How to Solve China’s Steel Overcapacity Problem

According to estimates by the Boston Consulting Group, China’s steel sector has 181 million tonnes of overcapacity, equivalent to 70% of total production in the European Union and nearly double the capacity of the United States’ steel industry.

Essentially, this is the outcome of a years-old government strategy to develop a steel sector to reduce reliance on imports, allow domestic companies to benefit from China’s rapid economic growth, provide employment opportunities and to show that China is a developed country with a sturdy industrial base.

While the strategy has successfully built up a sector far greater in scale than anywhere in the world, it has come at the expense of inefficient, unproductive investment and a rapid decline in profitability for companies in the sector. Data compiled by the Petersen Institute of International Economics show that profits in the steelmaking sector have rapidly declined during the past ten years and posted losses during 2013.

Overcapacity and lossmaking has been acknowledged as a significant problem by the government itself, citing the steel industry as an embodiment of the investment-heavy economic strategy of the past and a major source of the air pollution that envelopes China’s cities.

While the problems of the industry are well-known, what’s less clear is what to do about it. However, In a recent paper entitled ‘Coping With Overcapacity’ analysts at Boston Consulting Group have come up with the following ideas for firms to follow:

  • Getting a better understanding of their market and targeting specific segments: getting a detailed understanding of the value that steel creates in a specific customer industry will allow producers to tailor their products (steel grades and material treatments) and services (logistics) to bid for business at profitable prices.

  • Cross-licensing: a company based in one region could sell products under license for another player from a different region. This could increase the sales reach of the supplying company and widen the product portfolio of the selling company, without new capacity additions.

  • Flexible operating: reducing the number of blast furnaces under operation and only starting operations when market conditions dictate. By mapping demand trends using rigorous data analysis, companies can predict market conditions and adjust their operating plans.

  • Moving toward energy-efficient fuels: moving toward alternative energy sources such as hot briquettes iron and pellets, which burn more efficiently and cleanly than more traditional coal sources.

At the government level, macro-level policies could include:

  • Loosening regulations governing mergers and acquisitions: Seen as a trophy industry and a vital source of employment in many regions in China, local leaders have been reluctant to allow outside companies to take over failing steel mills for fear of negative repercussions on jobs. This attitude needs to change: with overcapacity widespread it’s time to allow rationalisation and more successful foreign firms to enter the industry.

  • Enforcing stricter environmental standards: Tougher environmental rules will drive cleaner, more efficient production and force older-generation plants out of business.

Taken together, all of these strategies are easier said that done. Crucially, the Chinese government must decide what attitude to take: whether to ease its attitude to foreign ownership and risk social instability by allowing foreign competition and forcing closures, or continue with a model that is responsible for both a colossal waste of resources and China’s abject levels of air pollution.

Recent signs, such as government discussions on allowing foreign firms into the sector and the beginning of tighter environmental standards for steel producers, suggest things are moving in the right direction. That said, this is merely just the beginning of the rationalisation of a sector that has been years in development. It won’t be easy, but it is a key testing ground for the Chinese government’s convictions about reform and if progress remains slow or non-existent, its leaders can’t complain that they haven’t been told.

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