a similar pattern. In Japan, once the urban population reached 50 percent of the total (in 1968), the pace of urbanization slowed significantly (from 1969-1982). Per-capita steel consumption peaked in the early 1970s, while urbanization continued to trend up, albeit much more slowly.
In China, we expect demand for infrastructure projects to slow in the next decade. However, demand for manufactured goods should grow steadily despite the slowdown in the pace of urbanization, as these goods have shorter lives.
The next 10 years might witness structural change in market applications for steel, given the increasing importance of the manufacturing sector that will be driven by domestic consumption. While a small group of steel mills in China have realized that it is time to change, most are not yet prepared to produce more high-end products.
In the very long term, we believe that mills should focus less on producing long products that are mostly used in construction, although we expect this structural shift in demand and output to take place gradually over the next 10 years. In our view, the current production infrastructure means that China's mills are not positioned to capture the best returns. Scrap steel availability should improve as the economy matures. Thus, new mill investments are likely to move away from basic oxygen furnaces (BOF) towards electric arc furnaces (EAF), following the path taken by steel mills in developed economies.
Another major change in China's steel manufacturing landscape over the next decade is the rebalancing of capacity, currently concentrated in the north. This shift will be driven primarily by government incentives, and mills will be able to improve profitability by expanding in the south and the west.
For western China, the plan is to "moderately" develop the regional steel industry given the strength in resources. Xinjiang Uygur Autonomous Region, in particular, is a popular location for new steelmaking capacity owing to readily available steelmaking raw materials, including iron ore and coal. Southern and south eastern China will be encouraged to build major steelmaking bases given the lack of sufficient steel production in this consumption-intensive region.
Less aggreesive
China has experienced oversupply and low utilization of infrastructure because of overdevelopment in the last 10 years. Thus, the pace of further development should slow, with less aggressive spending on new projects.
We acknowledge that China's current steel capacity exceeds domestic demand, but our view of long-term demand growth supports further selective expansion. Steel capacity utilization will remain high, averaging close to 90 percent over the next decade.
Hence, while we recognise that the current outlook for China's steel industry is pessimistic, we believe this is temporary and that demand growth will outpace supply growth from 2015.
We remain long-term iron ore bulls - underpinned by demand in China. We have lowered our 2012-15 iron ore price forecasts. However, our long-term price forecasts are unchanged, supported by escalating costs. We believe that forward prices, which are quoted in a range of between US$90 to US$94 per ton for delivery throughout 2015, do not yet fully factor in long-term demand from China. Steel consumption is likely to decline on a year-on-year basis when GDP growth is below 5 percent.
Judy Zhu, Koun-Ken Lee and Ouyang Wei are analysts with Standard Chartered Bank. The opinions expressed are their own.
The highest growth in steel consumption and production has come in the last decade, when the country's annual gross domestic product growth stabilized above 8 percent and urban growth created strong demand for the infrastructure development in rural areas.
While no market can grow forever, we think the Chinese steel demand growth will continue up to 2025 - a good five years beyond the general market consensus of 2020. We use per-capita consumption as a benchmark to help forecast the peak. Steel consumption in large countries over the course of their development - specifically, the relationship between per-capita steel consumption and per-capita GDP in real terms - follows a similar trend.
Steel intensive
Although we expect infrastructure to contribute less to GDP growth over the long term, and the contribution from domestic consumption to gradually increase, infrastructure will remain one of the most important economic growth drivers. A higher standard of living requires development of infrastructure and manufactured products. This includes building new houses, roads, railways, airports and bridges, as well as producing cars, white goods and more pipelines for energy transmission. All of these are steel-intensive.
In the last 10 years China's urban population has increased rapidly, from less than 40 percent to 51 percent of the total population, generating huge demand for infrastructure and manufactured goods. Urban population growth should slow from here, contributing less to per-capita use of steel.
Development in Japan and the US shows a similar pattern. In Japan, once the urban population reached 50 percent of the total (in 1968), the pace of urbanization slowed significantly (from 1969-1982). Per-capita steel consumption peaked in the early 1970s, while urbanization continued to trend up, albeit much more slowly.
In China, we expect demand for infrastructure projects to slow in the next decade. However, demand for manufactured goods should grow steadily despite the slowdown in the pace of urbanization, as these goods have shorter lives.
The next 10 years might witness structural change in market applications for steel, given the increasing importance of the manufacturing sector that will be driven by domestic consumption. While a small group of steel mills in China have realized that it is time to change, most are not yet prepared to produce more high-end products.
In the very long term, we believe that mills should focus less on producing long products that are mostly used in construction, although we expect this structural shift in demand and output to take place gradually over the next 10 years. In our view, the current production infrastructure means that China's mills are not positioned to capture the best returns. Scrap steel availability should improve as the economy matures. Thus, new mill investments are likely to move away from basic oxygen furnaces (BOF) towards electric arc furnaces (EAF), following the path taken by steel mills in developed economies.
Another major change in China's steel manufacturing landscape over the next decade is the rebalancing of capacity, currently concentrated in the north. This shift will be driven primarily by government incentives, and mills will be able to improve profitability by expanding in the south and the west.
For western China, the plan is to "moderately" develop the regional steel industry given the strength in resources. Xinjiang Uygur Autonomous Region, in particular, is a popular location for new steelmaking capacity owing to readily available steelmaking raw materials, including iron ore and coal. Southern and south eastern China will be encouraged to build major steelmaking bases given the lack of sufficient steel production in this consumption-intensive region.
Less aggreesive
China has experienced oversupply and low utilization of infrastructure because of overdevelopment in the last 10 years. Thus, the pace of further development should slow, with less aggressive spending on new projects.
We acknowledge that China's current steel capacity exceeds domestic demand, but our view of long-term demand growth supports further selective expansion. Steel capacity utilization will remain high, averaging close to 90 percent over the next decade.
Hence, while we recognise that the current outlook for China's steel industry is pessimistic, we believe this is temporary and that demand growth will outpace supply growth from 2015.
We remain long-term iron ore bulls - underpinned by demand in China. We have lowered our 2012-15 iron ore price forecasts. However, our long-term price forecasts are unchanged, supported by escalating costs. We believe that forward prices, which are quoted in a range of between US$90 to US$94 per ton for delivery throughout 2015, do not yet fully factor in long-term demand from China. Steel consumption is likely to decline on a year-on-year basis when GDP growth is below 5 percent.
Judy Zhu, Koun-Ken Lee and Ouyang Wei are analysts with Standard Chartered Bank. The opinions expressed are their own.
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