Overall Outlook

Recovery in global business cycle to lead to better outlook for steel consumption. Manufacturing indices across developed and developing markets have considerably outperformed y-o-y through most of 2017 while remaining in the expansion phase. Construction activities have also improved in most developed and developing countries. Accordingly, the International Monetary Fund (IMF) raised its forecast on world economic growth to 3.7% for 2018 in October. The World Steel Association (WSA) also raised its forecast for steel demand in 2017/2018 to 2.8%/1.6% from 1.3%/0.9%, respectively. Going forward, more infrastructure investments are expected in developing countries thanks to better financing – higher budget allocations, private-public partnerships, and support from China’s One Belt, One Road (OBOR) initiative. We forecast global steel demand to expand 1.6% and 1.3% y-o-y in 2018 and 2019, respectively. Despite an expected slowdown in China as it shifts to a consumption-driven economy, we believe steel demand growth will remain positive as other developing markets mature.

China’s faster and stronger steel sector supply reform and winter production cuts. China’s Ministry of Industry and Information Technology (MIIT) announced on 27 October that the country has already met its annual steel capacity elimination target of 50m tons for 2017. We also note that China has eliminated more than 115m tons of steelmaking capacity during 2016-2017, which implies that it has already achieved its goal of removing 100-150m tons of steel capacity by 2020. Northern China has imposed production-restricting measures for steel and raw materials to reduce smog and particulates during the winter heating season (November 2017-March 2018). During this period, steel mills in this region are required to limit the blast furnace output to 50% of capacity. Tangshan and Handan, located in China’s biggest steel-making province, Hebei (which accounts for 24% of China’s total steel production), enforced the measures in October, a month earlier than the official winter start date. We estimate that the winter production cut would reduce China’s steel production by c.33.5m tons, which translates to 11.8% of its monthly steel output during November 2017 to March 2018.

Global supply-demand balance to improve. The global oversupply of steel will likely abate by 55.9% y-o-y from 23m tons in 2016 to 10m tons in 2017 and by a further 17% y-o-y to 9m tons in 2018, in light of demand growth in most regions and restrictions on supply growth. In fact, overcapacity is easing thanks to China’s supply reform and with most steel-producing countries still undergoing restructuring and cautious over any capacity increase. Global steel production is expected to climb 5.4% in 2017 as some Chinese production will be captured in the statistics following the government shutdown of all intermediate frequency furnace (IFF) facilities. Hence, the business environment for the steel sector has been rather favourable in 2017 and would continue to be so going forward, unlike in 2014-2016.

Near-term steel prices supported by raw materials’ price gains. Iron ore prices have been recovering strongly, defying expectations of further price drop along with the production cuts in China. We believe this is attributable to i) firm steel prices despite weak iron ore prices, preventing a drastic fall in iron ore prices and shortening the period of price weakness; ii) the highest mill margins since 2013 driving iron ore demand; and iii) China’s restriction on sintering and higher coking coal prices stimulating demand for higher grade and lump iron ore. Also, coking coal prices have spiked, thanks to China’s winter measures which are estimated to reduce coking coal supply by 30% and concerns over possible supply disruptions in the monsoon season. On the back of the raw materials’ price rebound and low inventory with the producers and middlemen, steel prices are set to advance further. This suggests that steel mills’ earnings, especially for those unaffected by the winter production cuts, will be outstanding in 4Q17 and 1Q18.

Outlook for 2018: Steel prices to stabilise, along with raw materials’ price weakness. Prominent industry experts forecast iron ore prices to decline to the US$50-level due to persistent oversupply. However, we expect iron ore prices to average US$60/ton in 2018 as the increased market dominance by major miners should support prices. In addition, coal prices are expected to stabilise in 2018 as its price surge in 2017 was mainly due to the one-off and seasonal supply disruption. We foresee average coking coal prices to decline 15% y-o-y to US$180/ton in 2018. Following the raw materials’ downward price stabilisation, steel prices are unlikely to grow significantly in 2018. Nevertheless, we expect hot rolled coil (HRC) benchmark prices in 2018 to be similar to 2017’s as oversupply eases. Meanwhile, rebar prices are likely to increase 9% y-o-y in 2018 on substantial production capacity cut in China, including the shutdown of IFF facilities.

