China isn't a great source for primary metals

Tom Stundza -- Purchasing, 3/2/2006

Despite the sometimes irrational fears expressed by North American steel producers, it's unlikely that primary metal imports from China will glut U.S. and Canadian markets and depress market prices anytime soon.

Last year, China shipped a lot of metal and parts into the U.S. But, the country supplied only 7% of the steel imports into the U.S. at transaction prices actually 11% higher than the spot-market average.

"Sourcing steel coil—or aluminum plates for that matter—from Chinese producers doesn't make much sense on a cost-benefit analysis basis," says a purchasing executive with extensive low-cost country sourcing experience. "First off, prices aren't a bargain when there are extra costs from shipping, insuring and paying duties—not to mention the probable warehousing and transporting charges when the materials do arrive."

For the past decade, Chinese companies have cornered supply of niche products at home and globally. Dubbed "hidden champions" by the local media, they have tapped into the country's inexpensive labor pool, invested in innovation and quality and focused on thousands of industrial, commercial and consumer products for sale at home and abroad.

That view also is supported by buyers at U.S. manufacturing and distributors expanding purchases of products ranging from die-cast zinc parts, extruded aluminum components and injection-molded plastic pieces to semiconductors, telecommunications equipment, and other sophisticated digital devices.

So, while Chinese factories may be flooding the world with low-priced consumer electronics, their exports of primary steel, copper and aluminum products have been limited and at prices higher than home-market levels.

Bill Wang, president of China Research Corp. in Beijing, tells Purchasing that "the Chinese government has been discouraging steelmakers and other primary metals producers from exporting products since last March."

The reasoning was partly economic and partly public relations. "The government wanted to cool an overheated industrial economy that was apparent from overwhelming domestic demand for steel, aluminum, copper and zinc," says Wang. "At the same time, surging raw materials costs worldwide were being blamed on the excessive production in China."

So, he reports that the government stopped the tax refund to the steel exporters, who used to get 13% rebate on the FOB value of the steel exported." Other financial restraints were put on exports of nonferrous metals, as well.

"China will keep sending steel to the U.S., but too much, too soon or for too long," says Mark Casey, a former automotive industry metals buyer now operating a purchasing consultancy in Ohio. "China is a bit of a factor in the U.S. sheet market, but not a huge factor."

Steel mills, the Congressional Steel Caucus and the United Steelworkers union have been complaining about Chinese imports that they claim to have been dumped illegally into the U.S. President Bush recently rejected a request to implement a fair-trading policy, known as Section 421, which would limit the amount of steel imported from China.

A review of trade data shows the Chinese mills have only supplied 7% of all the imports into the U.S. in recent months. That's partly due to expanded foreign sourcing from other countries.

"We have decided to manufacture our transportation-sector products in Mexico and China instead of sourcing metals there and shipping them back to the U.S. and Canada for fabrication," says the purchasing manager for a metal fastener systems company in Texas. "Business was up last year and we expect it to maintain the same level. But there's no new growth seen so it's better to expand purchasing and production overseas."

A purchasing manager at a New York firm that makes wholesale distribution display racks, says that "prices from our overseas China suppliers have increased, due to changes in labor costs and currency fluctuations."

"China is being watched very closely by the American steel industry's lawyers in Washington, and the mills offshore know it," says Casey. "Nobody wants more dumping lawsuits, it is not good for anyone-buyers or suppliers."

Chinese sheet steel sold in China is about 40% cheaper than what is being charged in the U.S. Some steel mill executives claim this is because China has been artificially keeping its currency undervalued in relation to the U.S. dollar. However, the People's Bank of China, the central bank, has begun calculating the yuan's value against the dollar using a weighted average of the prices given by major world banks.

Steel-price futures have actually started to rebound slightly in China in recent weeks. Chinese hot-rolled sheet steel prices (excluding a 17% export value-added tax) will have risen to $360/net ton for late second quarter deliveries from $315 in the first quarter. Meanwhile, cold-rolled sheet steel prices are up to $492 from $464. According to one steel trader, this change will have little impact on steel-import trends.

"The Chinese just raised the price for June arrival because they certainly have excess capacity, so they will continue to sell it well under North American prices and still get more per ton," says analyst Charles Bradford at Bradford Research in New York.

