China's latest steel capacity swap move not enough to curb industry expansion

China has suspended approvals for the new steel capacity swaps from Aug. 23 to revise its years-old swap measures, but such a move is seen as too late to curb the steel industry's expansion, market sources said Aug. 29.

The focus of the revision is to assist the industry in reducing its overall pig iron and crude steel capacity and increasing the share of EAF steel capacity, sources said.

However, the move seems to be too late as the current steel capacity has already exceeded demand, and more brand-new facilities, which have already gotten approvals, are planned to come on stream from the remainder of 2024 to 2026, the sources added.

Reducing capacity is a must and the top priority for China's steel industry to restore healthy profit margins and maintain sustainable development, especially when domestic steel demand has been in a long-term structural downward trend, some mill sources said.

In addition to more stringent capacity swap measures, the way to reduce excessive steel capacity in the coming years is to enhance energy-saving targets and make carbon emissions more expensive, which will force less efficient mills out of the steel industry, they said.

Capacity expansion

Capacity swaps were first launched at a nationwide scale in 2018, initially aimed to replace outdated facilities with more advanced new ones while trimming excessive capacity at the same time.

However, the swap mechanism has instead led China's capacity to a rapid expansion ever since 2019, as on the one hand new facilities have turned out to be much more productive than old ones while some of the replaced facilities were no longer in operation long before 2019, according to an analysis of multiple company and association data by S&P Global Commodity Insights.

Commodity Insights estimated China's net crude steel capacity expansion at 42 million metric tons per year in 2019, and 15 MMt/y in 2020. The pig iron making capacity expansion was estimated at 23 MMt/y in 2019 and 11 MMt/y in 2020.

From the beginning of 2021 through August 2024, China commissioned 142.94 MMt/y of pig iron and 152.78 MMt/y of crude steel capacity, predicated on closures of about 129.19 MMt/y existing pig iron and 133.15 MMt/y existing crude steel capacity, according to the Commodity Insights calculations.

Furthermore, 134 MMt/y of new pig iron and 201 MMt/y of new crude steel making facilities are planned to be commissioned from the remainder of 2024 to the end of 2026, predicating on replacement of a similar amount of existing capacity.

Some market sources were skeptical whether these planned projects could be fully brought on stream, as poor market situations and bleak steel demand outlook were weakening steel makers' profitability and denting their interest and ability to build new pig iron and steel-making facilities.

"China's steel demand is on a downward trend, given the slumping property sector and slowed momentum in infrastructure construction, so I don't think the industry's overall profitability can have substantial improvement until some steel mills permanently withdraw from the industry," said a mill source.

According to the National Bureau of Statistics, China's ferrous smelting and processing industry recorded an aggregate loss of Yuan 2.76 billion ($387.4 million) over January-July. Some sources said the industry's losses were likely to widen in August amid weaker demand.

"But even if some of the planned capacity swap projects are abolished, and revised capacity swap measures could stop China's overall steel capacity from growing further, the steel market has already been under growing pressure of overcapacity, especially now that demand has been trending downwards," said another mill source.

Falling demand, decarbonization impact

Some market sources expected China's crude steel capacity to have reached around 1.25 billion-1.3 billion metric tons/year by the middle of 2024. But it is difficult to estimate China's actual steel capacity, they added.

This is because for many steel mills, if they want, they are capable of pushing their steel production by up to 150% of the designed capacity, with improved technology and higher utilization of scrap through the whole pig iron and steel-making process, said the sources.

"We believe China's steel demand is likely to decline to around 750-800 MMt/y in the next five to 10 years, which means at least 20% of the current steelmaking capacity will have to be cut, in order for the industry to regain its health," said a mill source.

China's apparent domestic steel consumption in 2023 fell by 3% on the year to 934 million metric tons, and fell further over January-July of 2024, by 4.9% on the year, to 547 million metric tons, according to Commodity Insights calculations. Apparent consumption equals to crude steel output minus net exports and increased steel inventories and reflects the amount of steel actually consumed domestically.

Most mill and trading sources expected to see some less efficient steel mills to withdraw from the industry in the coming years, as it will be difficult for them to remain profitable in an oversupplied market in the long run, let alone provide the capital and technology for energy saving and decarbonization.

China is planning to reduce over 2% energy consumption per ton of steel in the period of 2024-25.

That means if there is no breakthrough in energy-saving technologies, China's crude steel output by 2025 will need to be reduced by over 30 million metric tons from the 2023 level of 1.019 billion metric tons, to achieve the energy saving target, according to some market sources.

Meanwhile, the country has been pushing for the steel industry's adoption of the national compliance emissions trading system, or ETS, in 2024.

Including the sector in the ETS will exert a stronger push for more decarbonization investments, which will be unbearable for those weaker steel makers, said some sources.

China's emissions allowance price was Yuan 89.60/tCO2e ($12.56/tCO2e) on Aug. 23, while some long steel producers were facing a loss of Yuan 200-300/mt for much of August.

EAF growth

Despite poor steel demand, China's EAF steelmaking capacity has remained on the rise in an effort to decarbonize the steel industry.

According to data from Commodity Insights, Chinese steelmakers plan to commission 39.64 MMt/y of EAF steelmaking capacity in total in 2024, and 32.78 MMt/y in 2025, through the capacity swap mechanism.

Although some market sources expected some of the EAF projects to be delayed until after 2025 due to the currently poor steel market, slowing EAF capacity development.

As some of the new EAFs will replace existing converters, the total EAF capacity in China will be expanded by 37 MMt/y, once all these new EAFs are commissioned, according to calculations of the Commodity Insights. Some market sources estimated China's EAF capacity at close to 200 MMt/y by the end of 2023.

China plans to increase the proportion of EAF steel production to 15% of its total crude steel output by the end of 2025 from the current 10%. Some market sources said the target might be challenging to achieve, as EAF steel makers, mainly producing long steel products, will find it difficult to increase production due to declining demand for construction steel.