Analysis: China's steel inventories triple on year to 100 mil mt, posing big challenge for Q2

China's domestic manufacturing and construction activity might be picking up as its coronavirus lockdown measures ease, but the challenges for its steel sector have only just begun.

Soaring finished and semi-finished steel inventories held by steelmakers, rolling and processing plants and traders -- which S&P Global Platts estimates could hit 100 million mt by end March -- are set to put the Chinese market under immense pressure in April and May.

The total inventory is triple that at end March 2019, which Platts estimated at 33 million mt. It also equates to more than a month of domestic consumption in the strongest month of 2019, which was 81 million mt in December, according to Platts analysis.

Most of the 100 million mt of steel inventory cannot be monitored by the market as it has overflowed warehouse capacity and is being stored at unmonitored locations, as semi-finished steel products, or in transit.

China's finished steel output fell 3.4% or 6 million mt year on year over January-February, while crude steel output rose 3.1% or 5 million mt -- which indicates a large volume of steel is being stored as semi-finished products and not being counted in steel inventories monitored by the market.

Even if China's crude steel production could be capped at the current level and its domestic demand and exports were 30% higher in coming months than in December, inventories are unlikely to decline to the March 2019 level until May -- and even if this were to happen, such strong demand would drive up steel production, slowing the drawdown of inventories.

It will also be difficult for end-user demand in April or even May to recover to the 2019 average and reduce steel inventories. Government stimulus packages, no matter how strong, are only workable when people can work and move in large numbers, which is impossible while the coronavirus pandemic continues to spur lockdowns across the world.

China's domestic traders are facing tight cash flow as most of their reserves are tied up in inventories. Liquidity at steel mills is better, but could erode rapidly if inventories do not fall significantly.

DEMAND SUBDUED INTO Q3

Platts estimates China's real finished steel demand will fall 36% or by 70 million mt year on year in the first quarter.

While most of China's construction sites and factories are expected to have restarted by April, according to a market survey, their demand for steel may remain lower than in Q2 2019.

Manufacturers are unlikely to reach full capacity in April and May, given the turbulence wrought by the coronavirus pandemic on demand and supply chains both inside and outside of China.

So far China's loosening monetary policies have been focused on supporting business liquidity rather than stimulating consumer demand, which is difficult to boost until the pandemic is brought under control globally.

Construction activity at existing projects will accelerate in April, but it remains to be seen how much incremental demand will emerge.

Property sales have been hit hard in Q1 as buyers remain at home. Given the slowing economy and Beijing's determination to not use property for short-term stimulus, some market sources expect property sales will drop significantly in 2020 and new starts will decline in tandem.

The floor space of property new starts fell 45% on year over January-February, in parallel with a 40% drop in property sales -- the floor space of new starts rose 8.5% on year in 2019 and was the biggest contributor to incremental steel demand in the year.

The total investment for 2020 in fixed asset investment plans, mainly infrastructure projects, issued by 12 provinces and the municipalities of Beijing, Tianjin and Chongqing is down 4% on year at Yuan 6351 billion ($896 billion).

China has pledged to boost "new infrastructure" in 2020 to cushion the economic slowdown, but 5G, big data, artificial intelligence, new energy vehicle charging piles and intercity rail transit will consume far less steel than traditional infrastructure projects like airports, highways and railways.

EXPORT BOOST UNLIKELY

China has previously boosted steel exports when its domestic market was oversupplied, but overseas demand looks bleak in Q2, market sources said.

China's steel exports in March-April are expected to be higher than over January-February, but unlikely to be anywhere close to its 2019 levels of 6.327 million mt in March and 6.326 million mt in April.

While some Chinese mills have started cutting output in March due to high steel inventories and tight cash flow, others that cut or suspended output in January or February have restarted or raised production due to improved logistics and slightly improved demand.

Platts estimates China's pig iron capacity has increased by 23 million mt on year to 1,023 million mt/year in Q1. Platts analysis shows pig iron output in March could edge up 1% on year to 67 million mt, while Q1 output could rise 2.5% to 199 million mt.

Independent EAF steel mills have gradually restarted in March, adding more supply pressure. Although their production costs are generally Yuan 200-300/mt higher than integrated mills, they have almost zero steel inventories after two months' suspension and therefore currently have much healthier cash flows than integrated mills.

Maintenance work at blast furnaces in March is too little to slow down China's steel production in Q1 -- while crude steel output in March is expected to be lower on year, Q1 output is set to rise 1.6% to 234 million mt, Platts analysis shows.

The most important factor behind the resilient steel market over February-March was the expectation that China will release strong stimulus policies later in the year, especially for the infrastructure and property sectors, which account for about 55% of China's total steel consumption.

However, the market may soon find it that any stimulus policies are unlikely to be fully implemented until people both inside and outside of China can gather and move in large numbers, which is probably not in the picture for Q2.