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Analysis: China steel margins skating on thin ice


  • Steel margins were thin before the iron ore price rise

  • Iron ore demand remains strong because China is producing steel at record levels

  • Iron ore prices are likely to stay high until supply recovers and/or China cuts steel output

Chinese steelmakers have seen their margins eroded due in large part to seaborne iron ore prices rising by around 70% since the start of the year. But margins for domestic hot-rolled coil sales were already under pressure before Vale's iron ore tailings dam incident on January 25, and the cyclone that hit Australia's Pilbara region in March, caused iron ore prices to start their climb.

In January, S&P Global Platts 62% Fe iron ore benchmark averaged $76/mt CFR China; domestic Chinese HRC prices averaged $542/mt, and HRC margins were only $45/mt. The low steel margins had nothing to do with high iron ore prices, but more to do with lackluster downstream demand.

The market situation changed markedly from early June, however, when iron ore prices hit 5-year highs of more than $120/mt CFR due to tight supplies and falling port stocks. This squeezed HRC margins hard, down to breakeven levels at times, before they recovered to $32-36/mt later in June.

Steel margins started to fall from November last year as China's deleveraging program took the wind of the country's economic sails and stifled demand for steel.

Traders and privately-owned companies found credit harder to come by; and consumers who were already highly leveraged to property struggled to borrow.

The auto and white goods sectors suffered in particular, crimping demand for flat steel.

The weakness in manufacturing was borne out by China's two purchasing managers' indices, published by Caixin and the National Bureau of Statistics, which showed the sector was technically in contraction (below 50 points) over December to February before recovering from March. However, the improvement was short-lived, as the June PMIs were below 50 again.


Over January-June this year, Chinese domestic HRC prices averaged Yuan 3,857/mt ($560/mt), compared with Yuan 4,124/mt ($598.5/mt) in the first half of 2018. Over the same period, iron ore prices averaged $91.7/mt CFR, up from $61.9/mt a year earlier.

This shows that steel prices fell 6.4% on the year before in H1, while iron ore prices increased by 48%.

As a result, HRC margins over H1 this year dropped by 44% on the year before - from $132/mt in January-June 2018 to just $74/mt in the first six months of this year.

Chinese mills were unable to pass on the higher iron ore input costs to finished steel prices because of tepid downstream demand.

Export steel markets were even less attractive due to the amount of competing steel that has constrained global prices.

Furthermore, depressed manufacturing is not just confined to China; it seems to be a global issue, which is why HRC demand and prices everywhere are weak.


Apart from the odd exception, Chinese steel producers enjoyed a bull run between mid-2017 and October 2018. Fueled by strong domestic demand and high steel prices, steel mills reported robust financials.

For example, in the first half of 2018, Baosteel's profit rose by 62% to $1.5 billion. In contrast, Angang recently issued a profit warning, saying its January-June half net profit will be 67% lower on last year.

The hitherto positive financial performances were aided in part by relatively low iron ore prices over much of 2017 and 2018, which were largely rangebound at mid-$70/mt CFR levels - and seemingly decoupled from steel prices. Now, however, the two are inextricably linked once more.

Incentivized by strong profits in 2017 and 2018, Chinese mills lifted steel production and brought on new capacity.

Platts estimates that 25.3 million mt/year of new hot-strip mills were commissioned in 2018, with another 31.6 million mt/year due online this year. New blast furnace and electric arc furnace capacity is also being built.

These facilities are supposed to be replacing older dismantled ones of a similar size, but the new operations will be larger and more efficient. Steel capacity looks set to continue creeping up.

China's crude steel production continues to surge, notwithstanding announced output curbs in Hebei province in July for environmental reasons. Production over January-June was almost 10% higher on the year before.


China imported 1.064 billion mt of iron ore in 2018, down from 1.075 billion mt in 2017, according to China customs data. In June this year, China imported just 75.2 million mt, the lowest amount since early 2016.

Year-to-date imports of 500.5 million mt indicates imports could be lower again this year.

Exports from Australia have started to recover - with BHP and Fortescue Metals Group shipping at record levels in June. Rio has trimmed its export guidance by around 13 million mt this year, while the situation around Vale's production and exports remains unclear.

Most analysts predict a seaborne iron ore shortfall of around 40 million mt this year.

Given the big jump in steel production, squeeze in steel prices and tighter iron ore supply, it is not surprising that margins have been squashed and steelmakers are feeling the pressure once again.

Though demand will likely improve in Q4, the best way to ease the margin pressure would be to lower steel production and therefore iron ore requirements.

But this is unlikely to happen as Chinese mills are typically reluctant to trim production. Higher output lowers unit costs at a time of slim margins and no one wants to lose market share to the competitor down the road.

As a result, iron ore prices look set to be well supported over the balance of this year, but steel margins will continue to come under pressure.

Source: S&P Platts

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