have we reached “peak steel” demand in china? we think not
TRANSCRIPT
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08 March 2012Fixed Income Research
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Have We Reached “Peak Steel” Demand in China? We Think Not Commodities Research T
The Installed Stock of Steel is Still Very Low Research Analysts
Ric Deverell +44 20 7883 2523
Marcus Garvey +44 207 883 4787
Andrew Shaw +65 6212 4244
Ivan Szpakowski + 65 6212 3534
Martin Yu + 44 20 7883 2150
Over recent months many investors have begun to ask whether the “Chinese steel party” is likely to come to a painfully abrupt end this year. In terms of the shorter-term dynamics, we remain firmly of the view that Chinese consumption growth will show itself to have bottomed out in H1 this year, before recovering more robustly in H2 (see Chinese Housing and Commodity Demand: Healthy Growth Despite Private Dip).
More generally, as the impact of the 2009 stimulus package washes out of the system, many have begun to ask whether Chinese steel consumption may be in the process of finding a level peak, much as was seen in the USA in the 1970s and Japan in the 1980s. While the future is by its very nature uncertain, we consider such a peak highly unlikely anytime soon.
• China’s capital stock (including installed steel) is very low; and
• The key drivers of steel consumption (floor space added, increased high-rise construction, the general deepening of the capital stock, increased steel use in transport, and infrastructure improvements) are likely to maintain growth for some years longer.
After expanding at an average of around 19% p.a. in the period 2001-2005, steel consumption growth has slowed to roughly 11.% p.a. since 2006 – i.e., the steel intensity of GDP has already moderated substantially.
• However, rather than a one-off structural downshift, we expect a continued gradual moderation in the steel intensity of GDP growth, with rises in demand slowing to around 5% p.a. on average through to 2016.
Exhibit 1: China’s STOCK of capital is still very low...
Exhibit 2: China’s steel consumption yet to peak, but growth rates moderating
Capital stock per capita, US$ at constant 2005 prices Finished steel demand, natural log
$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
$140,000
2010 2010 PPPChina USA
1930 2009
4.5
5
5.5
6
6.5
7
2000 2005 2010 2015 2020
ForecastDemand
CAGR 2000-05: 18.7%
CAGR 2006-11: 11%
CAGR 2012-15: 4.9%
CAGR 2015-20: 2.5%
2000: 124.3 Mt
2005:347.5 Mt
2011:650 Mt
2015:787 Mt
2020:891 Mt
Source: Credit Suisse, US Bureau of Economic Analysis Source: Credit Suisse estimates, World Steel Association
.
08 March 2012
China’s Steel Demand: Is the Party Over? Worries in the near term… Over the past few months one of the key concerns for commodity investors has been the near-term outlook for Chinese commodity demand, with the housing sector at the epicenter of those concerns. As we noted in Chinese Housing and Commodity Demand: Healthy Growth Despite Private Dip, while we expect a cyclical slowdown in Chinese commodity consumption over H1 2012, we expect a recovery as the year progresses, with apparent steel consumption increasing by 4-5%1, copper 8% and aluminum 10% for the calendar year as a whole.
…leading to questions about structural decline Moving beyond the immediate cyclical prospects, however, a range of analysts and investors have recently begun to question whether China’s commodity consumption growth has entered a substantial structural slowdown, with the more extreme analyses suggesting that the nation’s commodity consumption may be nearing a level peak, or even facing a decline, as was the experience of the USA and Japan in the 1970s and 1980s respectively, for example.
Much of the discussion surrounding changes in the structural pace of commodity consumption in China has been driven by the now clear objective of the policymakers (as embodied in the 12th 5-Year Plan) to rebalance the Chinese economy away from exports and investment, and towards consumption and efficient, value-adding industry and services.
While we agree that this transformation is likely to occur over time, we do not expect there to be step change this year. Indeed, we suspect that such a significant economic transformation may take far longer than most expect.
Reshaping China’s economy presents a
major challenge to Beijing’s planners • We note that while many focus on the high level of investment as a share of GDP, the
savings rate in China is yet higher, reducing many of the normal concerns associated with high investment rates.
o It was the fact that investment was higher than savings (that is, they were running current account deficits) that led to problems in many Asian economies in the Asian crisis of 1997.
• While the high level of investment is likely to fall over time, it is notable that its current share of GDP is not materially higher than that seen for a period in several of the other Asian economies during their rapid industrialization.
