Can China adjust to slower steel demand growth?

LONDON: Global steel production slowed in August, according to the latest figures from the World Steel Association.
It always does in August, a dead month in the Northern Hemisphere steel calendar. But, crucially, on a year-on-year comparison global steel runs were 1.1 percent lower than in August 2011.
The headline global figure masks the scale of the production cuts being taken in economic weak spots such as the euro zone.
At 144 million tons annualized euro-zone production last month was the lowest since 2009, a telling comparison given what seems an inexorable slide back into recession in the region.
Other regions feeling the macro pain are Eastern Europe, where annualized production of 107 million tons in August was the lowest in two years, and South America, where production last month dropped almost 7 percent relative to last year.
Such is the "normal" lagging reaction of steel output to slowing manufacturing momentum.
However, there will be no sustainable recovery either in steel prices or in raw material markets such as iron ore and coking coal until China, the world's largest producer, follows suit.
Superficially, a 1.7-percent year-on-year drop in August output would seem to suggest that China's legion steel mills are getting the message.
There are two problems, though.
This pull-back is coming from an extremely elevated base. Chinese production had been running at near-record levels right through to July.
At 691 million tons annualized August's production was still high by any yardstick other than the preceding few months.
Secondly, the higher-frequency figures from the China Iron and Steel Association (CISA) showed output re-accelerating in the first part of this month.
This was probably a reaction to the combination of lower iron ore inputs after last month's brutal sell-off and a sharp rally in Shanghai steel rebar futures at the start of this month.
That rally was fueled by China's gift-wrapped announcement it was speeding up infrastructure spend to help stimulate its flagging economy.
However, the so-called stimulus proved to be all pretty packaging and little substance.
Shanghai investors' disappointed reaction was clear to see on Thursday, when rebar futures recorded their heaviest ever daily slump.
So, we're pretty much back where we started: China's steel industry producing too much metal relative to actual demand.
Margins are still painfully compressed, inventories are still too high and Chinese net exports are booming, flooding other markets with excess material.
August's trade figures showed net export growth running at close to 20 percent year-on-year in the first eight months of 2012. At the heart of the Chinese steel puzzle is the challenge facing a fractured sector of how to respond to slower demand growth.
Right now, too many Chinese mills are still pumping out too much steel, unprepared to sacrifice market share to margin pain.
That pain is the single-most important reason why iron ore prices have bombed.
It's not as if the country is importing less. August imports were up almost 6 percent year-on-year. But buyers are destocking higher-priced material and bargain-hunting for fresh replacement units.
There seems to be a growing realization that iron ore prices won't recover until Chinese steel prices recover and steel prices won't recover until production is cut back more aggressively to reflect real end-user demand.
It's about learning to live with excess production capacity, a lesson that other parts of the steel world have had to learn in the past, witness European mills' (relatively) fast response to slowing demand signals.
And it's a lesson that China's steel sector will need to learn going forwards as well.
Analysts the world over are chipping away at their GDP forecasts for China this year, as each new set of data extends the current "soft patch".
And some, such as Macquarie Bank, are now questioning whether old assumptions that Beijing will "do what it takes" to maintain headline growth figures still hold true.
Social stability rather than growth for growth's sake is Beijing's overriding concern, according to Macquarie, which argues that still-strong income growth and a still-tight labor market mitigate against any more "shock and awe" stimulus packages such as that unleashed in 2008-2009. If true, the implications for China's huge steel sector are massive.
Indeed, Macquarie has just cut its Chinese steel demand assessment for the 2012-2015 period from 5.0 percent per year to 3.6 percent.
That still translates into a continuing need for ever more quantities of steel and ever more quantities of the iron ore and coal that are required to make that steel.
But the question is whether an industry geared toward the sort of super-fast growth engineered in 2010 and 2011 can adapt to a more sedate growth environment?
Right now the signs aren't looking too promising.
August's slowdown in Chinese production was too shallow and may already have been largely reversed in the first part of September on the false-dawn Shanghai rebar rally.
The next couple of months should provide some insight as to whether an industry shaped by the battle for share of a fast-expanding market can shift to one shaped by operating margin and collective discipline.
— Andy Home is a Reuters columnist.
The opinions expressed are his own.

The outcome will have ramifications not just for China's steel sector but, via rising imports, the global steel industry and, via falling raw material prices, the global resources sector.
Expectations are already shifting.
Alberto Calderon, chief executive of BHP Billiton's aluminum, nickel and corporate development, told a conference earlier this week that the sort of "spectacular imbalance" between iron ore supply and demand seen last year won't happen again.
Quite right.
It's a different sort of "spectacular imbalance", that between China's steel production and its steel demand, that will now be the key influence on the company's vast iron ore operations in Western Australia.

— Andy Home is a Reuters columnist. The opinions expressed are his own.