Price outlook: Supported by China’s winter production cuts and raw materials’ price strength

Steel prices strengthened despite drop in raw material prices in September and October. Iron ore and coking coal prices weakened in September and October, with iron ore plunging to US$58.5/ton on 31 October from the peak of US$79/ton on 1 September due to expectations of sluggish demand following winter production cuts in China. During the same period, however, steel prices increased contrary to market expectations – the world benchmark HRC and China benchmark HRC prices registered gains of 6.3% and 1.5%, respectively. This is unusual given the weakness in raw material prices and hence, we interpret it as a tight steel market driven by the successful supply reform in China.

Chinese steel prices’ continued strength; world prices recover in November. China’s domestic steel prices have increased across all products in November. Rebar gained the most, up 16% to RMB4,121/ton (US$624/ton) on 1 December from RMB3,553/ton (US$536/ton) on 3 November. The increase in steel plate price was the smallest, at 3.8% to RMB3,640/ton (US$551/ton). Overall, long steel showed stronger performance than flat steel, thanks to the closure of IFF facilities in China which used to produce rebars mainly, and the larger reduction in long steel inventory versus flat steel. World benchmark HRC price has also started to recover after a tepid month, rising for the first time since end-September, inching up from US$561/ton to US$566/ton on 27 November.

China’s winter production cuts to support steel prices. Steel prices are being supported by restricted supply in China’s main steel-producing regions due to the government’s winter measures. Notably, Hebei, which accounts for 24% of total Chinese steel output, requires blast furnaces to cap the utilisation rate at 50% during winter (November 2017-March 2018). Tangshan, a city located in Hebei province, has even extended the enforcement period by starting the measure earlier, in October. We estimate the output loss as a result of these measures to amount to c.33.5m tons, equivalent to 11.8% of China’s total monthly steel output during the winter period. This should continue to act as a catalyst for steel prices, both domestically and internationally.

Steel demand appears healthy as inventory with steel mills and middlemen continued to decline.Despite concerns over a slowdown in steel demand due to restricted downstream activities (such as construction in northern China during the winter months), falling inventory throughout November implies continued demand for steel. China’s total steel inventory declined 9.9% m-o-m from 3.7m tons at end-October to 3.4m tons at end-November. This was driven by long steel inventory’s 20.2% m-o-m fall from 1.6m tons at end-October to 1.3m tons at end-November, while that of flat steel only decreased 2% m-o-m to 2.1m tons.

Near-term outlook: Steel prices supported by raw materials’ price gains. Iron ore prices have been recovering strongly, defying expectations of further price drop along with the production cuts in China. We believe this is attributable to i) firm steel prices despite weak iron ore prices, preventing a drastic fall in iron ore prices and shortening the period of price weakness; ii) the highest mill margins since 2013 driving iron ore demand; and iii) China’s restriction on sintering and higher coking coal prices stimulating demand for higher grade and lump iron ore. Also, coking coal prices have spiked, thanks to China’s winter measures which are estimated to reduce coking coal supply by 30% and concerns over possible supply disruptions in the monsoon season. On the back of the raw materials’ price rebound as mentioned earlier, steel prices are positioned to rise further. Rebar and HRC prices in China surged to US$88/ton (up 16%) and US$26/ton (up 5%), respectively, in November. Steel prices have started to soften in December, but we believe prices will be supported by a tight market, thanks to production cuts and low inventory. This suggests that steel mills’ earnings, especially for those unaffected by the winter production cuts, will be outstanding in 4Q17 and 1Q18.

Outlook for 2018: Steel prices to stabilise along with raw material prices’ weakness. Prominent industry experts forecast iron ore prices to decline to the US$50-level due to persistent oversupply. However, we expect iron ore prices to average US$60/ton in 2018 as the increased market dominance by major miners should support prices. In addition, coal prices are expected to stabilise in 2018 as its price surge in 2017 was mainly due to the one-off and seasonal supply disruption. We foresee average coking coal prices to decline 15% y-o-y to US$180/ton in 2018. Following the raw materials’ downward price stabilisation, steel prices are unlikely to grow significantly in 2018. Nevertheless, we expect hot rolled coil (HRC) benchmark prices in 2018 to be similar to 2017’s as oversupply eases. Meanwhile, rebar prices are likely to increase 9% y-o-y in 2018 on substantial production capacity cut in China, including the shutdown of IFF facilities.