1-2010 Chinese Steel
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All Aboard China's Coattails!

By Myra Pinkham, Contributing Editor

Will China lead the world out of recession or undermine the recovery with its predatory trade policies?

There is no doubt that China has pulled itself up by its bootstraps and is now in recovery mode. The big question is whether the global economy—and the U.S. steel industry—will follow on its coattails, or whether China’s questionable trade policies will undermine the world’s recovery.

Chinese Demand’s a Positive for Nonferrous
While opinions vary widely regarding China’s impact on the U.S. steel industry, China’s recovering economy is widely viewed as a positive for the domestic nonferrous markets.

“Other than India, China is the only good news in the world,” says John Tumazos, the principal of John Tumazos Very Independent Research LLC in Holmdel, N.J.  He observes that during the first nine months of 2009, Chinese consumption of copper was up 47 percent, nickel was up 89 percent, lead was up 23 percent and zinc was up 21 percent.

During the same period outside of China, global consumption of copper was down 16 percent, nickel was down 27 percent, lead was down 13 percent and zinc was down 19 percent. China’s apparent consumption of aluminum also has held up reasonably well, Tumazos notes.

China had a tough time early in the economic downturn, but it never declined as much as the rest of the world, says Terance Ko, director of management consulting for Hatch China in Beijing.

“China was the first country to curtail its aluminum production. They curtailed it quickly and they curtailed it deep,” says Kevin Anton, vice president of Alcoa Inc. and president of Alcoa Materials Management. “Then they put stimulus plans in place that generated real infrastructure spending. Now they have started to see increased consumption of aluminum.”

As a result, China is back to being a big importer of aluminum, says Jorge Vazquez, vice president of the Aluminum Intel unit of Harbor Intelligence, Laredo, Texas. China has already restarted all of the 3.48 million metric tons of annual capacity that it cut during the economic crisis and has added 1.32 million tons of new capacity. Even so, China had to import both primary aluminum and aluminum scrap in October to meet demand.

Alcoa’s Anton says that China was expected to import 1.5 million tons of primary aluminum, as well as record levels of aluminum scrap. The scrap imports displace metal, creating new primary aluminum demand in Western Europe and the United States, where the scrap originates. 

North American aluminum companies have developed a growing network of commercial relations with companies in China, says J. Stephen Larkin, president of the Aluminum Association in Arlington, Va. How much individual U.S. companies have benefited from China’s relative strength varies widely depending on the degree they have partnered with Chinese players.

Larkin was careful not to paint an overly rosy picture of China. “In the long term, it is in the mutual best interest of China and the United States to get along—not just politically but also commercially—but that doesn’t mean there aren’t any problems.”

Jesus Vallegas, a Harbor Intelligence aluminum market analyst, notes that China does export a lot of relatively cheap semi-finished aluminum goods, which could have a negative effect on other producers.

“But we have always been free traders,” says Larkin. “We believe we can hold our own in a market where the trade laws on the books are being enforced. But if that doesn’t happen, we will be pressing the government to do so.”

“China is a big factor in the market and that won’t change. It can be a positive as long as it remains a demand leader,” says Vallegas. He predicts China will remain a net importer of aluminum in 2010.

Many U.S. steel service center executives say China is a double-edged sword. At the moment, fueled by government economic stimulus programs, it is consuming most of the steel it produces, thus its demand for steelmaking raw materials is helping to sustain global steel prices. Service centers might have been harder hit throughout the economic downturn without Chinese demand for products from North America, says Bill Jones, vice chairman of O’Neal Industries Inc., Birmingham, Ala.

On the other hand, China is always a threat to begin exporting steel, which could drive the price downward. “If they don’t consume it domestically and send cheap steel, not just to the United States but anywhere in the world, it could have a negative impact on us and on our customers,” says David H. Hannah, chairman and chief executive officer of Reliance Steel & Aluminum Co., Los Angeles.

For the time being at least, many observers see the China effect as beneficial. “The remarkable rise of the Chinese economy is pulling up the global steel industry,” says Peter F. Marcus, managing director of World Steel Dynamics, Englewood Cliffs, N.J. 

“China has become a huge positive in the market. They clearly got their economic stimulus right, and their exports are way down,” adds Charles Bradford, partner and metals analyst for the Affiliated Research Group in New York.

David Phelps, president of the American Institute for International Steel in McLean, Va., agrees that once China recovers, it will help the rest of the steel industry out of the recession. “But that hasn’t happened yet. China’s economy is growing at a solid pace, but it hasn’t translated into an improvement in the United States.” He expects to see more evidence of the Chinese effect on the U.S. economy in the next few months.

Other industry observers see it differently. Thomas J. Gibson, president and chief executive officer of the American Iron and Steel Institute in Washington, D.C., maintains that the Chinese steel industry is “completely intertwined” with the Chinese government and is, therefore, a beneficiary of inappropriate government policies and subsidies. Therefore, the U.S. steel industry and those of other free-market economies are at a competitive disadvantage.

