China steel plant closure points to slow recovery

LAUNCESTON, Australia: The decision by Boashan Iron & Steel Co, China's biggest listed steelmaker, to idle a plant may both be a sign of how bad things are in the key sector and a contrarian signal that a turnaround is near.
It's easy to construct an argument that the move to close the 3 million ton-a-year plant in Shanghai is proof that China's steel sector has too much capacity and supply is well ahead of demand.
Closing down higher cost steel production is after all what should happen when demand cools and prices decline, and there is also a need to work through an overhang of inventory built up in the first half of 2012 when steelmakers maintained output even as economic growth eased.
However, an argument can also be built on saying the Boashan move is an early indicator that things should start turning around within the next 12 months.
Removing the higher cost production allows prices to stabilize as supply adjusts lower to reflect the change in demand.
What you are basically left with is a situation where the current short-term pain is replaced with longer-term gain.
The question then becomes how long are iron ore and steel producers going to have to wait for the good times to return?
It's worth looking back to the start of 2012 when many analysts thought Chinese commodity demand would slow in the first half before rebounding in the second.
Instead what happened is that the economic growth rate eased as expected, but raw commodity consumption and finished product output continued apace, particularly in the steel sector.
This led to a build-up of inventories, falling prices and the current situation, where even if demand does pick up, it will take some time to work its way down to commodity producers.
The most-traded steel rebar contract in Shanghai has lost 13 percent this year and while it has picked up slightly in recent weeks, it's still near the record low hit last month.
Spot iron ore prices have also rebounded recently, gaining 17 percent in September, but they were still down 22 percent for the third quarter, the steepest drop since the Steel Index starting compiling data in 2008.
The idling of the Boashan steel plant in Shanghai is unlikely to be the last such occurrence, especially if the Chinese government's $ 160 billion infrastructure-spending boost fails to increase demand meaningfully in the next few months.
Iron ore capacity is also being closed in China, with high-cost mines the first to go.
This is positive for the big, global iron ore miners such as Vale, BHP Billton and Rio Tinto, as their lower cost bases means they can keep producing at a profit long after Chinese rivals are deep in the red.
But just as analysts were off with the timing of the slowdown in China's commodity demand, hopes that it will rebound by the end of this year may be too optimistic as well.
Even if China's economic growth does start to regain momentum, and by that I mean a gross domestic product outcome above 8 percent in year-on-year terms, it's likely that commodity demand will lag the improvement, just as it remained resilient during the first half of slowing GDP growth.
The official Purchasing Managers' Index rose to 49.8 in September from 49.2 in August, which was the lowest reading since November 2011.
While still in contractionary territory below 50, the PMI is consistent with an economy bouncing along the bottom of the cycle.
But the compiler of the PMI, the National Bureau of Statistics, also said on Monday that while demand for food, beverages, tobacco and computers improved, that for steel, refined metals and construction materials remained under pressure.
This is consistent with the view that any recovery in the iron ore and steel sector is going to be slow, and more likely U-shaped rather than the more V-shaped rebound that happened after the 2008 global financial crisis.
The closure of one of Baoshan's steel plants confirms what we already know: namely that China's steel sector is now doing it tough and suffering from the hangover of over supply in a softening demand scenario.
But it also lays the groundwork for improvement in the sector, albeit a slow and lumpy recovery rather than strong and sustained as many producers would prefer.
— Clyde Russell is a Reuters market analyst. The views expressed are his own.