Reflect rapid build-up in production capacity

G. Chandrashekhar

Declining Trend

While globally

steel prices are moving up, rates in China's internal market are an exception.

The prices

are the result of supply side factor rather than demand side factor.

There is

evidence of rising cost pressures leading to a slowdown in the rate of Chinese capacity growth.

Mumbai, July 21

The global steel industry has not had it so good for sometime as now. Demand is unabated and prices are firm. Although the upward movement has somewhat slowed down in recent weeks, global steel prices have continued to remain producer-friendly in most regions.

The US and EU benchmark prices for key products are now a long way above their lows seen around August/September last year. Automotive and construction sectors are primary demand drivers for steel.

Strong economic growth

Rising steel demand is indicative of strong global economic growth and reinforces the picture of a global economy where demand for raw materials is exceptionally high.

While globally steel prices are moving up, prices in China's internal market are an exception. Local prices for sheet and long products have fallen in the past month. Does it signal a slowdown in the country's steel demand? Rather than any slowdown in end-use demand within China, lower prices are more a reflection of the rapid build-up in steel production capacity that China has seen over the past few years, according to Barclays Capital.

In perspective

To put this in perspective, as recently as early 2004, China's monthly steel production was running at a rate of 20 million tonnes (mt), accounting for about 24 per cent of global production. Last month, the production was 37 mt, accounting for 35 per cent of global production.

So, China's internal prices are the result of supply side factor (large production) rather than demand side factor (slowdown in consumption). It is well known that the country is a major producer, consumer and importer of a large number of commodities. Its demand-side influence on the world commodity market is well understood.

Growth in China's steel production has parallels in the base metals sector too where it has grown rapidly in recent years to become the world's largest producer of aluminium and zinc and the second largest producer of refined copper, an analyst with Barclays pointed out.

Ironically, in none of these sectors China has a competitive advantage in the basic raw materials (iron ore, bauxite/alumina, copper concentrates) required to sustain the massive production capacities it has built. So, in order to utilise the production capacities, the country has had to rely on imports on a massive scale.

Eroding advantages

A combination of proximity to local markets, tariff protection, low labour costs and artificially low energy costs have all contributed to China's growth in metals production capacity, but many of these advantages are now being eroded away, the analyst commented.

Meanwhile, the world's raw material markets remain exceptionally tight. Iron ore prices have moved higher again in the spot market while copper concentrates are in desperately short supply.

There is evidence of rising cost pressures leading to a slowdown in the rate of Chinese capacity growth for some metals. If this is sustained, it may add a new price supportive dynamic to a number of metals markets going forward.

(This article was published in the Business Line print edition dated July 22, 2006)
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