Most importantly, while the rate of investment has been very strong, the level of the capital stock in China remains very low compared to most industrial economies and, more importantly, compared to the needs (recognized in Beijing) of the country’s large, and crowded, urban and rural populations.
We believe this is a key point missed by bearish forecasters: China’s development focus has moved to a quest for improved quality of urban (and for that matter, rural) living, which will require sustained levels of investment to achieve social and political objectives.
• Images of farmers flooding into China’s cities are misleading: of the 20 million people added each year to the urban environment, more than half are “absorbed” by expanding metropolitan boundaries and infrastructure corridors.
1 Note: consumption, not production.
Have We Reached “Peak Steel” Demand in China? We Think Not 2
08 March 2012
• Crucially, China’s pattern of urban development is as much about urban renewal as it is about creating new towns. Most of its urban floor space is old, with inadequate, and in some cases appalling, utilities. China’s average urban floor space per capita ignores the overcrowded living conditions of the majority of households. We are in the midst of one of the largest and most sustained removals of slums in modern history.
Exhibit 3: China’s STOCK of capital is still very low Capital stock per capita, US$ at constant 2005 prices
$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
$140,000
2010 2010 PPPChina USA
1930 2009
Source: Credit Suisse, US Bureau of Economic Analysis
• So, investment will increasingly be directed at new second generation infrastructure, leveraging better technology: put simply, Beijing cannot afford to halt infrastructure development if it is to avert major problems associated with growing congestion, pollution, health and safety.
• Expenditure in this area is expected to slow in CAGR terms, from levels above 20% p.a. in recent years, but it is implausible that infrastructure spending will stagnate; we expect investment to maintain double digit rates (off a larger base) in the run-up to 2020.
• This includes renewed attention to networks from rail and mass-transit systems (rail length is planned to triple by 2020), water and waste treatment (long-neglected and very high on the social agenda) to power and energy infrastructure (targets far outpacing expected headline GDP growth).
• To us it is notable that even one of the key advocates of the structural change, the IMF, has its doubts about its likely pace. These concerns have been echoed in our meetings with government officials.
o In its recent sustainability report, the IMF noted that both the authorities and the IMF expect the investment surge associated with the stimulus to fade, as construction returns to a “more normal pace”.
o The IMF in its latest forecasts expects investment growth of 9.4% in 2012, and 8.9% in 2013, only modestly slower than was seen in 2011, suggesting very little rebalancing in the near term.
• The IMF also noted that it does not feel that the policies currently embodied in the 12th 5-Year Plan will be sufficient to result in a substantial increase in the savings consumption share of GDP.
o In this world, the authorities will be faced with the choice of either substantially weaker GDP growth, or the necessity to continue supporting rapid investment growth. The latter course to us seems more probable.
Have We Reached “Peak Steel” Demand in China? We Think Not 3
08 March 2012
In summary, we do not share the concerns of many investors.
• While it is likely that the pace of basic material consumption growth will slow gradually over time, this is part of an already established pattern. We do not see a sharp inflection point this year, although cycles often act as catalysts for faster change.
We also note that while growth is likely to evolve, the substantial increase in the base should ensure that China continues to make a large contribution to global growth.
• For example, 10% growth off a base of 100 is the same in terms of absolute increment as only 5% growth off a base of 200.
This argument is well illustrated by looking at the contribution of Chinese GDP growth to the global total:
• In the 1980s, China’s GDP growth averaged 10%, with China contributing less than 10% of global growth.
• In the 1990s, China’s GDP growth was also 10%, but its contribution stepped up to nearly 20%.
• Over 2000-10, China’s GDP growth again averaged around 10%, but the contribution grew to over 25%.
• Even if Chinese GDP growth slows to 8% p.a. in 2012-14 (substantially slower than in the last decade), its contribution to global growth should continue to increase, to more than a third in the first half of this decade.
Exhibit 4: Despite slower growth, China’s contribution to global totals is rising
Exhibit 5: The consensus has consistently underestimated China’s growth
China’s contribution to global GDP growth Chinese GDP growth relative to consensus forecasts
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
70s 80s 90s 00s 10s*
4
6
8
10
12
14
16
1997 1999 2001 2003 2005 2007 2009 2011
Actual Consensus ForecastS S
Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse Source: the BLOOMBERG PROFESSIONAL™ service, RBA, Credit Suisse
Finally, we should remember that the consensus has almost always underestimated the pace of Chinese growth. This was well illustrated just this week when markets were moved by the announcement that the government’s target for GDP growth in 2012 had fallen to 7.5% from the previous 8%. History suggests that these targets have little impact on the outcomes, other than perhaps providing a floor. The economy is at greater risk of overshooting this conservative benchmark, in our view, as was the case in the past.
