Pushing Chinese Steel Abroad

5 MINS READMay 18, 2016 | 02:31 GMT
Pushing Chinese Steel Abroad
China, by far the world's largest steel producer, is working to cut its production overcapacity, but local resistance has made that policy difficult to enforce.
(KEVIN FRAYER/Getty Images)

The Chinese government has an unusual problem: The country produces much more steel than it can actually use. A possible solution to the problem comports with the evolution of the Chinese economy.

On May 17, the People's Daily, citing the general manager of a Chinese investment company, reported that China was preparing to relocate 10 million metric tons (mmt) of steel production capacity to Brazil, about a third of which would be run by a consortium of China's high-end steel producers. Though the words of a single investment company manager do not represent the views of the government in Beijing, that the report came in the Chinese Communist Party's official mouthpiece suggests that the country's leaders are pushing for its major steel conglomerates — some of the world's largest steelmakers — to expand and dominate the global steel industry while making incremental moves to cut capacity at home. In addition, the news comes days after a similar proposal from a major Indian steel company to move Chinese steel production to India.

While China's steel giants already had made moves to set up operations abroad, they identified the need for more central government assistance with financing. They appear to have gotten their wish. The companies involved in the Brazil move will receive support from a branch of the China Development Bank, the country's premier policy bank, which specializes in providing loans to Chinese companies at below-market rates to support Beijing's economic objectives. Clearly, this move comes with some significant political backing. For these companies, offshoring their steel not only offers new opportunities in emerging markets such as India's, but it also aligns with the Chinese central government's objective of culling excess domestic steel production capacity. The global push into industry abroad represents a new direction for China as its economy shifts away from one based solely on manufacturing, heavy industry and raw industrial development. Many of China's industrial conglomerates — steel included — are now seeking to leverage their experience and expertise abroad.

Nonetheless, it is important to keep the amount of production the move would represent in perspective. China produced 800 mmt of steel last year and exported 112 mmt. Its exports alone slightly exceeded the entire production of the world's second-largest steel-producing country, Japan. China's total steel production capacity was far in excess, at 1.13 billion metric tons, much of it scattered among several thousand local mills that often use inefficient technologies and cannot achieve economies of scale. Still, political interference at the local level results in cheap loans that keep inefficient mills in the market when they would otherwise have been forced to leave. The net effect of the resulting overcapacity is that the marginal cost of Chinese steel is very high, and global steel prices have been forced down by oversupply.

Though the movement of some production to Brazil was spun as part of the effort to reduce the huge overcapacity problem, it represents just a drop in the bucket considering that China hopes to reduce its production by about 150 mmt in five years. The steel companies interested in the prospects of offshoring, such as Baosteel, Ansteel, and Wuhan Iron and Steel, are the larger (and generally better resourced) ones in China. They are almost certainly engaged in the same drive to phase out outdated and inefficient production facilities as the rest of the country, but they do not appear to be the primary impetus behind the plan to set up steel plants in Brazil.

Instead, what this represents is the continued evolution of China's heavy industries and economy as a whole. China is now following the likes of Japan, South Korea and Taiwan in moving up the value chain. Steel demand in China is no longer growing at the pace it once did. Moreover, the government is attempting to raise regulatory costs, such as penalties around environmental regulations, to force out the least efficient of its steel mills — but those costs are still spread across the entire sector. It makes sense that China's best-resourced steel companies would follow a corporate strategy of consolidating domestic production at their best facilities and moving what they can overseas, where operations may be more profitable — an option not available to smaller companies.

China's success in elevating its big industrial conglomerates into companies with a global presence has been clear. In steel, China can expect more successes, as countries such as India with high demand and relatively limited production seek to attract Chinese investments. Nonetheless, Beijing's policies in managing its large industrial conglomerates have been mirrored by an equal amount of difficulty in bending its small-scale industries — not just in steel but also in coal mining, concrete and glass manufacturing, and even power generation — to its will at the local level, where every central proclamation of reducing overcapacity appears to be matched by discoveries of once-shuttered plants resuming production.

The story of managing these industries is timeless in China, one in which the central government fights local governments intent on preserving the employment and social stability that local industries provide. Successfully moving some Chinese production abroad is not the same as successfully taming the tremendous problem of overcapacity — a much more deeply rooted problem.

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