China's shift on winter smog rules rattles steel markets

China will not repeat last year's blanket production cuts in heavy industries such as steel this winter.

Rather, local governments will be given the power to decide how to meet emission targets during the smog-prone winter heating season which runs from November to March.

The fear is that China's steel mills, already operating at elevated run rates, will keep churning out metal over a seasonally weak time for demand.

That risks flooding the domestic market, with the ensuing danger of more Chinese steel spilling out to the rest of the world.

Falling exports from China, the world's largest steel producer, have underpinned a global steel revival.

U.S. steel tariffs and European Union "safeguard measures" against Chinese steel are now starting to play their part but China's exports have been falling since late 2016.

They have done so in response to Beijing's simultaneous mass closure of steel capacity and rebooting of demand from the construction sector -- and its war on smog.

Which is why the apparent loosening of the winter heating season rules has rattled the steel pricing chain.

There's no doubt that last year's forced curtailments in the 26 cities surrounding Beijing and Tianjin hit national steel output.

Production contracted year-on-year in November and December, according to the National Bureau of Statistics. The official numbers come with the usual caveats but the slowdown from super-charged run rates in the middle of the year was clear.

Compliance was mandatory and there was a demonstrable reduction in particulate pollution across the affected area.

Things will change this coming winter.

"Local authorities should carry out production cuts based on their individual situation and refrain from adopting blanket cuts," the Ministry of Environment and Economy (MEE) said in its finalised plan released on Thursday.

Each plant will be judged on its merits. Those that comply with emissions standards will not have to cut production at all.

It looks at first glance as if economics has trumped environmental concerns at a time when Beijing is fighting to ward off a tariff-induced growth slowdown.

However, the shift in policy is more nuanced than it might initially appear.

Firstly, there is no suggestion that the war on smog is in any way over.

The MEE has set itself a target of reducing average particulate emissions by about 3 percent over the coming winter. Local authorities will be held accountable for delivering that target in their jurisdictions.

Given the goal, it makes no sense closing steel or any other capacity that meets environmental standards. Last year's blanket cuts were not only unfair on compliant producers but meant sacrificing economic growth for no environmental benefit.

This time around some steel production will be spared but it is equally possible some might be hit with even tougher restrictions than last year.

Moreover, the focus on what happens in the winter heating season may be misplaced.

Smog in the industrialised north of China is particularly bad in winter but it is not as if the rest of the year is characterised by clear blue skies.

Emissions-related cutbacks have been taking place over the summer months as well.

The city of Tangshan, China's No.1 steelmaking hub, ordered steel mills to cut output capacity by 30 percent to 50 percent over six weeks from July 20 to Aug. 31.

It's noticeable that Chinese annual production growth braked sharply in August from more than 7 percent to 2.7 percent.

This is clearly the broader direction of travel, emissions restrictions becoming a year-round event and, eventually, being expanded to encompass ever more regions.

The war on smog is by no means won. And until it is, steel production will continue to be impacted by rolling curtailments.