industry March 2016 Executive summary The planned 100-150mt of - - PowerPoint PPT Presentation

Reflections on restructuring of the Chinese steel industry

March 2016

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Executive summary

The planned 100-150mt of steel capacity reduction in China over the next 5 years is a step in the right direction to reducing overcapacity in an industry incurring unsustainably high losses. However, the risk is that the targeted reduction will not be sufficient to ensure sufficiently high utilisation rates required for industry sustainability. In addition, unless the central government ensures that the right systems are in place with the authority to enforce removal of a sufficient quantity of unprofitable capacity, the risk is that the pace of capacity reduction will be too slow

• The Chinese steel industry is facing challenges very similar to those faced by the European steel

industry in the 1970’s and 1980’s – Steel demand plateauing or declining after many years of strong industrialisation-driven growth – Unsustainably high losses – Overcapacity and high fragmentation of supply: too many producers chasing too little demand – Provincial governments in China (national governments in Europe) interested in maintaining capacity, investment, production and labour even in the face of losses

• The Davignon II plan implemented in Europe in the early 1980’s reduced capacity by 20 %,

improved utilisation rate by 10 percentage points and returned the industry to profit. In contrast to previous, ineffective policies, success of Davignon II was due to well designed and defined policies with clear targets and control systems, and the authority to enforce them

• The European experience highlights the need for clear instruments and authority to realise

required capacity cuts in China. In addition, the targeted reduction of 10-15% over 5 years risks being insufficient, especially if demand continues to decline

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At the beginning of the 1970s, the European steel industry faced challenges that are very similar to those facing the Chinese steel industry today

• Steel demand has effectively peaked
• Weak demand partly offset by higher

exports (ca. 18% of ASC)

• Overcapacity, with utilisation rate down to

75%

• Accumulated losses of RMB 9.2 billion

($14.8 billion), Jan-Nov 2015 (ca. $25/t)

• Highly fragmented industry
• Provincial interest in maintaining

capacity, investment, production and labour

• Relatively strong authority of Central

Government

China – today

• Steel demand peaked around 1973
• Weak demand partly offset by higher

exports (ca. 25% of ASC)

• Overcapacity, with utilisation rate

declining to around 65%

• Accumulated losses of ECU 3 billion

($3.4 billion) in 1977 (ca. $25/t)

• Highly fragmented industry
• National interest in maintaining

capacity, investment, production and labour

• Limited power of European community

Europe – beginning of 1970s ≈

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European steel demand peaked around 1973; Chinese steel demand has effectively peaked since 2013

Europe* - crude steel consumption kg/capita (LHS), yoy growth % (RHS)

* Western Europe (EU15)

• 20%
• 10%

0% 10% 20% 30% 40% 50% 100 200 300 400 500 600 700 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 annual growth rate (RHS) kg/capita (LHS) Demand growth (driven by industrialisation) Saturation of demand

• 20%
• 10%

0% 10% 20% 30% 40% 50% 100 200 300 400 500 600 700 annual growth rate (RHS) kg/capita (LHS)

China - crude steel consumption kg/capita (LHS), yoy growth % (RHS)

Demand growth (driven by industrialisation) Peak

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The losses in China are similar in scale to those incurred in Europe in the 1970s

Example of 2 European steel producers loss per tonne of steel ($/t) CISA members’ net profit composition (USD/tonne)

• 11
• 14
• 11
• 8
• 8
• 16
• 33
• 33
• 35
• 49
• 55

8 5 18 3 17 19 9 (2) 5 18 10

(3) (8) 7 (5) 9 3 (24) (35) (31) (31) (45)

• 110
• 90
• 70
• 50
• 30
• 10

10

CISA net profit of non-steel business $/t CISA net profit of steel business $/t CISA net profit $/t

• 33
• 10
• 45
• 35
• 75
• 109

(18) (7) (34) (13) (2) (11)

• 110
• 90
• 70
• 50
• 30
• 10

10

1975 1976 1977 1978 1979 1980

British Steel Company loss per tonne of steel ($/t) Arbed loss per tonne of steel ($/t)

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• Capacity reduction of ca. 40mt

(20%) within 5 years

• Reduction of manpower by ca.

200k (ca. 30%) over 6 years

• Improvement of industry

utilisation rate by almost 10%, despite declining demand

• Return of the industry to

profitability

• Clear targets of capacity cuts at plant level
• Well designed instruments to implement

plan

• In total ECU38 billion state aid
• Ca. ECU23 billion for debt restructuring
• Ca. ECU 2 billion for capacity cuts

(redeployment/redundancies)

• Legal framework for state aid to define and

control the allocating of funding

• Authority of European commission over

national governments

1977-1980 Davignon I plan

What policies? What was achieved?

1980-1985 Davignon II plan

• No capacity reduction
• Reduction of manpower by ca.

120k (ca. 15%) over 3 years

• Improvement of productivity
• No improvement of utilisation rate
• No new capacity
• State aid proposing capacity cuts

supporting redundancies

• Limited authority of European

commission over national subsidies and aids

Davignon II plan implemented in Europe reduced capacity by 20 %, improved utilisation rate by 10 percentage points and returned the industry to profit

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Production quota 1

X No government plan to impose production quotas  Voluntary production cuts as response to low profit margins resulted in temporary market stabilisation in the past  Mandatory production quotas applied to 4 cat. steel products (80% total steel

• utputs) for 3 years until June 1983

 Strict control system and fines imposed by Europe Court of Justice

Minimum prices Labour reduction Capacity cuts Europe – Davignon plan II China – government policies 2 3 4

Short term stabilisation

X No government plan to impose minimum prices  Compulsory minimum prices according to the sensitivity of the products to define what prices increase were necessary  Regulated by law with fines imposed by Europe Court of Justice  Targeted reduction of ca. 500k people (ca. 14%)  In total ca. RMB53 billion required (ca. RMB105000 per person) for 150mt cut, with 2/3 from Central Government (ca. RMB35 billion which reflects ca. 1/3 of total fund of RMB100bn)  Reduction of ca. 200k people (ca. 33%), including Davignon I of ca. 320k (ca. 45%)  Of ca. ECU38 billion total state aid ca. ECU2 billion (ca. 5%) for redundancies/ redeployment (ca. ECU 10000 per person) X Targeted capacity reduction of 100-150mt (9-14%) within 5 years – is this sufficient? X Required estimated debt restructuring of RMB 270 billion (5 times of aid of redeployment)  Central government has given clear high level target X Instruments and control system have to be put in place  Capacity reduction of ca. 40mt (20%) within 5 years  Financial aid of ca. ECU23 billion (12 times of aid of redeployment)  Legal power over national aids and subsidies decision  Precise business plan required proving long term financial viability

Sustainable market improvement

Key policies

/ /

Chinese government policy is directionally correct, but to be successful it needs clear systems/instruments and authority and should arguably target deeper reductions

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40% 50% 60% 70% 80% 90% 100% 50 100 150 200 250 300 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 Capacity Production Utilisation

• W. Europe* - production, capacity and

utilisation rate (million tonnes, %)

*EU 9 countries include Germany, UK, France, Italy, Ireland, Belgium, Denmark, Luxembourg, Netherlands

Capacity expansion

• to meet the high demand

growth Overcapacity

• when demand

saturated 40% 50% 60% 70% 80% 90% 100% 250 500 750 1000 1250 1500 Capacity Production Utilisation Capacity expansion

• to meet the high demand

growth Overcapacity

• when demand

slowed down

China - production, capacity and utilisation rate (million tonnes, %)

There is a real risk that capacity reduction will be insufficient and/or too slow; this is what happened in Europe in the 1970s