MNI ANALYSIS: China's Pollution Fight Clouds Iron Ore Outlook

--"26+2" Environmental Circular May Sap Near-Term Demand

--Pent-up Demand May be Released After Winter Months

By William Bi

     BEIJING (MNI) - This month, China's so-called "Black Metal Complex" --

markets for steel, iron ore, coal and any businesses related to the production

and consumption of the ferrous metal -- agonized over a major announcement from

the increasingly powerful Ministry of Environmental Protection. 

     Dubbed "26+2," the latest order gave tough-worded warnings to officials in

Beijing, Tianjin, and 26 other cities in the surrounding provinces: curb

heavy-polluting industries, keep the air clean or they face severe discipline.

In the winter heating months ahead, every city's pollution indicators will be

constantly monitored. 

     Regional governments have since rolled out specific measures, one of which

restricts steel production by 50% from Nov. 15 to March 15, the winter months

when emissions are at their highest due to the burning of coal for heating.

Producers' electricity usage will be monitored to ensure they don't defy orders

and resume production. 

     Initially, some traders interpreted this as bullish for steel, a

continuation of the same theme seen in the last two years: endless environmental

restrictions on heavy-polluting industries. Reduced production means reduced

supply, so prices should move up, traders naturally thought.

     Yet since the order was formally announced at the end of August, steel

futures traded in Shanghai have plunged, after it became apparent that unlike

previous measures, the new circular would also likely reduce consumption of

steel. 

     Along with smog-belching steel mills and cement plants, the circular also

targets dust levels at construction sites. The government indicated it may bar

all non-essential construction activities for a third of a year.  

     On Thursday, Jinan, the capital of Shandong province, banned all

construction activities between Nov. 15 and March 15, joining scores of other

cities listed in the "26+2" directive in displaying the local cadres' adherence

to the central government's directive. 

     "The message was in the document, but people initially jumped only on the

good-news part and glossed over the bad news," said Liu Liangliang, a

Beijing-based analyst at Yongan Futures Co. 

     Liu estimated that if the new rules are fully implemented, steel output may

be curbed by almost 33 million tons. That translates to reduced demand for iron

ore of about 53 million tons, or 60% of China's entire iron ore imports in

August. A rush towards using high-quality imported ore this year have driven

inbound shipments up 6.7% from a year ago. 

     The bottom line is demand for steel could drop significantly in the next

few months, Liu said, although it is nearly impossible to quantify the decline.

It remains to be seen how strictly authorities will comply with the stated

targets. The policy move also left questions on whether the restrictions may

expand to other cities not listed on the circular, Liu said. 

     "One would speculate that this is likely a temporary dip, and the pent-up

demand will explode when the ban is lifted. But many factors can change," Liu

said. 

     Liu's view is shared by an analyst at Mysteel.com, a Shanghai-based

consultancy. A few months ago, he forecast iron ore imports would exceed last

year's total by 30 million tons. Now, he sees the possibly the full-year total

will fall slightly below last year's. 

     Foreign suppliers remain skeptical amid all the noise, said an executive at

one of the top global iron ore producers. He expressed doubts that authorities

would shut down all construction activities for the entire period. The steel

industry has been one of the major beneficiaries of China's supply-side reform

drive, so the government isn't likely going to allow it to be damaged now, he

argued. 

     While contending that there may not be growth in imports of ore this year,

the mining executive said China's demand will remain steady in coming years as

its industry upgrades and its modernization projects continue.

     Much depends on the timing of how the government balances competing

interests, said Liu the analyst. Indeed, the Chinese government may feel steel

producers have made enough money in the last two years to withstand a few months

of pain for the more urgent needs of the country. 

     This week, state-sanctioned media reported that steel producers are raking

in "explosive profits" after prices rallied. The state-backed China Iron & Steel

Association was forced to come out and said the profit numbers were severely

inflated. 

     The association still projects year-over-year growth for both steel

consumption and demand. Liu Zhenjiang, the association's secretary general, a

post appointed by the government, expressed full optimism. 

     "The healthy development of the steel industry is very important to China's

modernization," Liu told an audience of steel producers and iron ore suppliers

in Qingdao. 

     The current winners in the steel industry owe everything to the government,

said Liu. 

     Less than two years ago, China was saddled with excess capacity in

virtually every industrial sector, including steel, coal, glass, petrochemicals,

and non-ferrous metals such as aluminum and zinc. By the end of 2015, the

Producer Price Index, a measure of wholesale prices, had seen negative growth

for more than 40 consecutive months. More than 80% of major state-owned

producers, which dominate these heavy industries, were unprofitable.

     Since 2016, when President Xi Jinping's initiative began to shut down

inefficient facilities, prices of steel and coal doubled. Environmental

regulators, once considered toothless, persisted with nation-wide crackdowns on

steel mills, coal mines and processing industries, halting operations either

illegal or inefficient. 

     Xi's bet paid off. Not only did major steel and coal mines return to

profitability and improve their finances, the PPI rose back into positive

territory and manufacturing recovered, sustaining the economy even as the

government worked to drain excess liquidity.

     "A steady China, even without growth, is enormous," said the mining

executive. "I just don't see its demand going away."

--MNI Beijing Bureau; +86 10 8532 5998; email: william.bi@mni-news.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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