China releases first production cut directive. What will be its implications on steel industry?

Crude steel production in the first quarter of 2023 (Q12023) from China's top seven producing provinces rose 6% y-o-y to 262 million tonnes (mnt) compared to 247 mnt in the same quarter in 2022, as per data maintained with SteelMint. Except for Jiangsu and Anhui, the balance five reported an increase in production with Hebei, which enjoys the highest share in the total, showing the steepest rise.

It may be mentioned that China's total crude steel production in 2022 declined by around 20 mnt (2%) to 1,013 million mnt from 1,033 mnt in 2021.

Hebei sees 21% increase in output

Amongst the seven provinces, Hebei is the largest crude steel producer and in Q1CY23 its output grew the highest amongst the seven provinces, by 21%, to 57 mnt against 47 mnt seen in the same quarter last calendar.

Hebei has the highest concentration of blast furnaces in China and many of these mills ramped up production with the onset of the new calendar in anticipation of demand picking up in Q1.

Jiangsu: Jiangsu, the second-highest crude steel producing province, however, saw a 1% y-o-y dip to 30.5 mnt against 31 mnt in the period under review. Jiangsu, which houses numerous electric arc furnaces, is the second-largest province in China, and contributes over 10% of the country's total crude steel production.

Shandong: This province is the fourth-largest crude steel producer and in these three months has seen an output growth of 14% to 19 mnt from 17 mnt in January-March, 2022.

First production cut document released

However, the Chinese government has been making efforts to reduce crude steel output, and stressing on quality rather than quantity. It had asked mills to formulate rational production plans and to ensure output did not exceed last calendar's volumes.

Since the beginning of the calendar, the steel industry has been impacted by the double whammy of insufficient demand and high costs and has been making losses. The government's booster shots were expected to increase steel demand. But high prices led to fluctuating and eventually waning demand amid a production glut.

Now, a key document from the Tanghshan City authorities, or "the first shot" was unveiled recently, which has made it clear production will have to be curbed. There was also news that mills in Hubei, Jiangsu and other regions have also received notices of production control, which prompted a significant drop in futures and spot market prices.

Implications of first production control document on steel market

1) Pressure to reduce production intensifies: Crude steel output in Q1 is up 6.1% y-o-y to 262 mnt while the domestic steel industry has lost RMB 4.84 billion ($6.98 billion), a y-o-y drop of 112%.

If output has to remain the same as last year's, ie, at 1.013 bnt, then over April-December, it has to be maintained at 751 mnt with a maximum monthly level of 83.5 mnt. The daily output level must be maintained at 2.73 mnt but it touched 2.91 in Q1 and is likely to hit a record high of 3.3 mnt in April.

Thus, the pressure to reduce production has increased exponentially.

2) Rationalise raw material prices: The cost of raw materials was high at the beginning of the year. These subsequently dropped when steel prices declined globally this year. However, the decline did not correspond to the drop in steel prices which put mills' margins under pressure. The iron ore index fell almost 12%, the lowest point this year, to 103.70 points compared to 117.70 points in January and a drop of 22%, from the highest point of 133.1 points on 15 March.

The price of Tangshan secondary metallurgical coke touched its lowest point of RMB 2,050/t in 2023. Compared to the highest point at the beginning of the year of RMB 2,650/t on January 3, it dropped RMB 600/t, or 22.6%.

Ferrous scrap in Tangshan was at RMB 2,510/t, down RMB 210/t, or 7.7% from RMB 2,720/t seen on 3 January and RMB 380/t lower from the highest point of RMB 2,890/t on March 13.

Production cuts will help to moderate these prices.

3) Bring mills back to profits: Since the beginning of this year, the domestic steel industry has faced the double whammy of "insufficient demand and relatively high costs", putting a squeeze on margins.

This year's crude steel output curbs will gradually bring back the supply-demand balance which, in turn, will rationalize raw material prices and hopefully help mills return to profit.

Outlook

Crude steel production in the first half of the year will show a gradual decline, and the pressure to reduce in the second half of the year will be greater, which may drive down the cost of raw materials.