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January 2012 Feature Articles
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For the first time in a decade, China’s steel industry is showing signs of slowing. But even if the steel production cutbacks are more permanent than blip, the world’s largest nation will remain a major influence on the steel supply chain in North America.

By Dan Markham, Senior Editor


For the past decade, China has been the specter haunting the U.S. steel industry, with its scary brand of communist capitalism and otherworldly growth. But according to many China observers, North America’s steel suppliers have less to fear from their giant competitor in the Far East as they embark on 2012.

For several years, the Chinese central government has floated the idea of slowing its overheated economy to head off inflation and other growing pains. In the second half of 2011, they put those words into action. China’s rate of growth has slowed substantially, say the experts, though it remains at high levels.

“They’re slowing it down from 12 percent to 6 percent, but it’s still growing. We’d be fantastically happy with 3.5 percent,” says Bill Barron with Barrington, Ill.-based KDC & Associates, whose company specializes in sourcing Chinese products for American manufacturers.

Steel production in China, however, has been in actual retreat. “China’s monthly production of steel has come down from netting an annualized rate of 700 million metric tons per year to closer to 600 million tons,” says John Short, director of metals for Newedge, a global brokerage company. “That’s all since last summer.”

According to Chicago-based Steel Market Intelligence, Chinese steel production fell in November to 1.66 million tons per day from 1.76 million tons in October. It was down 16.8 percent from its June peak, and even experienced a rare year-on-year drop of 0.6 percent. Such an uncharacteristic decline indicates a new level of seriousness about the central government’s desire to rein in growth, and along with it steel production.

Court Strikes Down Use of CVDs Against Nonmarket Economies

U.S. industries that have grappled with unfair trading practices by Chinese and other foreign competitors have lost a powerful weapon in that fight. In late December, in a non-steel case, the U.S. Court of Appeals for the Federal Circuit struck down the Commerce Department’s ability to apply countervailing duty tariffs against nonmarket economies on top of antidumping duties.

Though the ruling was based on a case involving Chinese tire imports, the precedent will affect all products. For steel, the ruling will have a significant impact in the tubular market, for instance, where CVDs are in place on at least seven products. Some duty rates on tubular goods top 600 percent.

Not surprisingly, the ruling was greeted with trepidation by leading U.S. trade groups.
“AISI is gravely concerned with this erroneous court decision, which will cost valuable American jobs at a time when we need to be creating jobs,” says Thomas Gibson, AISI CEO. “With over 20 Chinese products currently subject to countervailing duties—duties that were imposed only after a comprehensive investigation—this ruling gives Chinese producers and exporters a license to unfairly attack the U.S. market with the full resources of the Chinese government.”

Even if expected appeals fail, the removal of CVDs against various steel products will not happen overnight. Additionally, antidumping duties will remain in place on products where violations were demonstrated.

The court cited a 1984 ruling that prevented the use of CVDs against nonmarket economies, while also noting that laws passed in 1988 and 1994 by Congress reaffirmed this position.

“If left to stand, this ruling will deny the U.S. government a critical WTO-authorized tool to address one of China’s leading trade-distorting practices. AISI urges the Obama administration and the Congress to begin work immediately to enact legislation clarifying that the CVD law continues to apply to nonmarket economies like China, where the Department of Commerce determines that it can isolate and measure subsidies,” Gibson says. “Congress has never passed any legislation prohibiting the application of the CVD law to nonmarket economies, and the court’s mistaken conclusion to the contrary must be corrected.”

The presiding judge in the tire case agreed that Congress is the place to remedy the situation. “If Commerce believes that the law should be changed, the appropriate approach is to seek legislative change,” Judge Jane A. Restani wrote in her ruling.
During its rapid run-up, many analysts expected the Chinese steel industry to eventually hit 1 billion metric tons in annual production (the whole world produced about 1.4 billion tons in 2011). The fear among producers in other parts of the world is that China will make more steel than it can use and begin to dump cheap exports on the global market. But Short says the country’s industry has hit its natural cap. And the reason is quite simple: Chinese steel production is not profitable. “It doesn’t make a lot of sense to make steel in China because they don’t make money,” Short says. “We don’t see China roaring ahead to a billion tons of steel.”

In the future, during periods of high growth, he believes the Chinese steel industry may reach 700 million tons. Normal levels of growth will support a 600-million-ton level, while output may drop below 500 million tons during slower periods.
 
Analyst Michelle Applebaum of Steel Market Intelligence agrees that China has lost its appetite for unrestrained growth in steel. “The size and spread of Chinese production cuts in recent months is bullish for the global steel industry and is further evidence of a seemingly permanent policy shift for Beijing,” she wrote in the November SMI report on Chinese steel. “The production decline is a reflection of a fairly rapid supply response driving production cuts. Weakening demand due to credit tightening, combined with lower prices, has pushed most Chinese producers back into the red.”

The net effect of China’s scaled-back steel production is a decline in the number of Chinese products on the international market—good news for steelmakers in other countries. Though China has not been a major exporter to the United States, its exports to nearby countries such as Japan and South Korea can trigger other exports from Southeast Asia and create a cascading effect throughout the world’s supply chain.

