The chief problem facing the Chinese metallurgical industry is over-capacity and the fragmentation of a large portion of production in the hands of a multitude of small producers; a situation which is undermining Chinese firms' leverage over costs and causing product price volatility, according to BMI's China Metals Report. China has around 700 steelmakers, and the industry is highly fragmented. In the face of the current downturn in steel prices, China is promoting consolidation to achieve a more disciplined steel market with improved leverage and bargaining power with iron ore miners, as well as preventing over-capacity. Many analysts believe the top 10 Chinese steelmakers will have to achieve a 70% market share to control prices, compared to the current 42%. Consolidation is likely to lead to the elimination of surplus capacity which is dragging down steel prices, with smaller mills likely to close. By 2009, China's over-capacity was estimated at around 100mn tonnes per annum (tpa). The problem of fragmentation of ownership is also witnessed in the aluminium industry. By 2009, China had 15.65mn tpa of aluminium smelter capacity, of which small-scale smelters represented 48%. Consolidation has occurred, with 12 aluminium producers merging to form market-leader the Aluminium Corporation of China (Chinalco) in 2001. However, further consolidation is required to create producers large enough to maximise efficiency, lower costs and dictate market prices. The need for consolidation and streamlining is more evident as the metals industry has slipped into recession. In 2008, the boom in the Chinese metallurgical industry came to an abrupt end. Output peaked at an all-time high of 46.94mn tonnes in June but by Q408 production had plummeted to levels not seen for over two years, and down 11.7% year-on-year (y-o-y) on Q407. A similar trend was witnessed in primary aluminium production, which was down 11.1% y-o-y. With domestic steel demand set to decline and exports likely to fall, Chinese steel output will be lower than in 2008 - BMI forecasts a 16.9% fall to 414.6mn tonnes. Flats are set to fall faster than longs. While a steep decline in construction activity will depress demand for longs, this will be partly offset by statefunded infrastructure projects, which amount to around 50mn tonnes of steel. Other manufacturing industries such as the automotive sector and household appliances, which require flat products, will witness a rapid downturn. BMI expects a drop of around 12% in flats demand, leading to an 11.5mn tonnes fall in demand. As a result of anticipated closures of smaller plants, the recovery in steel production will be at a far lower growth rate than seen in recent years, with BMI forecasting growth of 4.5% in 2010 and in the 5.6-6.6% range in the following three years, totalling 520.2mn tonnes by 2013, a 4.2% increase on 2008. In 2009, China will produce aluminium at below cost due to over-supply. The break-even point for Chinese aluminium production is US$2,000 per tonne, twice the level achieved in neighbouring India. At the same time, the aluminium industry will be faced with the same problems as the steel industry in terms of over-capacity, with demand falling well short of capacity. A key issue is the reduction of electricity prices, with power representing 40% of the total cost of primary aluminium production in China, compared to the global average of 25%. As a result of falling demand, aluminium output was progressively cut from September 2008 and by March 2009 production had been cut by 3.5mn tonnes. In turn, alumina output was cut by about 9.6mn tonnes. On the basis of trends within the automotive and household appliance industries, BMI forecasts a 19% fall in aluminium output to 9.8mn tonnes. We expect consolidation within the Chinese aluminium industry as a result of the collapse in both domestic and export demand, leading to the closure of smaller smelters - representing 48% of capacity by January 2009. As such, 2008 levels are unlikely to be reached until 2013, with a sluggish recovery.
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