As a way of illustrating the arguments underpinning these views, this note focuses on the steel market as an example. Over recent weeks many investors have asked us the question: “Has China’s annual steel demand (and hence production) reached a permanent peak?”
Have We Reached “Peak Steel” Demand in China? We Think Not 4
08 March 2012
China’s Steel Demand Growth The big question – is it over? This is not a new question: In 2003-04, the National Development and Reform Council (NDRC) wanted to cap China’s steel production capacity at 300 Mt/y, and in 2005 the government forecast that steel demand in 2010 would be a little over 300 Mt, more than 250 Mt below the level recorded in that year. Debate has run long on the likely pinnacle for steel consumption per capita, with most analysts assuming that China would at least reach the 600 kg per person achieved by the USA at its peak, and possibly eclipse the 700 kg or more reached by Japan at the height of its investment cycle. This compares with a level of 480 kg per person in China in 2011. China, with an urbanizing population of 1.4 billion would lift annual steel consumption close to the 1 Bt/y mark on this measure, though picking the time of this anticipated plateau is problematical.
Intensity of use per person – will China
peak above Japan’s 700 kg per capita?
This is due to limitations in the comparisons between China and developed nations; China is a continental-maritime economy, with a large population and an urban development pattern entailing very high population density. There are examples useful for mapping intensity of use trends, but it is now clear that China is unique in more ways than it is similar to other nations. For every city dweller associated with high steel use – China’s richest cities are characterized by steel use per capita of more than 1,000 kg – there is a rural resident that consumes little, if any, steel – the tyranny of weighted averages.
In the case of more developed nations, “peak steel” has typically arrived at a point when real GDP per capita approaches US$20,000 (on a purchasing power parity basis), more than double the income levels of China in 2012. However, charting intensity per capita, while being a useful guide, does not provide a reliable forecasting tool.
China’s annual steel demand – further yet to go In this report we lay out our own views of demand to 2020. This encapsulates a view that steel demand in China will approach 900 Mt/y by 2020, and potentially the 1 Bt/y mark by 2025, but that the pace of growth in both tonnage terms and in relationship to GDP growth will continue to slow as part of an already established pattern.
Exhibit 6: China’s steel intensity of use is below the peaks reached by Japan and the USA
Exhibit 7: Weighted average intensity of use masks wide differences between China’s cities and regions
Steel use and GDP per capita Steel demand and GDP per capita
Source: BHP Billiton – Steelmaking Materials Briefing, 30 September 2011 Source: BHP Billiton – Western Australian Iron Ore site tour, 27 September 2011
We also outline the core assumptions implicit in a belief that steel demand in China has already hit its peak and will grow no further; specifically, this path entails much lower rates of GDP growth and rapidly-receding investment growth, with major implications for social conditions in China.
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08 March 2012
Accumulating China’s capital stock Of all the industrial commodities, steel is the most heavily exposed to investment (rather than consumption) activity. Basically, steel is used in constructing a nation’s capital stock of buildings, infrastructure and equipment. Today, 80% of China’s annual steel demand is accounted for by buildings (of which homes account for 60%), primary and secondary infrastructure, and the capital goods (machinery and equipment) used in growing the nation’s industry, which accounts for almost 50% of GDP. Other sectors such as transport and consumer/metal goods are growing rapidly, but in tonnage terms these still represent more modest totals for steel; unlike the USA, these uses are dwarfed by steel’s role in “structures”.
China’s use of steel has grown by more than 10 times in the past two decades, rising from levels barely above 60 Mt/y to around 650 Mt in 2011. In the past 50 years the country has accumulated almost 5 billion tonnes of steel, of which more than 3.7 billion tonnes has been installed in the last decade alone.
China’s accumulated steel
“stock” per person is less than one-
sixth of that of the USA and Japan
China’s annual steel use today – the flow into this stock – is 6-7 times greater than that of the USA and Japan/Korea, at their peak. Yet China’s cumulative stock of steel is little more than 3 tonnes per person, compared with a level of 18-19 tonnes per capita in the USA and Japan/Korea.