How much of China’s steel ends up on the open market is dictated by central government policies. At the moment, the Chinese government is “in a mode to police them tightly,” Short says. “Letting any more than four to five million metric tons go every month is going to be very difficult.”

Through the first nine months of 2011, the U.S. imported 951,000 tons of steel from China. That made China eighth on the list of foreign suppliers to the United States, according to the American Institute for International Steel, a trade group that represents foreign producers.

“Imports of Chinese steel products are down dramatically over the last two years, in part because of trade cases, but also in large part due to their economy growing faster than they were adding capacity. There was a long period of time where their growth was outpacing demand, but that appears not to be the case now,” says Dave Phelps, president of the McLean, Va.-based AIIS.

A rival association sees things differently, however. The American Iron and Steel Institute, Washington, D.C., which represents domestic suppliers, expects Chinese steel coming onshore to grow. AISI CEO Thomas Gibson says his trade group’s main concerns are “that the Chinese government will continue to provide massive subsidies to China’s steel and steel-related state-owned enterprises; that a severely undervalued Chinese currency will continue to provide an unfair competitive advantage to Chinese steel producers and other manufacturers; and that excess capacity conditions and slowing demand in China’s domestic market could lead to Chinese export surges.”

AISI sees China moving away from market-oriented reforms and more toward a model of “state capitalism,” Gibson adds.

In addition, U.S. industries concerned with China’s practices have lost a few methods to combat them. In December, a federal court overturned the use of countervailing duties against nonmarket economies (see sidebar). Also, last month marked the 10-year anniversary of China’s entrance into the World Trade Organization, a controversial admittance that carried with it annual reviews of China’s compliance for the first eight years and a final review after a decade. From now on, China will only be subject to the same trade policy review mechanism other WTO members must face.

“The transitional review mechanism has provided the United States with a somewhat useful tool for fact-finding and casting attention on controversies within the U.S.-China trade relationship,” according to the 2011 Report to Congress of the U.S.-China Economic and Security Review Commission.

Of course, production is just one part of the steel supply chain. When it comes to downstream products, China’s presence continues to grow.

“Logically, the concern should focus on downstream products,” Phelps says. “That’s where the domestic steel industry and AIIS might see eye to eye. We’d rather see steel mill products imported into the U.S. than fabricated products downstream because you lose your customers that way.”

Phelps’ fears are well founded, according to the congressional report. Through the first eight months of 2011, Chinese goods exported to the United States totaled $255.4 billion, compared to $66.1 billion worth of goods that went from the U.S. to China. Still, it’s not the magnitude that is most concerning, but the composition away from labor-intensive products toward more high tech.

“Production is driven increasingly less by low-cost labor and increasingly more by low-cost capital, which is used to build next-generation manufacturing facilities and to produce advanced technology products for export,” the report states. Exports of labor-intensive products constituted 37 percent of Chinese exports in 2000, but only 14 percent by 2010.

“America’s export strength lay in such complex capital goods as aircraft, electrical machinery, generators, and medical and scientific equipment. China’s exports to the United States are increasingly from its capital-intensive industries, particularly advanced technology products,” the report states. In August, the U.S. exported $1.9 billion worth of advanced technology products to China, while importing $10.9 billion—a record one-month deficit of $9 billion.

Various groups, such as the Reshoring Initiative, are working to attract value-added manufacturing back to North America. But there is a limit to how much reshoring realistically can take place, warns KDC’s Barron.

“Some businesses have moved back, with Mexico picking up a lot, but for some industries there is nothing to move back to,” Barron says, citing the computer electronics industry, which has completely relocated to Asia.

Still, there is considerable hope that China’s overall economic policy is shifting inward. “They’re trying to change their economy from one that’s export driven to one that’s domestic driven,” says analyst Charles Bradford of Bradford Research in New York.
 
Whether its products are destined for foreign shores or to satisfy its growing middle class, China’s appetite for steel will have a considerable affect on the price the world over. During its run-up, China has had a voracious appetite for raw materials, serving as a key driver in the rapid escalation of input costs. “For decades and decades, the iron ore producers in the world and the U.S. were the poor country cousins of the domestic steel industry, and now they’re the king,” Phelps says. “The growth of China changed everything when it comes to raw materials.”

But with China scaling back its steel production, the demand for iron ore and other raw materials has softened. “We’ll have a much lower iron ore floor going forward in 2012 than we had in 2011,” Short says. Consequently, the peak pricing for hot-rolled seen in 2011 is unlikely to repeat this year. Hot-rolled in the United States topped out over $900 last year, but Short does not see the current fundamentals supporting such highs in 2012.

While China’s sheer size will keep it at the top of the watch list, Europe’s well-documented problems could have a bigger impact on the United States in 2012. “The European steel business is in a difficult position right now,” Bradford says. “Some of those mills are in very bad shape. Could they try to export to the United States to bail themselves out? I think that’s more of a possibility than China doing it.”
 
Europe has long been a significant destination for Chinese steel, he adds. Recession in Europe could kill consumption and leave some of that Chinese steel looking for a new home—possibly in the United States.

Thus 2012 could see the U.S. market trade one specter for another.

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