Charting the right strategies for a leaner, profitable steel industry

With overcapacity and weak demand putting the sector in the red, the government is taking drastic steps

The deep reforms that China's steel industry is undergoing, following years of weak demand and severe overcapacity from the country's rapid development, are a positive signal, experts said.

"The expansion impulse in the steel industry has stopped," Wang Xiaoqi, deputy head of the China Iron and Steel Association, said on Aug 21.

Steel industry investment for the first six months of this year declined 7.08 percent from the same period last year to 237.5 billion yuan ($38.6 billion), according to the association.

It was the largest decline in investment among 19 major industries in the country and was attributed to policy and market adjustments.

The central government is cutting steel production to solve overcapacity issues and protect the environment.

The Ministry of Industry and Information Technology announced in July the first list of 74 iron and steel companies that must shut down outdated production lines. The second list, announced in August, involved two steel-smelting companies, as the country's economic slowdown has also led to weakening steel demand.

The association said the sharp drop in real estate investment for the first six months of the year greatly affected steel consumption.

Investment in the real estate sector grew 14.1 percent year-on-year, 6.2 percentage points less than the same period last year.

New construction declined 16.4 percent year-on-year. A lack of new construction in the second half will continue to constrain steel consumption, the association said.

"Except for steel projects under construction, there will be no more new production capacity in steel refining, which means the overcapacity problem that has existed for a long time is beginning to ease," Wang said.

Zhang Changfu, secretary-general of the association, said steel consumption driven by economic growth will continue to decrease because of the country's economic restructuring, which is shifting from massive infrastructure construction to consumption.

For the first half of the year, China consumed 376 million metric tons of crude steel, up 0.4 percent year-on-year.

But crude steel output still totaled 412 million tons, up 2.99 percent, despite the government's efforts to cut crude steel output.

China's steel production capacity and output have grown rapidly since 2002. Last year, domestic crude steel capacity reached 1 billion tons, compared with only 800 million tons of demand, according to a report of Sublime China Information Group Co, a commodities consultancy.

It said China's crude steel capacity will reach 1.07 billion tons by the year's end.

Wu Xichun, honorary president of the association, said that steel production capacity expanded quickly after 2008. But only 67 percent of the newly added capacity was actually used.

He said most steel companies expanded production capacity even when they were already in the red.

"It is a tough task to cut steel capacity. It requires firm determination by the government and the industry," he said.

Rapid expansion and overcapacity have caused many of those steel companies to suffer losses.

"Ten years ago, a sales department head at a small steel company could earn a lot of money under the table because he was empowered to choose buyers," said an official at a steel company in Hebei province, China's biggest steel producer, who declined to be named.

At the time, supply fell short of demand, and there were often lines of buyers outside a steel company waiting for a contract. But steel companies are now having trouble finding buyers even after offering huge discounts, the official said.

Qu Xiuli, deputy secretary-general of the association, said steel companies must be aware of the potential risks in the capital chain.

She said the steel companies' expenses increased and receivables grew in the first half, requiring the companies to strengthen their capital management.

The association's data showed that steel companies' receivables rose 13 percent in the first half and that large and medium-scale steel companies saw a total loss of 660 million yuan.

Zhang Lin, a senior researcher at the Lange Steel Information Research Center, said the way out for the steel industry is through mergers and acquisitions.

China has thousands of steel companies, many of which produce similar products and compete by lowering prices, Zhang said.

"The number of China's steel companies should be cut in order to form core competitiveness in the international market," she said.

Under the background of a gloomy market, mergers will allow both buyers and sellers to strengthen their advantages, according to Zhang.