These statistics reveal the key differences between China’s economic development and that of other nations – China’s population is equally split between urban and rural living, though the pace of urbanization is advancing rapidly (at close to 20 million new urban residents each year). The use of steel is overwhelmingly connected to this urban expansion and pattern of renewal and development.
Exhibit 8: China’s annual consumption of steel is still well below Japan and Korea’s levels…
Exhibit 9: …and the country’s accumulated “stock” of steel is far below the US and Japan/Korea’s levels
Finished steel demand per capita, kg (2010) Finished steel in accumulated capital stock, tonnes per person
0
100
200
300
400
500
600
700
China USA Japan + Korea
0
5
10
15
20
25
China USA Japan + Korea
Source: World Steel Association, Credit Suisse Source: World Steel Association, Credit Suisse
Most importantly, there is a view that China’s capital stock accumulation is near completion. In our opinion this is a myth, apparent to any visitor spending time in China’s overcrowded cities and travelling on its congested transport systems and highways. In the following, we highlight a few examples.
• China is expected to double its urban housing stock by 2025 to around 40 billion square meters: Much more than this will need to be added in terms of new floor space, to take into account the replacement of poor quality housing. In other words, China needs to build more than the total floor space that exists today again in the next 10-15 years if it is to avoid deteriorating urban living conditions.
Have We Reached “Peak Steel” Demand in China? We Think Not 6
08 March 2012
• Doubling China’s expressways by 2020 will not reduce traffic density: China has already constructed a network of more than 65,000 km of expressways (multi-lane highways), 30 times more than were installed in 1995. Consequently, China’s density of passenger cars per kilometer of expressway has fallen from 377 in 1995 to around 300 today (compared to approximately 260 in the USA). China’s auto population density is less than 6% (cars per 1,000 people), a level reached in the USA before 1920; rising incomes are resulting in rapid growth in vehicle population in China and, on conservative measures based on government targets, car density per expressway kilometer is expected to rise to almost 550 – double US levels – by 2020. This occurs despite a target of installing an additional 35,000 km of additional expressways.
On many measures of infrastructure
needs, China is not even “half built”
Exhibit 10: China’s car production (log level) Log, thousands
2.5
2.6
2.7
2.8
2.9
3
3.1
3.2
3.3
2003 2004 2005 2006 2007 2008 2009 2010 2011
Chinese Auto Production, Log(thousands) 2003-2007 Trendline
Global Financial Crisis
Enactment of subsidies
Expiration of subsidies
Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse
• Rapid growth in urban mass-transit metro systems: Today, 11 of China’s major cities have urban metro rail systems. Another 50 cities are said to meet the government criteria of more than 3 million people and GDP thresholds to gain support for subway construction. China has an estimated 1,500 km of subway lines, treble the level of five years ago. This network is expected to double by 2015 and to double again by 2020.
• Rail networks are just one-eighth those of the USA on a per capita basis: Despite recent problems associated with China’s passenger rail plans – setbacks to high-speed rail ambitions have yet to be fully overcome – China has the world’s second largest rail network after the USA. With a similar land mass of 9.3 million square kilometers, though, China’s 95,000 km is still half that of the US network in length for a population four times larger – barely 12-13% of US totals on a per capita basis.
Have We Reached “Peak Steel” Demand in China? We Think Not 7
08 March 2012
Exhibit 11: Accumulating the capital stock of steel takes decades
Exhibit 12: US intensity of steel use per capita did not peak until the 1970s
Finished steel consumption, Mt Kg/capita (lhs), Percent (rhs)
0
20
40
60
80
100
120
140
160
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
2010
USA
Japan + S. Korea
70 Years50 Years
0
100
200
300
400
500
600
700
800
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%US Steel intensity, kg/capita Urbanisation
Source: World Steel Association, Credit Suisse Source: World Steel Association, Credit Suisse
• “Water, water, everywhere, but not a drop to drink!” China’s Ministry of Environmental Protection states that 400 of 663 cities it has monitored face water shortages, while the Ministry of Water Resources calculates China’s per capita water availability at one quarter of the world average. Half the population drinks contaminated and unsafe water. The sector is in line for considerably greater attention from an investment perspective in the next 5-10 years, with wastewater treatment capacity set to double by 2020, based on government targets.