China's economy surged 9.9% in 2005 from a year earlier. But after three years of robust expansion, fueled partly by booming exports, Chinese leaders now face a challenge sustaining the momentum by encouraging greater domestic spending. Chinese leaders avoided a much-feared economic hard landing by cracking down on overheated investment in metals and other manufacturing sectors. Now, the national leadership has abandoned the previous five-year economic plan's development of industrial capacity based on the export market, Instead, the World Economic Forum at the Swiss ski resort of Davos was told that China's new five-year plan will stress development of domestic housing, upgraded health and education facilities, improved water and air pollution systems and light industrial and commercial enterprises based on home-country consumption growth.

The Chinese metals industry continues to be in a profit squeeze because of the usual reasons—sluggish sales growth, excess global output, fierce price competition and rising prices for raw materials. "The Chinese economy is inefficient, still relatively primitive and shockingly bad at allocating capital," according to Jim Jubak, senior markets editor for MSN Money. "The result is massive over-investment in sectors already bloated with excess capacity."

According to Jubak, steel production in China grew by 23% in 2004 and then by 25% to 349 million metric tons in 2005. It is projected to increase by yet another 50 million tons, or about 15%, in 2006. This output capacity of the domestic steel industry now exceeds market demand by 120 million metric tons a year. As a result, steel prices fell sharply last year.

"Considering that major steel-consuming companies are growing at much lower rates, is it any wonder that home-market steel prices are falling?" asks Jubak.

So, already in place is new industrial policy and action plan for the steel industry, which the Asia Pulse New Service says will result in a massive eventual reorganization around only a few steelmaking behemoths.

China ranks among the top eight steel-importing nations but even metals traders and distributors interviewed suggest that purchasing in other Asian and European nations is less of a hassle these days because of these ongoing production combinations, trans-regional mergers and acquisitions and ownership reorganizations within China's iron and steel enterprises.

"The increase in raw material costs and weakened demand for steel products have caused margin pressure and created impetus for consolidation in China's steel sector," says Danny Chen, associate director at Fitch Ratings in Beijing. "So, an abundant supply of raw materials, convenient transport and sufficient government support are the main reasons for the steelmakers to become bigger and stronger."

The consolidation in China's steel industry will center on the country's four largest players in order to enhance the sector's competitiveness and unity, according to a new Fitch Ratings report. The mergers and acquisitions will be led by Baosteel Group in Shanghai, Shougang Co. in Beijing, Wuhan Iron and Steel Co. in Hubei Province and Anben Iron & Steel Group in Shenyang (created by the merger of Anshan Iron & Steel and Benxi Iron & Steel).

North American buyers can expect to see less Chinese copper and aluminum again this year because of the new industrial policies. China is the world's biggest producer of aluminum, but shortages of alumina and electricity in some regions have been keeping a lid on aluminum production and, thus, driving prices up. Market analysts say that Chinese smelting costs have helped boost world aluminum ingot prices to $1.20/lb early this year-as compared with an annual average 85¢ in 2005 on the London Metals Exchange.

China exported 1.3 million metric tons of aluminum worldwide last year, a 22% drop from the previous year, according to the Customs General Administration of China in Beijing. After adjusting for imports, China's net exports of aluminum were just 660,000 metric tons last year. "China's aluminum net exports may further drop in 2006, due to production cuts by local smelters," reckons Wang Feihong, senior analyst at Antaike Information Development Co. in Beijing.

Exports also have been falling as Chinese smelters cut production after the government imposed a 55% export tax on aluminum as part of a central planning curb on industrial metals' production and exports. This year, China's net exports of aluminum are expected to drop to 300,000 metric tons, forecasts Ding Shenwei, director of China research at the International Finance Corp.'s field office in Beijing.

After falling an average 13% for the previous two years, imports of copper into China, the world's biggest consumer of the refined metal, rose in 2005 as faster economic growth spurred demand for cables and electric wires. The country increased offshore purchases to 1.3 million metric tons, according to the Customs General Administration of China while world exports were just 141,000 metric tons.

Chinese copper demand should remain strong for the next several years, according to analysts, partly because of wire and cable needs for new construction and partly because the country wants to become a leading user of hybrid cars, which contain twice as much copper as conventional motor vehicles. Analysts say that sustained Chinese demand in the face of disappointing production reports by major producers has helped push London Metal Exchange copper prices to record heights of $2.50/lb in early February-up from $1.67 last year.