Closer Look: Is Cutting Steel Overcapacity Working as Well As it Appears?

Efforts to trim excess capacity seem to have paid off as the steel industry appeared to have met more than 80% of its annual target by September and steel prices rebounded.

This may sound like good news, but it does not necessarily mean that the sector is set for a recovery any sooner than expected. Here's why:

The latest figures on the progress of capacity cuts — now reaching 36 million tons of steel, or 80% of the national annual target — that were revealed by Ministry of Industry and Information Technology official Huang Libin at a news conference on Thursday surprised market-watchers. That's largely because two months previously, steel producers were reported to have met just 47% of their target reductions.

During the announcement in August, Zhao Chenxin from the National Development and Reform Commission said that cuts in steel capacity had fallen behind schedule. This prompted several government departments to send inspection teams to local governments and steelmakers to check on their progress, which put a lot pressure on them.

Steel producers responded to this by adopting ingenious measures to nearly double the amount of capacity trimmed by counting long-closed production lines as newly reduced overcapacity in a bid to conjure up more-attractive figures.

Some of these "dead" steel factories, which had ceased production for as long as three years, have been recorded by provincial governments as trimmed capacity, an industry source told Caixin.

In one survey, industry-watcher CUSteel estimated that 71% of the combined annual targets of 24 provincial governments involved long-shuttered mills, representing a reduction in capacity of 82 million tons of steel.

Many factories were also ordered to suspend operations during major events such as the G20 summit in Hangzhou in September, and events to mark the 40th anniversary of the Tangshan earthquake in July, which also helped to hasten reductions in overcapacity.

However, we should never rely on random events to enforce reform.

This said, profits for companies across the steel sector have shown a marked rise. Members of the China Iron and Steel Association, 373 firms in total, saw their balance sheets rebound from showing losses in the first eight months of 2015 to turning a profit for the same period this year, thanks in part to rising steel prices.

Steel prices rose by 30% in the first three quarters of 2016, which might have been a result of reductions in capacity, but some experts believe this may have only had a limited influence on the market as a whole.

The 45-million-ton target for capacity cuts for steel production were based on the total amount of capacity in 2014, 1.1 billion tons, as published by the National Bureau of Statistics. However, this figure did not cover small steel factories, which were believed by insiders to have pushed up total annual production to as much as 1.2 billion tons.

The uptick in steel prices also prompted some dormant factories to restart their machinery. In September, steel production increased by 3.9% from a year earlier, much more than a 0.1% contraction in the first eight months.

Since the start of September, reductions in capacity haven't helped to raise steel prices. Instead, rising import prices for coke, a type of fuel made of coal, and iron ore have boosted steel prices, which would in turn push the value of steel higher.

So in general, the situation in the steel sector is not quite as rosy as the figures suggest.

Contact editor Calum Gordon (calum@caixin.com)