China's "zombie" industries menace global markets
TORU SUGAWARA, Nikkei staff writer
TANGSHAN, China -- The abandoned Tangshan Xingye Gongmao steel plant in Tangshan, Hebei Province, paints a stark picture of the country's troubled industry. Heaps of coal 3 meters high peak out from under black sheets, while in another area of the 500,000-sq.-meter complex a rust-eaten furnace sits unused.
The private company, established in 1984, was one of several steelmakers whose equipment was forcibly dismantled by provincial government one day last November. A local newspaper reported that 10 furnaces operated by eight companies in the province were "suspended indefinitely" on that day alone.
China accounts for half of the world's crude steel production, and a quarter of the domestic output comes from Hebei. Tangshan Iron & Steel, a subsidiary of the world's third-largest steelmaker, Hebei Iron & Steel Group, is headquartered in Tangshan. Numerous private steelmakers operate there as well.
The city produced more than 80 million tons of crude steel, nearly half the province's output last year, and the region is regularly blamed for aggravating air pollution in Beijing.
The Hebei provincial government plans to dispose of steelmaking facilities with a total annual capacity of 60 million tons and reorganize small makers by 2017. Regional authorities reportedly removed 16 furnaces run by 15 companies in five districts, including Tangshan and Qinhuangdao, in February. Hebei's crude steel production in the first three months of this year fell 2.44 million tons, or 4.6% on the year, to 50.21 million tons.
Regional officials are keen to act following the central government's instruction last October for five industries -- steel, cement, electrolytic aluminum, sheet glass and shipbuilding -- to address their overproduction problem by curtailing excessive capacity expansion and adopting market mechanisms to promote selection and realignment.
Local governments have long given preferential treatment to state-run steelmakers based in their regions, but their attitude seems to be changing. In the inland city of Chongqing, leading heavy-industry company Chongqing Iron and Steel Group saw government subsidies drop from 2 billion yuan ($32.2 million) in 2012 to 3.93 million yuan in 2013. Some analysts are expressing hope that provincial governments are finally getting serious about market reforms.
But regional efforts often have little impact in the world's top steel-producing country. Jiangsu Province is the second-biggest crude steel producer after Hebei, and its output in the first quarter of this year was 23.62 million tons, up 2.34 million tons, or 11%, on the year. This increase almost completely offsets the output decline in Hebei.
Average daily crude steel production in China hit a new record of around 2.3 million tons in April and has risen 14% since the end of last year. Mike Elliott, Global and Asia-Pacific mining and metals leader at British consulting firm Ernst & Young, estimates that demand for steel products in China will grow around 3% this year. With production growth far outpacing demand growth, the steel market is experiencing a historic plunge in prices.
Songjiang steel wholesale market in suburban Shanghai used to house 2,000 trading companies, making it one of the area's largest steel markets. Now, it receives few visitors and many of the dealers have closed down. "Our business has been terrible since last year," said a man at one of the remaining companies.
China Iron and Steel Association Vice Chairman Liu Zhenjiang is worried about the business environment, saying, "The industry has entered a midwinter." The association's index for domestic steel prices has fallen to the level it was at 20 years ago. About 80 main steelmakers posted a combined pretax loss of 2.32 billion yuan in the January-March period.
Foreign steelmakers are growing increasingly frustrated with the market slump China has created.
"China's economy is slowing down, but Chinese steelmakers keep on boosting their output," Yun Ki-mok, senior vice president in charge of raw materials at South Korean steel giant Posco.
Due to the stronger won, South Korean makers are facing fierce competition with their Japanese counterparts over high value-added products. They are also being hit by falling prices for general-purpose products as Chinese items continue to flood the market. The risk of being sandwiched between Japanese and Chinese rivals has many South Korean companies concerned about their future competitiveness.
Even the world's second-largest steelmaker, Nippon Steel & Sumitomo Metal, is uneasy, despite posting a net profit of 242.7 billion yen ($2.37 billion) in the year through March 2014.