“We welcome fair competition. We communicate and cooperate with the Chinese steel industry. But to the extent that the Chinese government is part of the Chinese steel industry and engages in predatory mercantile practices here in the United States to facilitate the dumping of Chinese steel, we will continue to use every legal remedy and every political tool available to us to fight that,” Gibson says.

“We can compete against private business, but we can’t compete against a government, at least not long term,” adds Thomas A. Danjczek, president of the Steel Manufacturers Association in Washington, D.C., which, like AISI, represents domestic steelmakers. “We wish them well. We support their growth. But we want them to play fair.”

“It is all about the ability to sustain jobs and the future of manufacturing,” says Gary Hubbard, a spokesman for the United Steelworkers union. “There is no question that China still has a long way to go to develop their industry, but we in the United States can’t be a dumping ground to help China build up its middle class.”

With about a 50 percent share of the global steel market, China’s impact will be felt—good or bad—for the foreseeable future. The recent U.S.-China Economic and Security Review Commission’s seventh annual report to Congress was highly critical of China’s likely effect on the U.S. market.

Upon releasing the report in mid-November, Carolyn Bartholomew, the commission’s chairwoman, stated that despite evidence global economic imbalances fueled the current financial crisis, “China persists in maintaining a wide variety of industrial policies to support an export and investment led growth modelx[which] has created a low-cost haven for foreign and domestic manufacturers.”

While the international community has welcomed China’s swift response to the global economic crisis, the report states, “doubts remain about the eventual effect that China’s stimulus will have. The government in Beijing is still pursuing an export-led strategy based on a wide variety of subsidies to export industries, including an RMB that remains substantially undervalued. If China continues to pursue huge trade and investment surpluses and to accumulate vast financial claims, it will hinder the necessary global economic adjustment, create excess manufacturing capacity and lay the groundwork for the next crisis.”

It goes on to say, “Despite international calls for more market reforms and greater market access, China continues to employ an industrial policy that risks expanding the trade imbalance,” including using strict capital controls to keep the value of the RMB artificially low and encouraging foreign manufacturing to relocate to China.

“The problem is that China doesn’t play by the rules, but rather it plays to advance itself in the international arena,” says Alan H. Price, partner and head of the international trade practice of attorneys Wiley Rein LLP in Washington, D.C.

Terance Ko, director of management consulting for Hatch China in Beijing, has a different perspective. “It isn’t that China is out to get the United States. China has no interest to export to the United States. There is no financial advantage to produce products in China just to export them,” he says. However, he admits, China will do so if there is an opportunistic reason. “Sometimes the international market is more attractive than the domestic market. If the price is favorable, of course China will export product to the United States.”

As far as pegging its currency to the U.S. dollar, Ko says China has no hidden agenda other than the government’s need for stability in a period of high political risk. “It is more difficult to make business decisions when there are big currency fluctuations. If the RMB floated freely, there would be a lot of speculators buying and selling currency.” He denies that this practice is cause to call China a currency manipulator. “Every country in Asia is pegged to the U.S. dollar in one way or another,” he adds.

Leaders of the U.S. steel industry assert that pegging the RMB to the dollar puts China at a distinct trade advantage, which is why AISI and others are working with Congress to pass the Currency Reform for Free Trade Act. The measure would establish trade remedy provisions to neutralize currency undervaluation, not only by China but other nations as well.

Many industry observers question whether this legislation, similar to failed bills in the past, has any chance of succeeding. “The Bush administration wasn’t strong enough to stand up to China, and it doesn’t appear that the current administration will be strong enough either,” says O’Neal’s Jones. 

Peter Morici, professor at the University of Maryland’s Robert H. Smith School of Business and a former chief economist with the U.S. International Trade Commission, is also skeptical. Calling the bill political posturing, he says “nothing will pass, or at least nothing with any teeth in it.”

“We need to deny market access to those who don’t play by the rules, and that won’t happen until the U.S. government declares China’s currency manipulation a subsidy,” says SMA’s Danjczek. “China must be made to play by World Trade Organization rules. China is eating our lunch and now wants to have some dinner.”

AISI estimates that China’s RMB is overvalued by 35 to 40 percent, which gives their producers a big cost advantage. Tony Taccone, partner with First River Consulting in Pittsburgh, explains that the current weak U.S. dollar should have the effect of decreasing imports and increasing exports, “but that can only happen if all currencies float.”
“The problem with currency manipulation is that it only provides a temporary fix,” says Michelle Applebaum, principal of Steel Market Intelligence in Chicago. “It isn’t sustainable. Eventually the piper needs to get paid. Chinese steel costs will go up and steel prices will go up with them.”

