Here's why trouble's brewing for high-cost iron ore and coal miners

Getty.

China’s steel industry, responsible for producing more than half global output according to data release by the World Steel Association, is bleeding cash. Every producer is feeling pain, raising the prospect that production may shrink substantially in the years ahead.

And no, that’s not sentiment from an ardent iron ore bear, quite the contrary. It’s from the chairman of China’s second largest steel producer, Shanghai Baosteel Group.

Speaking overnight in Shanghai, Xu Lejiang told reporters that losses for the industry totaled 18 billion yuan ($2.8 billion) over the first eight months of the year compared with a profit of 14 billion yuan in the same period a year earlier, suggesting that Chinese steel production may decline by as much as 20% due to chronic sector oversupply.

“If we extrapolate the previous experience in Europe, the United States, Japan, their steel sectors have all gone through painful restructuring in the past, with steel output all contracting by about 20%,” Xu told Bloomberg.

“China will eventually get there as well, regardless how long it takes.”

“The whole steel sector is struggling and no one can be insulated. The sector is facing increasing pressure on funding as banks have been tightening lending to the sector — both loans and the financing provided for steel and raw material stockpiles.”

Based on data supplied by the China iron and steel association (CISA), Chinese crude steel production jumped more than 12-fold in the 24 years to 2014, something that coincided with China marching up the rankings of the largest economies within the world.

Now, with China’s government now targeting services and consumption-led growth, rather than that from industry and trade, demand for steel product that propelled production higher on the back of rampant infrastructure investment is slowing, pointing to the likelihood that steel production within the country may have peaked.

According to CISA, Chinese crude steel output probably peaked last year at 823 million metric tons. Fitting with that view, according to data released by the government alongside the Q3 GDP report, crude steel production in first nine months of the year totaled 608.9 million tonnes. That’s a decline of 2.1% on the same period a year earlier.

The chart below from the World Steel Association, showing both global and Chinese steel production, bolsters the view that steel production is waning.

With Chinese steel producers now bleeding cash on the back of overcapacity within the sector, the question many will be asking is whether that will soon be replicated further up the supply chain.

While iron ore and coal miners have been cutting costs aggressively in an attempt to remain profitable, that can only last so long. With seaborne supply of iron ore and coal continuing to grow, weak demand and steel production falling, it’s clear that price risks for both are to the downside.

If Xu is right and Chinese steel production is to slump by 20% in the years ahead, it will not only see Chinese steel smelters go out of business but also many of the high-cost miners that supply them.

You can read more here.

NOW WATCH: Money & Markets videos

Want to read a more in-depth view on the trends influencing Australian business and the global economy? BI / Research is designed to help executives and industry leaders understand the major challenges and opportunities for industry, technology, strategy and the economy in the future. Sign up for free at research.businessinsider.com.au.