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Credit crunch puts China's steel mills, traders under intense pressure to cut output, prices

China's steel mills and traders are grappling with increasingly tight cash flows due to soaring finished steel inventories and slow sales, which are likely to result in production cuts and lower pricing, market sources said Monday.


Mills and traders have significant money tied up in inventories and the longer they hold onto stock, the more interest they are required to pay. Traders, in particular, tend to secure collateral loans.


Steel output cut plans announced so far by mills will result in a 2.6 million mt of pig iron loss in March. However, production cuts are likely to continue to deepen in March and exceed the February pig iron loss, which S&P Global Platts estimates was 4.5 million mt. This equates to around 7.5% of pig iron output in February 2019.


Dazhou Iron & Steel, or Dagang, an integrated long steel producer in Sichuan province in southeast China with a crude steel capacity of 3.2 million mt/year, recently suspended all of its iron and steel production, according to a source with the mill.


"Frozen end-user demand has led to soaring finished steel inventories and brought great pressure on our cash flow," he said.


According to a report from state-owned China Metallurgical News, Dagang has built up around 140,000 mt of finished steel inventories, occupying capital of nearly Yuan 500 million ($71.5 million). Meanwhile, the company has to continue to pay wages, electricity, freight and other fixed expenses that amount to Yuan 260 million/month.


The mill source added that in the week over February 24 to March 1, only about 10% of construction sites in Chongqing municipality, a major market for the mill, had restarted. "Dagang's warehouses and local spot markets are over brimming with steel inventories," he said.


He said more construction projects would resume in March, but the recovery in construction activity was likely to be slow, partly due to a shortage of labor and protective gear, and partly because of the risk of new coronavirus infections.


Another mill source in central China expected more mills would carry out maintenance in March in a bid to slow down steel production amid low demand. This would especially be the case for mills that had yet to reduce production in January or February, and therefore are grappling with high steel inventories.


Finished steel inventories at mills monitored by the China Iron & Steel Association totaled 21.34 million mt February 20, up 45% year on year. Market sources said stocks would climb higher in March if there were no efficient output cuts.


Sources were still unconvinced that mills would significantly lower production, particularly efficient ones and those with stable sales channels. Logistics have improved for both raw materials and finished steel, and there were still profits on offer, one source said.


China's domestic rebar and hot-rolled coil margins were currently at $33.33/mt and $21.99/mt, respectively, according to Platts mill margin data.


IMPACT TO LAST INTO APRIL

Steel traders are also battling high finished steel inventories and capital constraints, which may affect their steel order bookings for March and April deliveries.


According to CISA, steel inventories held by traders in spot markets totaled 17.35 million mt February 20, 5% higher than the peak of 2019 at 16.45 million mt. However, market sources said real inventories in spot markets were probably much higher as a lot of stock was still in transit due to disrupted logistics. Steel is also likely being stored in alternative locations rather than in normal warehouses, which are already full.


Some sources said total inventories across the supply chain were expected to have reached around 60 million mt in late February, three times as high as normal levels for the time of year.


Steel traders typically take out collateral loans to hold inventories. The longer they hold their inventories and the more steel prices fall, the more traders need to pay in collateral loan margins and interest.


Shanghai's steel traders' association issued an open letter on February 27 requesting steel mills relax payment policies for traders' order bookings in the short term. Mills will usually not deliver the goods until they receive full payment.


Source: S&P Platts

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