One of the last lifelines for China's steel industry may be cut, and that's bad news for iron ore

Sean Gallup/Getty Images

2015 was a tough year for China’s steel industry. Crippling overcapacity as a result of past building binges, along with a decline in Chinese domestic demand, wreaked havoc on the sector, causing many steel mills to suffer substantial operating losses.

According to the China Iron and Steel Association (CISA), large and medium-sized steel mills suffered losses of 53.1 billion yuan ($8.18 billion) in the first eleven months of 2015.

Of the 101 steel mills tracked by the group, total sales revenue fell to 2.66 trillion yuan, a decline of 19.3% from the same period a year earlier.

Up until recently, exporting cheap, excess steel product to offshore markets provided a lifeline to many Chinese mills, helping to partially alleviate dire demand conditions at home.

Over 2015, Chinese crude steel exports rose to 99.6 million tonnes, equating to a substantial 25.5% increase on the levels of a year earlier.

Given falling demand at home, largely as a result of a massive supply overhang in unsold residential units in smaller tier three and four Chinese cities, it all but kept steel prices, and the raw material prices required to produce it, from collapsing even further.

The chart below, supplied by CBA, reveals the acceleration in Chinese steel exports seen in recent years.

However, based on recent data released by China’s customs bureau, that sole lifeline to China’s steel industry may now coming to an end, creating renewed doubt over whether the 20% plus surge in the iron ore price since mid-December can be sustained in the period ahead.

According to Chinese trade data for January released earlier this week, net Chinese steel exports fell by 7% to 8.81 million tonnes, leaving the 12-month drop at 4%.

According to Vivek Dhar, mining and energy commodities researcher at the CBA, the decline was likely due to a ramping up in trade tensions between China and other steel producing nations, particularly in South East Asia.

“The contraction in China’s net steel exports in January likely reflects growing trade frictions as a number of countries have responded to cheap Chinese steel exports,” said Dhar in research note released on Tuesday. “According to the South East Asian Iron & Steel Institute, more than 20 trade complaints have been lodged against Chinese steel exports, with seven cases stemming from south-east Asia.

“The lift in China’s crude steel exports last year highlights the weakness in China’s domestic steel consumption, which is underpinned by slowing construction in China’s property sector, particularly in Tier 3 and 4 cities, which account for 80-90% of new construction volumes.”

Dhar suggests that even with an expected decline in Chinese steel production in 2016, something that would mark the first back-to-back production drop since records began, any trade barriers imposed by other nations on Chinese steel exports could create a severe glut in Chinese steel markets, placing renewed pressure on prices.

“We currently forecast China’s crude steel output to contract again this year due to weaker domestic consumption, with steel exports unlikely to provide any real offset as countries put up trade barriers on steel,” says Dhar. “Under this view, we could see a glut of steel in China push down domestic steel prices, likely translating through to weaker iron ore prices due to margin pressure.”

According to China’s state-run People’s Daily newspaper, around half of the 800 million tonnes of steel China produced in 2015 was deemed to be excess capacity.

The enormous glut saw Chinese premier Li Keqiang pledge to take “firmer resolve and greater efforts” to tackle overcapacity in the nation’s manufacturing sector late last year.

Li singled out the nation’s struggling steel and coal sectors as areas of particular concern.

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