The capesize market has kept enjoying a robust September so far with freight rates approaching the magical level of $40,000 pd (not seeing since 2011) for a round-voyage trip between Brazil and China. Given that rates were at about $5,000 pd in early June this year, the freight increase is phenomenal and most-welcome in an otherwise uninspiring shipping market, in general.
The increase in the cape market has been triggered by China’s elevated iron ore mostly (and some coal) import activity over the same period. This time however, more of the imports (proportionally) were originating from Brazil than the previous mini-peak of the market earlier this year; Brazilian imports usually absorb three times as much capesize tonnage as Australian imports do due to distance, which explains partially the freight increase. It is not known yet whether the increased iron ore imports are purely for inventory replenishing purposes or due to increased iron ore production, as updated, reliable statistics are not available yet. This differentiation between end-production and stock piling in general is useful as the latter explanation equates to ‘stuffing the channel’ improvement. It is known that Chinese iron ore stockpiles have been maintained at the 20-day mark this year (about 70 million tons), while in the last few years that mark was at about 30-to-40 days of demand. Also, the price of steel plate at Chinese shores increased from about $100/ton in late May to $130/ton at present after briefly setting a recent high of about $140/ton.
The recent rally in the cape market has not really spread proportionally to other asset classes in the dry bulk market, and the crude tanker market is definitely under renewed duress. The big question then becomes whether the cape rally is sustainable and it can be an inflection point for the shipping market.
Iron ore and metallurgical coal are used for the production of steel, which to be used for infrastructure projects, construction, in heavy industries, etc In a sense, the steel industry and its health thereof is an integral parameter to the health of the of the iron ore trade (and capes.)
A recent article in Week in China, a Hong Kong-based insightful weekly publication about Chinese matters, about the steel industry got us thinking. Here are few major points: there are about 21,000 steel mils in China according to the Research Center for Chinese Politics and Business at Indiana University, ranging from the heavyweights like the state-owned, publicly listed companies like Baoshan Iron and Steel (Baosteel) to start-up steel makers. In 2012, about 715 million tons of steel was produced in China, and the industry overcapacity stands at about 300 million tons, for a total overall capacity of more than one billion tons per annum. This is not a typo, Chinese steel production capacity exceeds demand by 300 million tons per annum; to put this into perspective, the whole annual European steel production stands at 150 million tons presently, so China’s spare capacity is twice Europe’s annual production. Chinese steel mill utilization rate has remained in the 70-80% range in the recent past. [The European steel industry has tremendous overcapacity in its own right, in full disclosure, as capacity stands at 2008 levels of 200 million tons per annum].
So, how an industry with 40% overcapacity (much worse than that in shipping, actually) and a low utilization rate (again, lower than in shipping) gets to make money? Glad that you asked!
In an article titled ‘In a precarious state,’ Week in China reports that Chinese steel firms have run a debt tab of RMB 3 trillion (US$ 490 billion). About three-quarters of these loans are bank loans and in general have short maturities, usually less than one year, and thus they will have to be re-financed in the immediate future. Focusing on the established and most solid players, the largest 30 steel mills in China have outstanding loans of RMB 760 bln (US$ 125 bln). As we mentioned in previous posting, China’s ‘shadow banking’ is estimated at about US$ 2 trillion, so any way one slices the data, the steel industry has a significant share of it; some have argued that the steel industry may be of higher cause of concern than overstretched property developers and local government financing vehicles. A recent study by Morgan Stanley titled ‘China Deleveraging, Can the banks tide out a financial storm’, ‘Ferrous metal smelting & pressing’ is the most underperforming industry and by far the highest risk of concern to their lenders.
Chinese steel mills, without any government subsidies, in general lose RMB 100 – 300 per ton produced (about $15 – 50 per ton.) All inclusive, the industry’s margin is as thin as 0.04%.
China’s recent ‘rebalancing efforts’ have taken into consideration ‘excess capacity’, and officially the government has ordered 1,900 companies in the steel, aluminum and concrete industries to be shut down; about seven million metric tons of steel capacity to be taken out of the market by the end of September 2013 (about 2.5% of the 300 mil ton overcapacity.) The curbing is rather mild, and as Reuters’ article emphasizes: “Beijing's previous efforts to rein in "blind expansion" in some sectors have been thwarted by local governments that have offered cheap land, tax deductions, subsidies and loans to attract investment, the People's Daily said on Tuesday, citing a spokesman for Ministry of Industry and Information Technology.” However, one cannot ignore the writing on the wall…
Chronic overcapacity may be interpreted that if/when the Chinese economy grows again at 15%, there will be plenty of 'shovel ready' plants to rev up production, which would be an immediate blessing for the iron ore and cape markets... But again, all this overcapacity will have to be kept alive until then, either by political will or at considerable destruction of wealth...
The recent cape rally has partially attributed to Brazil’s iron ore coming back to the market after an exceptionally heavy rain season earlier in the year and port facilities becoming available again. Chinese steel mills, especially the smaller ones and the ones with their debt financing coming due immediately, kept buying iron ore despite increasing prices of the commodity in an effort to ‘keep the bicycle moving’: once they stopped buying and producing, despite the government’s edict and the bad economics of their production, banks would be much more inclined not to re-finance loans coming due…
Far from us being 'dragon slayers' (pessimists on China) and would rather side with the 'Panda lovers' camp (optimists on China); and, no-one said that Chinese local politics and statistics are always translucent and that China does not have the magic to surprise. However, it seems that the Chinese steel industry, the cornerstone of any sustainable cape recovery, may just not be the rock where great fortunes can be build upon at present.
© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.
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