Gunning for One Belt One Road

Silk Road_1

By Titus Zheng, FIS Singapore

China’s One Belt One Road (OBOR) project might prove to be the right catalyst just to lift the recent bearish market sentiment in the steel and iron ore markets. At a forum held 14-15 May, China’s president Xi Jinping pledged to inject an additional USD124 billion into plans for a new Silk Road.

The development of OBOR – or at least the announcement of the latest updates – seemed to invigorate the market, coinciding with some price upticks in steel and iron ore. However, perhaps these assumptions are rather coincidental in nature, as OBOR is a very long term project. In addition, OBOR is still faced with many doubts about its transparency in government procurement as well as the high-quality financing needed to avoid unsustainable debt burdens and encourage broad participation.

China’s steel output grew 4.9% in April. As the OBOR meeting drew to a close, the state bureau of China recorded a rise in steel production to 72.78m tonnes in April, up 4.9% month-on-month. For the first four months, China also saw its overall steel output grew by 4.6% year-on-year to 273.9m tonnes, despite the Chinese authorities’ ongoing efforts to curb on excess capacity.

The surplus worried the market on whether the demand side could can keep up with the ongoing supply glut of steel products. Moreover, China’s port inventory showed no signs of drawing down but instead recorded 136.82 million tonnes on Friday 12 May 2017, up 678,000 tonnes week-on-week, based on Umetal’s survey of 42 Chinese ports.

Eurofer forecasts China to raise steel output despite capacity cuts. The European Union expects China to produce more steel over the next quarters despite the country’s pledge to cut steel capacity by 2020. According to European Union steel body Eurofer president Geert Van Poelvoorde, while Chinese authorities are serious about reducing steel capacity, this does not translate to production cuts.

The body stated that last year’s capacity cuts has mainly involved idling plants, cuts which have helped to relieve the state budget as some mills were heavily subsidized by the government. Despite the determination of the government to cut steel capacity, the supply glut situation will continue as suppliers like Iran and Russia have added “new capacity beyond their domestic needs”.  For instance, Iran has planned to expand capacity by almost 24 million tonnes by 2019 in addition to existing estimated capacity of 28 million tonnes, based on findings from Organisation for Economic Cooperation and Development.

China’s industrial output softened in April. The latest data on China’s retail sales, investment and industrial production are showing signs of slowdown as compared to previous month. For instance, retail sales reached 10.7% in April compared to 10.9% in March, while urban fixed-asset investment grew 8.9% in April, down from growth of 9.2% in March as well as falling short of expectations for an estimate rise of 9.1%.

Similarly, the country’s industrial production growth stood at 6.5%, well below the expected growth of 7.1%. Thus, all three economic gauges were down despite an increase in total social financing grown by 12.8% in April as compared to 12.5% in March.

Mills in Handan to cut output by 50%. Mills in Handan, China were heard to be cutting their production by 50% ahead of the OBOR forum. The cut was seen as a normal practice among the Chinese authorities to reduce mills’ sintering and coking operation by half during important events to improve air quality.

In the meantime, an environmental protection inspection was also conducted over the Hebei province before the OBOR meeting, covering cities such as Tangshan, Shijiazhuang, Baoding, Cangzhou, Langfang, Hengshui and Xingtao. Mills in these cities may be forced to suspend operations if they failed to comply with emission guidelines set by the Chinese authorities.

The reduced mill activity may prompt much procurement of stocks from the ports and one trade source stated that some mills’ inventories were very low and might restock soon. However, most buyers still prefer to sit on the sidelines at the moment, waiting for clarity on market direction.

Coking coal market is no longer supply-sensitive. Coking coal demand remains lukewarm even with the return of Japanese and Korean participants from their Golden week holiday. Despite the news of supply disruption of South 32’s mine at Illawarra, coking coal prices seemed to shrug off the label of being supply-sensitive and remained unaffected.

In the current soft market, a trade source indicated that Chinese mills expected their domestic coking coal prices to fall further, thus most end-users turned away from buying new seaborne cargoes for the moment.

Going down the Rabbit hole. The OBOR forum certainly acted as a stimulant to the steel and iron ore markets in term of making waves on the news-wires. But FIS believes that the physical market has yet to react to the various multi-billion projects proposed under OBOR – which is almost seven times larger than America’s Marshall Plan to rebuild Europe after the World War Two.

For the moment, a bearish outlook clouds the iron ore market and as such, analysts at Macquarie Bank expect the iron ore prices to fall to USD48/tonne by the end of the year, while Citigroup forecast that prices would average USD45/tonne this year, lower than the Australian government’s forecast of a USD66/tonne average in 2017 – and USD55/tonne by March 2018.