China closes excess capacity, but diminishing demand will undermine the efforts
China is going to close its outdated steel capacity which will bring the country total steel capacity below one billion tonnes by 2025, according to China Iron and Steel Association (CISA). Commodity Inside understands that this is in line with the country efforts on improving environmental conditions as well with the current Sino-US trade tensions. There is a massive pressure on China to reduce its excess steel supply as its cheaper exports are damaging steel industries across the world including the US.
Most of the Chinese steel companies are run by the provincial governments. So, keeping employment and a contribution of the provincial government to the GDP remained some of the key goals for the state-owned companies, whereas making a profit was the last prioritised part in their business model. Such market condition nurtured an unhealthy competition and surplus capacity in the market, where more than half of the companies have now been suffering losses. Induction furnaces exacerbated the Chinese steel market further through pollution, cheap low-quality steel and excess supply in the market.
The situation has now been changing as priorities for the provincial governments have now shifted as well. China announced in early 2016 to close around 150 million tonnes capacity out of its total 1.2 billion tonnes capacity over the five years period to help increase profitability and capacity utilisation rates. CISA estimates that so far around 120 million tonnes of crude steel capacity had already been closed. China is aiming to close around 30 million tonnes of capacity in 2018. There are also some questions about what really counted as capacity closures- temporary closures, relocation or permanent closures through dismantling. It seems the combination of all of these. So far, M&A proved a very effective tool in increasing the capacity utilisation and improving margins. The consolidation process also helped in permanently shutting down capacity in key provinces.
Obaid Shah understands that given China is moving from manufacturing to a service-based economy, so certainly, steel demand is likely to decline gradually. Therefore, any efforts to close excess capacity will likely be offset by a reduction in real demand. So, it is highly likely that steel overcapacity will persist for a very long period. One Belt One Road (OBOR) initiative is one of the tools which are used to address the excess capacity issue but not enough to be a panacea.
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