The Chinese steel industry is struggling to meet soaring demand from infrastructure and social housing projects, and is turning to high cost, previously shuttered, steel mills to make up the difference.

On-going analysis by steel consultants MEPS International, as part of their China Steel Insight report, highlights a discrepancy between finished and crude steel production data. This suggests that crude steel output was under-reported by 10.6Mt during the first half of this year. The motives for this latest phase of under-reporting are different from those in 2010. A tight market for construction steel has incentivised previously closed out-dated capacity to resume production this year. These mills are some of the most inefficient, high cost steel producers in China. Not enjoying local government protection, they were on the front line of Beijing’s drive to close obsolete steelmaking capacity.

These illegal steel mills have been motivated to restart production by strong profit margins, as Chinese manufacturers of construction steel strain to meet market demand. The government has announced plans to start work on ten million economic housing units this year but has restricted investment in bar and rod steel mills in favour of those producing higher value flat products. This has pushed up the price of material such as rebar, to near parity with higher quality steel used in manufacturing.

In the current environment of strong demand for construction steel, there is little room for a substantial fall in Chinese steel prices, given that the market is dependent on output from these high cost illegal steel producers.

MEPS forecast that the price of rebar will hit a 2011 average of RMB 4700/t (US$736/t), including VAT, up 17% from 2010. Global iron ore prices will also continue to find support from China. Steel production by illegal mills has contributed to record demand for domestic iron ore, which can only be met by the engagement of high cost iron ore producers. With a tight global supply of iron ore, this is acting as a floor to seaborne prices, pushing values up.

MEPS analysis stands in contrast to recent comments by former China Iron and Steel Association secretary general, Luo Bingsheng, who argued that global iron ore prices have been kept high by Chinese traders importing more iron ore than needed. He suggested, at a recent trade conference, that on the basis of reported steel production, Chinese iron ore imports were 18Mt above requirements between January and July this year. He predicts that this surplus supply will begin to weigh down on prices. MEPS consultant Rafael Halpin argues that, “If account is taken of under-reported steel output, China’s imports of iron ore are in line with requirements during the first half of this year, and Chinese demand for the material should continue to support prices”.

Source: New MEPS Report China Steel Insight