• Energy infrastructure is a key target for the current 5-Year Plan: As one example, annual spending on power infrastructure is expected to double to RMB1.7 trillion by 2020, largely focused on efficiency improvements and deepening of the national grid. Generation capacity should more than double to 2,000 GW within the next decade.
Absolute tonnes vs. percentage growth Exhibit 14 shows which sectors have contributed to steel demand growth most in the past decade. We have highlighted before that steel demand experienced a period of anomalously high growth from 2001, a year in which major reforms were enacted to open up the private property sector. This “golden era” appears to have come to an end in 2007, masked in part by the effects of the 2008-09 slowdown which saw steel demand stagnate for the first time in more than 10 years. In 2001-07, the ratio of steel demand to GDP growth exceeded 2:1, but the ratio has fallen back to an average of a little over 1:1 in 2007-11.
Steel intensity of use relative to GDP
has fallen back from the unusually high
levels of 2001-07
We expect the steel intensity of GDP growth to continue to moderate as the gradual economic transformation sought by the authorities takes place. Importantly, however, we do not expect a step change this year, with the transformation likely to be a more gradual process than most fear.
Have We Reached “Peak Steel” Demand in China? We Think Not 8
08 March 2012
Exhibit 13: The relationship between GDP and steel demand growth has changed over time
Exhibit 14: Reflecting a rising “return” on the capital stock of steel that is installed in “structures”
Ratio of steel demand to GDP growth in 2000-20 Finished steel demand by sector in China – 2000-20, Mt
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
Forecast
0100200300400500600700800900
1000
2000 2005 2010 2012 2015 2020
OtherMetal GoodsConsumer GoodsTransportCapital GoodsInfrastructureConstruction
124
348
576
787
890
680
Source: NBS, World Steel Association, Credit Suisse estimates Source: World Steel Association, Credit Suisse estimates
• Specifically, after tracking at a rate of around 1.1:1 with GDP growth since 2007, following the surge earlier in the decade, we expect the ratio to slowly fall further over coming years, to average 0.6-0.7 in the years to 2016 and around 0.4 thereafter. Assuming GDP growth of 7-8% over this period, this would suggest annual compound growth rates of a still healthy 5%, albeit down from the 11% p.a. seen in 2007-11.
o Looking further ahead, we assume that steel demand growth slows even further to 2-3% p.a. as we approach 2020.
In tonnage terms, this translates into a decline in average annual incremental growth from more than 50 Mt/y in 2007-11 to 30-40 Mt/y in 2012-16 and easing to 20 Mt./y by 2020. Doubtless we will experience sharp year-on-year variations around this trend-line. This would translate into slightly higher tonnages at the crude steel production level (beyond the question of likely trade in steel products).
In addition to the macro parameters outlined above, these forecasts are underpinned by our sector analysis:
• During the 2001-07 boom, China’s steel demand was largely accounted for by construction – buildings were responsible for more than 55% of the total cumulative use of steel in 2001-07, followed by capital goods (16%) and infrastructure (11%).
• Construction was still the most important driver of demand in 2007-11, but its contribution fell below 50%, while capital goods accelerated its contribution to 23%.
• Steel’s smaller end uses have also become more important since the 2001-07 boom. In aggregate, transport, consumer durables and all other uses have increased their share of cumulative use and are expected to contribute more than 20% of demand totals in the course of the 12th 5-Year Plan (2012-16) – these sectors are an important target for value-added revenue from steel producers.
Have We Reached “Peak Steel” Demand in China? We Think Not 9
08 March 2012
Five key driver’s of steel demand growth… In reality, there are many influences that dictate the rate of the “flow” of steel into core applications. We examine five of these seen as critical for determining the point at which steel demand peaks. An end to growth in steel would require a sharp change and stagnation in some, if not all, of these key drivers, impacting the flow into China’s capital stock. These are:
Driver 1: Increases in the amount of floor space added. Dominated by residential accommodation, new floor space installed has increased every year since 2000, with one exception (2008). On that occasion, growth accelerated sharply in the following year, and we postulate that any slowdown in H1 2012 will trigger a later catch-up phase again, albeit at lower pace than in 2009. The net flow of people into the urban environment is but one aspect fuelling growth in floor space additions; there are a number of contributing factors:
Rising floor space per capita and
replacement of old urban housing are
key drivers of annual growth in new floor space
• Average floor space per capita is expected to rise from 30 sqm to a government target of more than 40 sqm. Rising disposable income and changes in the nuclear family are influencing these patterns, as is high-rise development.