While still pegged to the dollar, the Chinese government has allowed its currency to gradually appreciate about 20 percent over the last three to four years, Ko says. Most industry observers say that isn’t enough, but Bradford disagrees. If the RMB appreciates another 40 percent, it could result in an economic catastrophe, he says. “It would further weaken the U.S. dollar, and we would have to counter that by increasing interest rates. That is not what we want to do when we are trying to come out of a recession.”
While criticized for its monetary policies, China is widely lauded for the effectiveness of its economic stimulus program. Danjczek says he is downright jealous. “Their economic stimulus is not just a spending program, but a very meaningful infrastructure investment program.” 

“We are hopeful that our government takes a page out of the Chinese playbook, if we are going to do a second round of a jobs bill, to include a much bigger infrastructure component,” Gibson adds.

Given the nature of its government, China was able to institute a spending program within a few weeks rather than a few months, as in the United States and other democratic nations, Ko notes. Thus China’s economy did not falter as much as those in other countries and, as an unintended consequence, helped the rest of the world to recover.
Much of this has to do with China’s huge share of the global market, which has grown considerably since the beginning of the downturn. Before the economic crisis, about a third of the world’s steel was made in China. While the United States, the European Union and other OECD nations slowed their steel production as demand weakened, China, being a nonmarket economy, did not. “So the net effect is that China is now making half of the world’s steel,” says AISI’s Gibson.

“[Chinese demand] is now having a huge impact on global raw material costs and that will drag the global steel market forward,” says Paul Scott, managing consultant of the London-based CRU Analysis’ steel team. “Despite the fact that U.S. demand remains weak, there will be upward pressure on prices. In fact, we might see record crude steel prices globally.”

China’s surge in steelmaking volumes has already tightened up the availability of iron ore, coking coal and ferrous scrap and has caused spot steel prices to rise from $405 to $455 per metric ton (excluding the 17 percent VAT), prompting traders to buy ahead on a speculative basis, says WSD’s Marcus.
Some industry observers believe that some of this tightness has been artificially created by China's export controls on certain raw materials. Price says this gives their own manufacturers a cost advantage by not letting markets arbitrage. This is why the United States has initiated a WTO case against China's export policy, along with other trade action (most recently on U.S. OCTG and drill pipe imports).

In 2010, China is likely to import sizable quantities of coke, ore and scrap from the United States, where mills continue to operate at reduced capacities. This could place additional upward pressure on pricing, which would be a positive for both U.S. steelmakers and steel distributors, experts say.

Some question whether these price increases will be sustainable over the long haul, however, unless China finally addresses its 150 million to 200 million tons of inefficient, excess steelmaking capacity (which is more than the total steel production capacity of the entire NAFTA region).

“China has been saying that they would shut down some of their less efficient steelmaking capacity, but any moves to do so have been minimal to date,” SMA’s Danjczek says.
The Chinese central government has directed that older, smaller, less efficient, higher polluting capacity be taken offline, Gibson notes. But the problem is many of those enterprises are owned or controlled by local levels of government, which are ignoring any kind of central dictate to control capacity.

That could be trouble for steel prices, says Kim Leppold, senior steel analyst for Metal Bulletin Research. When there is a lull in demand, Chinese steelmakers don’t pull back production. They just export the excess.

Ko says these mills have a right to continue operating. “The central government can influence the rationale for companies to produce or not produce steel by restricting bank loans, not issuing permits, etc., but they can’t tell companies not to produce at all.” Given China’s current economic expansion, there is a need for excess steel production capacity, he adds. “Without it, there would be no room for further growth.”

Last year, for the first time since 2004, China was a net importer of steel, and it is expected to import more than it exports again this year, says Lynn Lupori-Gray, senior consultant for Hatch Management Consulting in Pittsburgh. This is partly due to the effect of trade cases filed against Chinese producers, but is mostly a reflection of the persistently weak steel demand in the United States.

“There is little question on anyone’s mind that once consumption picks up in the U.S., imports will as well,” says Price at Wiley Rein LLP.

Reliance’s Hannah is unconcerned about Chinese imports undercutting steel prices any time soon. “Given all that we have been going through, I think the appetite of U.S. steel buyers to take on the risk of large quantities of imported material has been severely diminished,” he says.

In general, experts expect the economic relationship between the United States and China to remain complicated and contentious for some time. “China could be viewed as a threat and a formidable competitor on a number of fronts, including U.S. steel imports [both for steel and steel-containing finished goods] and investments in the United States [such as China’s Tianjin Pipe Group’s plans to build a seamless pipe mill in Texas], and much more,” says Lupori-Gray.

But on balance, China is currently a positive for the U.S. market, including steel service centers, Taccone says. “Any economy growing at the rate it is growing and consuming as it is consuming drives up both raw material and finished goods prices.”  

 

  
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