China is Taking a Breather in its War on Smog This Winter

In recent years China’s steel sector — particularly the large, state-owned steel mills — have benefited from the enforced closure of capacity on environmental grounds during the winter heating season.

Contrarian as it may at first sound, closure of private mills largely — on the basis they are unregulated  and are supposedly the most polluting steel mills — was a boost to larger competitors.

About 140 million tons of “illegal” production was closed last year, only for capacity to be further restricted by Beijing’s war on smog during the winter heating season. The forced closure of steel mills in 26 cities around Beijing and Tianjin hit national output, contributing to a year-on-year contraction in output during November and December last year.

Demand, however, remained buoyant. As a result, prices rose and exports, the relief valve for excess capacity, fell.

It should be no surprise that steel mills in the rest of the world all benefited from less competition and, as a result, higher prices (long before America’s 25% steel import tariffs lifted prices further). Indeed, cumulatively, strong domestic demand and state meddling on environmental grounds have allowed China’s steel sector to make good money and focus on the buoyant domestic market for the last two years.

China’s steelmaking capacity may have contracted from 1.15 billion tons in 2015 to 1.05 billion tons by last year, but it would take only a few percentage points of weakening domestic demand to open the floodgates for more exports.

Without the imposed discipline of winter closures, steel mills may be encouraged to keep high run rates as demand softens. With a weaker currency, export prices could be sufficiently competitive to drag down global price levels; that would be good for consumers, but it’s not what mills outside of China will be wanting in 2019.