STEEL
The Induction Reduction
August 2017
The Chinese Government has enforced the closure of all Induction Furnace (IF) steelmaking capacity, contributing to a spike in Chinese rebar prices. AME estimates that 30-50Mtpa of unreported IF production has been eliminated, which will result in official production numbers rising in the second half of the year. The top 10 producers in China account for less than 30% of total production.

However, by squeezing small players out of the market, the reforms will allow the government to exhort more control over the highly fragmented industry and assist in responding to international criticisms of overcapacity.

 

 

Enforcing Change 

From the 1st July, the use of induction furnaces has been limited to ferroalloy production, specialty steel, stainless and other high alloy steelmaking, China has enforced the closure of all other IF steelmaking capacity. China is estimated to have 100–150Mtpa of installed IF capacity, responsible for unreported production of approximately 30–50Mtpa. The government has made a concerted effort in enforcing IF elimination. Indeed, reports from China indicate that after spending the first half of the year identifying over 600 IF operators, water and electricity services were cut to these facilities to ensure production ceased. AME believes that the real motive behind the elimination comes down to three factors: environment monitoring, steel product quality, and a desire to reform the highly fragmented sector. 

Excessive environmental emissions in major cities has led to government restrictions on production when air quality standards approach dangerous levels, and IF operators have been continually blamed for flouting these restrictions. Limiting the number of steel producers makes environmental emission monitoring, and enforcement, a simpler task for authorities. Larger integrated and EAF mills have large amounts of capital invested in sites and can be more easily pressured to develop and maintain advanced environmental management systems.  

Scrap steel fed furnaces, such as IFs, are very susceptible to impurities and compositional variation in the raw materials, resulting in substandard products of unknown mechanical properties being produced. The products produced by IF operators are used primarily in residential construction, placing the community at risk. 

Over the past decade small IF operations in China have been crucial in absorbing domestically generated scrap. The elimination of IF steelmaking frees a significant amount of scrap steel that can be diverted from IF producers to EAF and integrated steel producers who can increase utilisation. This will encourage the continued development of the domestic scrap networks which will be critical in the medium term for capturing the expected growth in China’s obsolete scrap generation.


The Price of Change 

The figure below shows the price fluctuation in China over the last year for rebar and hot rolled coil (HRC). Induction furnaces were targeted in December 2016 when several provincial governments ordered the dismantling of illegal operations. In January 2017, the Ministry of Industry announced that the sale of scrap to IF operations is now prohibited. This was followed in February with banks being prohibited from issuing loans to IF operations. The elimination of IF capacity reduced the supply of rebar, which at a time of government stimulus drove high demand from the domestic construction sector, causing prices to increase. This price increase has enticed companies to maximise rebar production over HRC, a traditionally premium product.  

 

 

The New Equilibrium 

Past crackdowns by the Chinese government on inefficient production capacity has led to unintended consequences. Just over a decade ago, the government attempted to close small scale blast furnaces within city limits by banning their production of pig iron, which forced furnace owners to skirt the rules by processing alternative feed stock, playing a large part in the early development of nickel pig iron (NPI). Time will tell whether China has learnt from prior mistakes. Early indications are that the government has allowed less leeway this time around. In the short term, restoration and growth of billet and rebar capacity will stabilise the supply side effect on prices, which will continue to be driven by demand mechanisms. 30-50Mt may be a large amount in any other country, however, in China this only equates to 3-6% of total crude steel production. With BOF scrap rates of less than 10%, typically 20-25% in developed nations, there is ample capacity to absorb the surplus steel scrap generated by the IF elimination. 

There remains an opportunity for EAF producers to increase their market share. EAF production peaked in 2011 at 70.9Mt, this is 28.9Mt more than was produced last year. The elimination of IF capacity will drive the recommissioning of EAF assets and encourage investment into EAF steel production. AME believes investors should be cautious as small capacity and recommissioned EAFs, together with inefficient integrated mills, are likely to be the next target of steel supply side reforms.