Analysis of the Development Status and Prospects of China's Steel Industry in 2018

The year 2017 was an extremely symbolic one for the iron and steel industry. After the economy hit bottom and rebounded in 2016, it maintained a stable high level. The wave of supply-side structural reform surged forward, and strong administrative controls—such as the rectification of strip steel and production restrictions imposed for environmental protection—further pushed the industry's profitability to a decade-high. By the end of December 2017, the profit per ton of hot-rolled coil (HRC) and rebar had reached as high as RMB 738 and RMB 1,304 respectively, exceeding the levels recorded in the same period of 2007.

Faced with such high profitability, it is imperative for us to look beyond the complex superficial phenomena and re-examine the core of the steel industry: what exactly is the source of this profitability?

Trend Chart of Steel Price, Ore Price and Profitability (2007–2017)

Data Source: Compiled from Publicly Available Information

Two Pathways for Steel Enterprises' Profit Growth

As a typical cost-plus industry, the profitability of the steel sector is not necessarily correlated with raw material prices. For example, in 2016, the iron ore price rebounded from a low of around $40 to over $70, yet the profit per ton of rebar exceeded RMB 1,000 during the same period. Conversely, since the start of 2015, the iron ore price dropped from a high of $70 to a multi-year low of $38, but steel enterprises incurred losses of RMB 200–300 per ton instead. Real-world evidence has proven that traditional perceptions fail to explain the intrinsic dynamics of the industry.

We argue that, given the high homogeneity of finished steel products, the profitability of individual smelting enterprises depends on the gap between their own processing and manufacturing costs and the industry’s marginal cost. The profit growth of target investment enterprises can be achieved in two ways: on the one hand, it can benefit from the upward movement of the industry’s marginal cost; on the other hand, it can be realized by optimizing costs and changing their relative position in the industry’s cost curve. The direction and speed of the rise in the industry’s marginal cost are determined by the industry’s capacity utilization rate and the shape of its cost curve, while shifts in relative position stem more from the emergence of new technologies or turning points in industry policies.

The steel industry is a typical midstream processing sector.

Data Source: Compiled from Publicly Available Information

Since most listed steel companies are state-owned, they are at a disadvantage compared with private steel enterprises in terms of cost control. The industry’s inherent stepped smelting cost structure means that the profit realization of most listed steel companies in the high-cost zone must meet the condition of operating rates approaching the limit—simply put, a shortage of production capacity across the entire industry. This was fully manifested in periods such as 2000–2004, June–July 2009 following the 4-trillion-yuan stimulus plan, and the period after the crackdown on strip steel in 2017.

Schematic Diagram of China’s Steel Industry’s Stepped Processing Cost Structure

Data Source: Compiled from Publicly Available Information

Capacity Supply in 2017 Reached a Periodic Bottleneck

The campaign to rectify strip steel that began in the fourth quarter of 2016 brought the industry’s capacity reduction drive to a climax. By the end of June 2017, strip steel production capacity had been basically eliminated. Over 600 strip steel producers were banned or shut down across 27 provinces (autonomous regions and municipalities directly under the Central Government) nationwide, involving approximately 120 million tons of production capacity and affecting 50–60 million tons of operational output.

Given the covert nature of strip steel production, the withdrawal of a large amount of hidden production capacity led to a rapid increase in reported output, pushing the industry’s actual capacity utilization rate to an extremely high level. We observed that although the profit per ton of steel continued to rise after May 2017, the industry’s average daily steel output fluctuated narrowly around 2.4 million tons. The insensitivity of output to profitability indicated that the industry’s supply capacity had basically reached its maximum, with the actual capacity utilization rate operating at a peak level.

This is evidenced by specific cases: in the third quarter of 2017, Shougang Shunyi Cold Rolling Plant and *ST Chonggang—both of which had been suffering consecutive losses—turned profitable. The profitability of steel enterprises in the high-cost zone of the industry signifies that the industry’s capacity utilization rate had reached full-load status.