China: Lift in steel production overstated in the official data - Westpac

Justin Smirk, Research Analyst at Westpac, notes that there was a solid rally (+44%) in iron ore prices since the early June low but it has been part of a broader rally in commodity prices with a 35% gain in met coal prices, a 25% gain in thermal coal prices and a 17% gain in base metal prices.

Key Quotes

“There were many factors behind the rally but the overall picture can be reduced to a fortuitous combination of slightly softer than expected supply and modestly stronger than expected demand. While this is expected to remain supportive of prices through 2017 as we move through 2018 we expect the overall environment to be less constructive.”

“Global growth and resulting demand has been stronger than expected with global trade growing at a 5% pace in the year to June. The positive global momentum has coincided with the somewhat surprising robustness in Chinese construction activity which has supported strong growth in Chinese steel production and falling steel inventories driving a robust rally in steel prices. This solid demand backdrop has been a factor behind the robust rise in iron ore and metallurgical coal prices.”

“There is, however, an important caveat which cautions against taking the strong gains in steel production (on track to report a gain of 4% to 5% this year compared to earlier expectation for a contraction) at face value. In 2017 Chinese authorities clamped down on illegal Electric Induction Furnaces (EIF) with a large number being shut down. As they are illegal it is hard to get reliable data on just how much production has been taken offline but some estimates suggest that total steel production, if you include all illegal production, is quite likely to have been flat in the year to July, or at best a very small gain, compared to the 10% growth reported in the official data. That is, a large part of the rise in official steel production appears to be to a lift in reported production offsetting a loss in unreported EIF production.”

“Also supportive of iron ore prices has been constrained ore production. Despite the higher prices, exports from Australian and Brazil have flat-lined while the marginal players in the seaborne trade are yet to re-enter the market. And even with lifting margins and an average cost of production around US$73/t (compare to the current average spot price for domestic Chinese ore of around US$85/t), Chinese ore production is flat in the year to July.”

“The last week has seen a correction in iron ore (to US$66.1/t) and met coal (US$208/t) prices. Our forecast is for a correction in both iron ore and met coal prices as we move towards year end based on modest recovery in supply, particularly but not exclusively from Australia, as well as a moderation in demand as Chinese growth slows and the steel inventory cycle matures. Our 2018 end points are US$57t for iron ore and US$122/t for Qld HCC.”