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Steel: Countering the Chinese dragon! - Views on News from Equitymaster
 
 
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  • Nov 10, 2006

    Steel: Countering the Chinese dragon!

    The global steel industry is highly cyclical, very competitive and fragmented in terms of market share. Currently the industry is at the height of the business cycle and is going through a consolidation phase, which might result in the smaller players being acquired by the larger ones. The total output from the industry exceeded 1.4 billion tons in 2005, most of it accounted for by the increase in output from China. Currently, China produces over one third of the world's crude steel and consumes in the same proportion. It is the largest iron ore importing country.

    Chinese steel industry overview:

    The Chinese steel industry continues to be primarily state-owned extremely fragmented and highly subsidized. Although minority positions in some of the larger producers are privately owned, the Chinese government holds a majority interest in every major Chinese steel producer. There are approximately 800 steel mills in China. In 2000, China produced 126 million tonnes (MT) of steel that was scaled up to 348 MT in 2005, an increase of 176% in only 5 years. The country from being a net importer is now becoming a net exporter. Exports have shot up by 48% YoY in 2005. In absolute terms, imports stood at 9.4 MT and exports at 17.1 MT in the first half of the current fiscal. So much has been the production growth that Chinese imports of iron ore shot up by 23% YoY.

    The Chinese steel industry in its current form is the creation of the Chinese government. It has benefited from massive direct and indirect subsidies. The Chinese government has subsidized the steel industry, the effects of which are manifold. Few examples of the various direct subsidies provided to the steel industry are; transfer of ownership, cash grants, debt for equity swaps, benefits for export performance, energy and raw material grants, import barriers, etc.

    Consequences on global steel industry:

    China's massive subsidization of its steel industry is having consequences that are truly global. The world in many ways constitutes an integrated market for steel. Through a dramatic expansion in capacity fueled largely by subsidies and government-directed lending, the Chinese steel industry is destabilizing the market. Excess capacity in China is estimated to be in the range of 65 MT to 100 MT. Excess capacity of this order, at the time when investment in steel has not come to a stop, will affect domestic and global steel prices. Already, the prices in China are much lower as compared to other neighbouring countries. Low prices have already hit Asian markets. Also, with the additions in capacity and production scaling up, demand for raw materials will rise and with supply constraints, raw material prices will increase.

    China is thus depriving steel producers in other countries of valuable sales by building up its steel industry to artificial levels. This is significant, because steel is a highly cyclical industry; producers depend upon high production and prices in good times to help them weather the inevitable downturn. Chinese exports have flooded world markets, driving down prices.

    Implications for Indian companies

    India being a large exporter of both the iron ore as well as finished steel to China, the recent developments will obviously have a bearing on the domestic steel industry. Indian steel companies are amongst the lowest cost producers and India being rich in mineral resources, they may not feel that significant a brunt of lower prices, as compared to producers in other countries, atleast in the near term. However, over the longer term, they need to take certain steps to ensure that the impact of a fall in prices does as little damage as possible. These companies need to increase the share of value added products and better product mix to have a business model that is sustainable in the long-term. In this regard, the recent move of Tata Steel, one of India's leading steel manufacturers, to acquire Corus, the Anglo Dutch steel giant, is indeed a step in the right direction. This we believe is a perfect example of how maximum synergies can be exploited by marrying the low cost production skills of one company with a high end product manufacturing expertise of another company. Thus, although the Indian companies might not be able to avoid the cyclical nature of the industry, by having a completely integrated operation, they can atleast minimise the damage.

     

     

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