How China’s Economic Shock Therapy is Shaking Up Commodities

China’s steel industry expanded from backwater to global giant in the past three decades and it’s now making the first concerted push to shrink the bloated sector.

Net capacity reductions -- the amount shuttered minus new additions -- will reach almost 200 million metric tons over 2016 and 2017, according to a Morgan Stanley estimate in a note dated Sept. 25, more than Japan’s total annual capacity. It still leaves China with a total capacity of about 1 billion tons a year.

The clampdown was rolled out in three waves:

• The first Five-Year Plan announced in January 2016 ordered 150 million tons of outdated or redundant official capacity to close by 2020, mostly in the state sector. More than 100 million tons have already been shuttered, according to government data.

• Mass closures of illegal and grey economy plants that employ low-tech induction furnaces, which were never counted in official steel output data.

• Orders for steel production to be temporarily reduced, with up to 50 percent of plants to close temporarily in the winter months across the steel hubs of northern China. This could theoretically lead to a loss of 32 million tons, according to Macquarie Group Ltd.

At the same time, the nation has been adding fresh, mostly low-cost capacity, which consultant Kallanish Commodities Ltd. estimates at 5.8 million tons last year and as much as 30 million tons this year.

Increased supply after the temporary closures in winter “should eventually overwhelm demand, restoring inventories and bringing down steel prices with it,” Macquarie analysts said in an emailed note dated Oct. 10. “As Chinese domestic prices turn lower, steel exports will rise, eventually putting downside pressure on other regions, including the U.S.”

Source : Bloomberg