It does not seem like it, but winter is coming. Last week, the Chinese government announced another round of heating season capacity cuts for its heavy industry, intended to reduce emissions and improve air quality in the northern provinces.
Steel capacity needs to be cut by 50 percent in the affected cities – like last year – but the regional scope has been broadened and local governments have been invited to participate.
The impact on steel production and iron ore consumption could be much bigger than last year, in particular if more strictly enforced. In fact, China’s steel production was up during last year’s capacity cuts as mills in unaffected cities and provinces boosted capacity utilisation to offset cuts in affected cities.
Steel-making raw materials such as iron ore and coke rallied on the news, up between 3 percent and 6 percent since the end of last week, likely reflecting expectations of pre-production of steel ahead of the heating season cuts. Yet steel prices were also up around 3 percent, providing an incentive to higher-cost steel mills to start or expand production.
While the enforcement of the capacity cuts clouds the outlook for iron ore and steel, we are convinced that the Chinese government will maintain adequate steel supplies to the economy’s key infrastructure, manufacturing and property sectors. The government will not deliberately drive a slowdown in these sectors.
That said, short-term price risks are skewed to the upside, not least because sentiment improves and speculative traders return to the futures markets.
Medium to longer term, we still see a weakening demand backdrop for iron ore and steel in China, leaving the markets well supplied and limiting the upside to prices.
Any opinions expressed here are the author’s own.
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