• Demolition of existing old floor space (usually of poor quality) with new, higher-quality units has many years to run. Less than one-third of China’s urban floor space is by any sense of the word “modern”. Replacing poor quality, over-crowded dwellings is a key priority of government in the next decade.
• An expected doubling of China’s urban residential housing stock to more than 40 billion square meters in 2010-25 masks the removal and replacement of an estimated 3% of existing urban floor space each year.
• Cyclical variations in this activity will be a feature of this trend, reflecting, for example, current shifts in policy and financing structures.
The increase in supply of housing to meet greater mass needs is likely to result in a period of sharper acceleration in floor space additions, but probably beyond 2012.
Driver 2: High-rise living is driving rapid increases in steel intensity of construction. China’s cities are characterized by high population density and a preference for high-rise living. China today has more than 160 cities with populations greater than 1 million.
High-rise living comes with high
steel intensity per square meter • The larger cities have an urban density of more than 20,000 people per square km, 4-5
times denser than London, Los Angeles, New York and Tokyo. High-rise living brings economic benefits (not least, sparing increasingly scarce arable land) in such cities, but comes with far higher steel intensity.
Exhibit 15: Urbanization rates are forecast to increase from 50% to 64% by 2025…
Exhibit 16: …accompanied by rising floor space per capita
Urban population in China, % of total Urban residential floor space per capita, square meters
0
10
20
30
40
50
60
70
2000 2005 2010 2015 2020 2025
0
5
10
15
20
25
30
35
40
45
50
2000 2005 2010 2015 2020 2025
Source: UN Source: NBS, Credit Suisse estimates
Have We Reached “Peak Steel” Demand in China? We Think Not 10
08 March 2012
• China’s megacities will see a rapid increase in very high-rise (>30-storey) units in the next 10-15 years, representing almost half the floor space installed. Even in smaller cities, lower rise (less than 6-storey buildings) will be relatively uncommon.
• Steel use per square meter of high-rise buildings exceeds 100 kg; in tenements of 7-15 floors it is typically 65-75 kg/sqm. Steel intensity of commercial buildings is usually higher, and is also rising.
• Net increases in average steel intensity of construction of more than 50% in the next 10-15 years are contributing more to annual steel demand growth than new floor space additions alone.
Exhibit 17: Replacement of low-grade housing is a key driver of steel demand growth; high-rise units are raising steel intensity
Exhibit 18: China’s infrastructure roll-out is far from complete – including enhancement and improvement of existing networks and utilities
Shanghai housing clearance – many more dwellings to come The Three Gorges Dam – much more power infrastructure to come
Source: Credit Suisse Source: Credit Suisse
Driver 3: Increase in the fleet of capital goods. The absolute size of China’s industrial economy – and indeed its emerging services – will continue to grow, stimulating continued growth in the fleet of equipment and machinery to service this growth. Growth in steel demand in this sector has outpaced all other applications in the past decade, but from a low base. Compound annual growth averaged 16% in 2007-11, and we expect rates of growth to continue to match or slightly outpace GDP growth at around 9% in 2012-16. A number of trends are apparent here:
• Natural growth has, and should continue to be, an important driver. However, import substitution has also been responsible for a high pace of growth in steel use in this sector, especially as, to date, the most rapid growth has taken place in more basic, large volume products.
• Rates of growth relative to sector GDP expansion will moderate, reflecting a gradual shift towards producing higher-value added equipment; however, this evolution will take time (China still relies on imports of the most sophisticated machinery and equipment, though there are many examples where manufacturers are making inroads).
• Manufacturers are primarily servicing domestic markets, but are also positioning for export business, especially into other emerging markets.
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08 March 2012
Driver 4: Increase in transport sector steel use. China’s vehicle and transport fleets are rising rapidly, but are far from maturity. Natural growth in these markets should also continue to match the general rate of GDP growth reflecting:
Steel’s smaller uses are growing rapidly
and are far from a point of market
saturation
• Increases in vehicle fleet population and density to match comparable Asian regions – China’s vehicle production and ownership is rising rapidly, but the country has less than 60 autos per 1,000 people, compared to more than 160 in East Asia as a whole and almost 600 in Western Europe.
• Continued growth in truck and passenger transport fleets, mitigated by modal shifts to greater use of rail; however, expansion of China’s export markets in this sector is also an influence.
