Rising trend slows as buyers slow purchasing
Chinese export steel prices have risen steeply since 10 October, with CRU’s daily HR coil assessment rising from $370 /t FOB Tianjin to $511 /t FOB on Wednesday 21 December. A similar rising trend has been seen in other steel commodity products, with CRU’s rebar assessment rising from $333 /t FOB Tianjin to $442 /t FOB Tianjin over the same period.
However, Chinese export steel prices have begun to fall after recent rises outpaced overseas demand, with CRU’s daily HR coil FOB Tianjin assessment dropping back to $511 /t, having reached as high as $518 /t on Friday 16 December.
The softening is not unexpected. As Asian steel traders and buyers have stressed to CRU, Chinese price rises have not been driven by surging Asian demand, despite the continuing strength of apparent steel demand growth in some regional economies. In fact, Chinese steel traders and exporters report that the rise in prices (and the difficulty in predicting the price trend one or two months ahead) has encouraged buyers to shorten stockholding cycles and disincentivised major purchases: as a result, overall Chinese commodity steel export volumes have declined over the fourth quarter of 2016.
While this partly reflects the impact of trade barriers in some markets, Chinese exporters are also facing increasing competition in their main export markets. Keenly-priced exports from Indian, Russian and Korean competitors are eroding Chinese exporters’ market share, while CRU has also seen opportunistic Turkish exports into East Asian markets in December. The latter is likely to be driven by near term subdued demand within the domestic Turkish market.
Onshore derivatives, renminbi depreciation trump fundamentals
However, supply and demand fundamentals have not been the main driver of price formation so far in 2016. Rather, CRU expects three factors are likely to affect the formation of Chinese export prices in the near term: the depreciation of the renminbi against the US dollar, and its impact on raw material input costs; Chinese mills’ willingness to accept lower profit margins in the export market; and market sentiment, which continues to be affected by onshore ferrous derivatives.
Firstly, the US Federal Reserve’s announcement on 14 December that it was increasing the Federal Funds rate by 25 basis points was widely expected by the Asian steel market, and the downward trajectory of the renminbi against the US dollar after the US election result indicates that it was priced in.
China’s exposure to US dollar-denominated seaborne raw materials is well understood by the market. As most of China’s steel output is domestically consumed and renminbi-denominated, it is likely to have an inflationary effect on China’s domestic steel prices, both directly by pushing up input costs, and indirectly as mills will hike list prices to defend margins in response to the increase in raw materials costs. The renminbi has depreciated against the US dollar by over 4% since 30 September, which has exacerbated the effect of a near 20% increase in US dollar-denominated seaborne iron ore prices over the period.
Despite China's position as the de facto price setter for global steel prices, Chinese mills focusing on commodity steel products do not enjoy the same ability to pass on cost increases to overseas customers. In fact, a larger risk is that cost sensitive steel buyers may request mills pass on lower costs through to prices, although production cost proxies based on raw material inputs will understate the deflationary impact of the renminbi depreciation on Chinese mills' other operations. However, Chinese exporters are likely to strongly resist buyer pressure to share the benefits of the weaker renminbi in export prices.
The chart below helps to explain why Chinese mils are unwilling to lower export prices. Although the spread between CRU's daily domestic and export assessments appears to be quite stable, CRU notes that approximately in December approximately $15/t of the spread between CRU's domestic Shanghai price and the HR coil FOB Tianjin assessment is due to the depreciation of the renminbi since 19 September (see chart). In other words, domestic sales would have been even more profitable compared with export sales were it not for the recent depreciation.
The chart below demonstrates how export margins over variable costs for a typical coastal mill have increased strongly to $96 /t and $58 /t for HR coil and rebar exports compared with the strongly negative margins of $25 /t and $12 /t reached on 12 October, only slightly above the nadir reached in the week prior to the Golden Week holidays.
Sales teams at Chinese mills confirm that margins on domestic sales have been stronger. This is substantiated by mill behaviour, as they have begun to adapt their sales patterns in response to the superior margins that domestic sales currently offer. While some mills (such as Angang) have announced export allocation reductions for 2017, other mills have simply reduced availability or announced scheduled maintenance. CRU will begin publishing a weekly domestic margin over variable costs in its China Steel Service in January 2017.
Secondly, much attention was focused on the role played by onshore ferrous derivatives during this period, with frenetic derivatives trading activity feeding through into the physical steel market. Market expectations both within China and among traders and buyers in its neighbouring countries were set by the Chinese onshore derivatives contracts.
However, trading activity slowed after the Chinese authorities raised the margins required to trade ferrous derivatives four times in November, and the spread between the Shanghai Futures Exchange rebar contract and domestic physical steel prices has narrowed (see chart below).
What has received less attention was the role played by market participants taking long positions in the ferrous derivatives market as a hedge against a likely depreciation of the renminbi against the US dollar. The recent emergence of a negative premium between the SHFE rebar contract and physical ex-mill prices may be worth monitoring more closely (see chart). However, Eastern China's leading steel makers, Shagang, Yonggang and Zenith Steel Group, unanimously raised their rebar domestic sales price for end-December by RMB100 /t to RMB3,550 /t, theoretical weight and including 17% VAT.
China Steel Service: Introduction
The China Steel Service incorporates high frequency pricing (daily and weekly) covering the most traded commodity grades of steel in the Chinese export market. The report includes the first daily commodity assessments to be produced by CRU. The service adopts an analytical approach to Chinese steel market coverage, combining rigorous price assessments, detailed export data and CRU's proprietary production cost and EBITDA margin data, to provide in depth coverage of the Chinese steel market. The product, which has no equivalent in the market, has been developed in response to client demand for improved insight into the Chinese export market. Chinese steel export volumes currently play a key role in determining steel prices globally, while Chinese steel production volumes heavily influence steelmaking raw material prices.
If you would like to know more about the service, you can trial it here.
Nick Edstrom | Head of prices
Nick is Head of Prices at CRU, and is involved in various aspects of index development and promotion across the company.
Nick Edström joined CRU in 2016 from Argus Media, where he established Argus's iron ore, ferrous scrap and steel prices business.
He previously worked at Platts and Steel Business Briefing as European Steel Editor. He holds a first class degree in Modern Languages from Kings College London.