In Japan, demand for steel plate for automobiles is growing, helped by the yen's fall. Demand from the construction sector is also steady because of infrastructure and other projects in areas hit by the 2011 earthquake and tsunami. But the company's prospects on the global market are not so bright. President Kosei Shindo says China's increased production is delaying a recovery in international steel prices.
Chinese makers' appetite for output shows no sign of abating. According to a survey by Custeel, a Chinese steel industry-related website, 24 new furnaces are due to start operating in 2014 with a combined annual production capacity of 35 million tons. Although that figure is half what it was last year, capacity continues to grow despite a market slump.
The sheet glass industry, another singled out by the government as "overproducing," may end up following a similar path.
According to Guotai Junan Securities, there are 290 sheet glass production lines across China, and 42 new ones are expected to open this year. Just like with steel products, prices of sheet glass are falling due to oversupply. Makers stuck with excess inventories because of a slump in the real estate market are looking to overseas markets to make up for weak domestic demand.
Chinese statistics show that the export volume of sheet glass was 17.58 million sq. meters in April, up 11.4% from a year before. On a monetary basis, exports surged 140% to $131.65 million. The main destinations of those exports were in Southeast Asia, and sales of high-performance insulating glass for buildings are believed to have increased.
Japanese rivals are growing anxious. They enjoy a major presence in Thailand and other parts of Southeast Asia, where many of them have production bases. But with Chinese products that are 10-20% cheaper flooding in, Japanese companies could soon see their competitive edge slipping.
Industry officials expect that China's sheet glass market will further worsen toward next year because of weak demand from the real estate sector. It is easy to expect manufacturers will try to offload their huge inventories abroad, just as steelmakers have done.
Explaining the irrational
Why are Chinese manufacturers boosting output even though it is deteriorating their earnings?
One factor is their unshakable belief in economic growth.
Investment in rural infrastructure projects is continuing as the government pushes for urbanization. "Domestic steel consumption will keep on growing by 2018 or 2020," He Wenbo, president of state-run Baosteel Group, said. As long as demand continues to rise, no matter how slowly, production cuts are the last thing on the minds of Chinese makers.
Another reason is the deep-rooted tendency among local government officials to emphasize regional gross domestic product.
Since the introduction of the reform and opening-up policy about 30 years ago, China has placed top priority on economic growth. The typical development model is to sell the right for land use to attract factories, create jobs and secure tax revenues. Regional bureaucrats who pursued this model have received high marks from the party.
Heavy industry is a particular boon in terms of jobs and taxes. With steelworks and other factories playing such a major part in their own job assessment, regional officials are reluctant to shut them down.
"However hard the central government urges local authorities to stop focusing on regional GDP and turn their attention to energy-saving and environmental measures, changing their mindset is no easy task," said Yihong Yu, director of the Institute of Industrial Economics at Fudan University School of Management.
Yu seems to be right. The media reported that two furnaces were removed from a private steelworks in Qinhuangdao, Hebei Province, in February. But when I visited there in May to see whether that had actually happened, coking coal was being poured into a furnace.
"It's running seven days a week," a security guard said. It may have been a new furnace, but an employee tried hard to delete photographs of it from my digital camera, raising the suspicion that the steelworks was operating illegally.
There are suspicions about Tangshan Xingye Gongma, too.
Neighbors say the company went under years ago. A newspaper left in a dusty security guard office was dated April 29, 2011, hinting that the maker may have stopped operating three years ago.
It is possible that regional governments are turning a blind eye to illegally operating steelmakers and claiming that they disposed of facilities that have actually been out of service for many years. If that is the case, the problem of oversupply is not really being addressed at all.
Still, local authorities are certainly feeling pressure.
"There's an atmosphere that we have to obey the central government at the moment," an official of a coastal province said. This atmosphere is due in large part to the anti-graft campaign launched by President Xi Jinping, who took office in late 2012. Bureaucrats risk allegations of corruption if they side with local companies, according to the official.
Fake disposals of production facilities might stop if leaders in Beijing tighten their control over regional authorities. But this indicates that the central government can control regional officials only by keeping them on a tight leash.