Driver 5: Shifting emphasis on critical infrastructure. China’s focus on infrastructure development will persist, with an extra emphasis on energy, pollution control and raising efficiency, health and safety. It is possible that we are under-estimating the direct uses of steel in infrastructure. All things being equal though, a constant rate of installing, for example, road and rail “line-kilometers” should entail a constant rate of steel use; in the case of infrastructure the “flow” will be most heavily influenced by cyclical changes in the pace of investment in the sector, shifts between infrastructure sectors (with different steel intensities) and replacement rates of existing infrastructure (e.g., highway repairs).
Tracking these changes in terms of their relative importance to steel and other commodities is a challenge, but is worthy of close monitoring; for example, a stronger emphasis on improving the power grid is clearly beneficial for aluminium and copper use.
An important element of expanding the stock of infrastructure is the opening up of other activities through increases in productivity. The development of construction and industry along important road and rail corridors and in satellite cities is clearly a major factor in the annual increases of floor space over the past decade. Further, steel demand growth will likely be strongest in those activities, such as energy infrastructure, which are central to the current 5-Year Plan objectives.
Growth in a myriad of other applications is likely to persist at relatively high rates in percentage terms, but volumetrically is subordinate to the influences outlined above.
Are we being too bullish … or bearish? On balance, we believe that we have constructed a view of future steel demand in China that reflects both the aspirations of the government to effect a change in economic direction, and to meet the need to extend and deepen China’s capital stock of buildings, infrastructure and goods supporting both its industrial growth and evolution:
• Our forecasts are consistent with the emergence of a stronger services-based and higher value-added industrial economy.
• We consider that there is an upside risk to these forecasts should this year’s cyclical concerns give way to a period of satisfying pent-up demand through higher investment rates than we have incorporated in our forecasts over 2012-20.
We have highlighted that the period from 2001 to 2007 proved to be an anomalous one for steel demand growth. However, to believe that annual steel demand has now reached a level plateau, and that it may even fall into decline, is to assume that China’s goals of improving urban (and indeed, rural) living standards are to be thwarted.
• A belief in “peak steel” implicitly comes with a core view of a sharper fall-off in investment activity and levels than is the case in our forecasts. We feel this peaking would have to be associated with headline GDP growth well below the 7-8% we expect in 2012-16.
Have We Reached “Peak Steel” Demand in China? We Think Not 12
08 March 2012
Have We Reached “Peak Steel” Demand in China? We Think Not 13
In short, “peak steel” would mean a capping out of the rate of creating housing supply, road, rail and utility infrastructure – a lower quality outcome. The consequences of this result would emerge soon in the form of stagnating and deteriorating urban living conditions – rising congestion, decaying utility infrastructure, inadequate shelter, especially for lower income groups, and disappointed aspirations. This would be a gloomy prognosis that could precipitate a big sell-off across basic materials plays and could also have knock-on effects into the broader global economy.
Our own central forecasts point to future challenges for steelmakers and raw materials suppliers. While collectively these suppliers have consistently under-estimated the scale of China’s demand, increased flow in supply – a long-lagged response to higher prices – and more intensive competition are sowing the seeds for further changes in the game in the next decade.
GLOBAL COMMODITIES RESEARCH
Ric Deverell, Managing Director Global Head of Commodities Research
+44 20 7883 2523 [email protected]
Eric Miller, Managing Director Global Head of Fixed Income and Economic Research
+1 212 538 6480 [email protected]
LONDON One Cabot Square, London E14 4QJ, United Kingdom
Tom Kendall, Director Head of Precious Metals Research +44 20 7883 2432 [email protected]
Marcus Garvey, Analyst +44 20 7883 4787 [email protected]
Martin Yu, Analyst +44 20 7883 2150 [email protected]
TECHNICAL ANALYSIS Cilline Bain, Associate +44 20 7888 7174 [email protected]
NEW YORK 11 Madison Avenue, New York, NY 10010
Jan Stuart, Managing Director Head of Energy Research +1 212 325 1013 [email protected]
Joachim Azria, Associate +1 212 325 4556 [email protected]
Stefan Revielle, Associate +1 212 538 6802 [email protected]
SINGAPORE One Raffles Link, Singapore 039393
Andrew Shaw, Director Head of Base Metals & Bulks Research +65 6212 4244 [email protected]
Ivan Szpakowski, Associate +65 6212 3534 [email protected]
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