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Alarm bells in Beijing as steel production reaches all-time high

China turns microscope on steelmakers over profit declines and risk of new glut

Rising Chinese steel production in 2019 coincided with falling profits for major players.   © Reuters

SHANGHAI -- As China's steel production reaches record levels, the Chinese government is growing increasingly uneasy about a harmful glut in the market.

Though the nation's steel output posted its first decline in three-and-a-half years in October, overall production for 2019 appears to have reached an all-time high.

The government has started looking into the operational status of blast furnaces across the nation as well as new production investments by steelmakers, seeking to prevent another bout of oversupply that sinks earnings.

At the end of November, three governmental bodies supervising the steel industry, including the National Development and Reform Commission, jointly issued a warning to steelmakers saying there is still "excess capacity" in the Chinese steel industry, which "cannot be ignored."

In the warning, the three organizations said they will monitor capital investment by the steelmakers in the next three years and examine the operational situations of their blast furnaces.

Chinese regulators have been alarmed by a spike in steel production in 2019. China's crude steel output dipped 0.6% in October to 81.52 million tons, but it rebounded in November, posting a 4% on-year increase. In the first 11 months of the year, Chinese manufacturers churned out 904.17 million tons of crude steel, up 7% from the same period in 2018. It is highly likely that the total output in 2019 hit an all-time high.

Though Chinese steelmakers ramped up production in 2019, their earnings sank. Baoshan Iron & Steel, a unit of China Baowu Steel Group, the nation's largest steelmaker, saw its net profit in the first nine months of 2019 plunge 43% from a year earlier to 8.8 billion yuan ($1.26 billion). Profits at most other major steelmakers also fell.

The Chinese government says it burned off some 120 million tons of the country's steel production capacity through weeding out unprofitable makers and other measures in 2016 and 2017. A further 30 million tons of capacity were cut in 2018.

Beijing has also pledged to wipe out production of substandard steel known as di tiao gang, often made in small workshop-style factories from melted scrap iron and steel, which does not appear in official statistics.

These steps were taken in response to international criticism about China's excess steel production capacity, which critics say has roiled the international market by creating a glut.

As a result, steel prices rebounded in 2017 and 2018, pushing up profits at Chinese steelmakers.

Meanwhile, China's economic slowdown has become increasingly more pronounced amid the country's prolonged trade war with the U.S., cramping domestic demand growth. Steel prices have started sagging again, prompting Chinese makers to expand production to secure profits. This has caused the market to soften further in a vicious cycle.

Under strong pressure to eliminate the capacity overhang and improve their environmental performances, Chinese steelmakers have shut down aged blast furnaces and built new, cleaner furnaces in the past several years. Many of these new production facilities have been scheduled to come on stream in 2019 and 2020. Unlike aged furnaces, the new ones can run at full throttle. Some analysts say they are contributing to the uptrend in crude steel production in the country.

The situation has made Chinese authorities aware of the need to tighten control on domestic steel production. In Hebei Province, a steel production center, a top executive of a steel company that failed to obey instructions from authorities has been detained.

To solve the deep-seated structural problem of excess capacity in the steel industry, the government has set out to consolidate the bloated industry. In November, Shougang Group, the nation's sixth-largest steelmaker, announced it will transfer a 15% stake in the company to Baowu, the biggest, for free. This move came on the heels of Baowu's takeover of rival Magang Group, the ninth-largest producer, in September.

More government-led moves for industry consolidation, probably involving Baowu or Shougang, seem to be in store.

Both Baowu and Shougang are state-owned enterprises, and the share transfer was approved by the State-owned Assets Supervision and Administration Commission of the State Council, which supervises policies concerning state-owned enterprises.

There is speculation that Beijing is laying the groundwork for a merger between the two steel giants.

"There is no doubt that the authority is trying to promote further consolidation of the industry around Baowu," says an industry executive. The stock transfer is probably "a step to make the next consolidation move."

Shougang, based in Beijing, produced some 27 million tons of crude steel in 2018. The merger between Baowu and Magang was completed in September. Their combined crude steel production in 2018 was nearly 90 million tons, compared with some 97 million tons produced by top-ranked ArcelorMittal.

A megamerger between Baowu and Shougang would create the world's largest steelmaker in terms of crude steel production.

But Beijing's principal objective in pushing for further industry consolidation is to avoid becoming a target of international criticism again over disruptive excess capacity.

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