This is a tricky question, not least because the devil will be in the detail. Steel-Insight is giving a guide to the current situation, the proposed changes and what impact will this have on the market.
Where we are now
All steel sold by Chinese mills is subject to 17% VAT. However, certain products receive a VAT rebate when exported. At the moment, alloy bar and alloy plate receive a 13% rebate, while alloy wire rod and alloy HR coil receive a 9% rebate.
In addition, boron-added billet is also mis-classified as boron-added bar for export in order to avoid a 25% export tariff (in addition to the full VAT imposed).
CR coil and galvanized also receive rebates, but this is not alloy-dependent and for now, it appears that these rebates are unlikely to be revoked. The key issue is on the alloy side.
So what are the proposed changes?
This remains uncertain. The Chinese Ministry of Finance is discussing classification of export codes and is considering the removal of rebates. Any change will probably take effect from January 1st 2015, but the exact changes have yet to be decided. There are a number of options.
- Nothing happens. This would depress export prices to an even greater extent than our base case.
- The addition of a separate code for boron-added material in 2014 suggests that the Ministry of Finance will act to exclude boron-added material and remove the rebate. If however, it retains a rebate for other alloy material, then we believe that for long products at least, mills can add chrome (slightly more expensive) but retain the alloy classification. Under this scenario, there would be an initial pullback in export volumes and a higher price, but the industry would soon adapt.
- VAT rebates are removed from all alloy steel classifications. This would have a significant effect on prices and is our base case analysis.
- VAT rebates are removed from all steel products. This would be the most efficient way to avoid future problems, but may trigger such a negative response from the steel industry that the Ministry may not be willing to impose it.
Probable Impact of Removal of Rebates – Short Term
Export Prices would go up:
- The cost of the additional VAT i.e. 8% for HR coil, will be added to the current export price. At current prices of $475/tonne fob, this would increase the price to approximately $510/tonne – an increase of $35/tonne. For rebar (current price of $420/tonne fob), the removal of the 13% rebate would move prices to $470/tonne fob – an increase of $50/tonne.
- Some Chinese mills have already placed clauses into sales contracts for 2015 sales whereby the buyer would be responsible for paying at least half of any increase in the VAT rebate.
Regional prices would go up
- Other Asian mills would probably increase prices to improve profitability. Currently (with China at $475/tonne fob for HR coil), South Korean and Taiwanese mills are selling HR coil at $500-520/tonne fob with Japanese mills at $520-540/tonne fob. While these differentials may shrink, we would expect regional mills to try and retain a premium pricing structure.
In conclusion, there would be some short-term disruption to the market. Buyers may be placing orders now for delivery prior to the end of the year in order to get a lower price. That may lead to a surge in exports late this year with a consequent drop-off early in 2015. It would also result in a stand-off between buyers and sellers as where the price ends up in early 2015.
Probable Impact of Removal of Rebates – Medium & Longer-Term
Chinese mills will want to export
- In our opinion, the Chinese steel industry has excess capacity. Best estimates of crude capacity are in excess of 1.1bn tonnes with expected output in 2014 just over 800m tonnes, giving a utilisation rate of 70-75%. As such, there is significant spare capacity within the system.
- Chinese steel demand is slowing. Consumption (apparent crude steel) is likely to be in the region of 740-750m tonnes in 2014 and realistic growth rates are 2-5% per annum for the next few years.
As such, there is capacity and desire to export from Chinese mills.
Relative cost position is improving
- The Chinese steel industry is dependent on imports of iron ore – around 70% of iron contained in steel is imported. That placed it a significant disadvantage to steel industries that were vertically integrated into iron ore (e.g. India, Ukraine/Russia and to a lesser extent Japanese & Korean mills that own iron ore & coal in Australia) when iron ore prices were high i.e. $200/tonne. However, iron ore prices are now around 40% of the peak price (currently around $75/tonne) and the integrated steelmakers no longer have a significant cost advantage in raw materials. We expect raw materials to remain at lower levels for an extended period (3-5 years at least). This is particularly important on the commodity end of the market, where the integrated producers in the CIS and India are the main competitors to Chinese steel.
- In addition, Chinese steelmakers have a cost advantage in terms of lower labour and environmental costs compared to regional mills in Japan and South Korea.
As such, we would expect Chinese mills will be able to compete with regional steelmakers on a cost basis even with the removal of rebates.
After initial disruption that may result in falling export volumes, we expect Chinese export volumes of flat rolled steel to continue at high levels through 2015 and beyond. Although the absolute price level will increase, we believe that Chinese steelmakers will be cost-competitive with regional steelmakers. Depending on what regulatory changes are made, there may be some change in the distribution of exports by product. For example, there may be a net benefit to Chinese steel producers that can produce more value-added material that may not be subject to the removal of VAT rebates.
What about billet?
The other key factor is what Chinese authorities do about the mis-classification of billet. Due to its mis-classification, the actual volumes of billet exports are unclear. However, we estimate that they have been 300-600,000 tpm in the second half of 2014.
The falling price of integrated raw materials has given Chinese producers a major cost advantage in long products in 2014 (see chart) as the majority of long products elsewhere in the world are made from ferrous scrap, which until recently had not suffered a price correction. In our opinion, the relative cost advantage for Chinese steel mills this year in long products has helped drive long product exports higher.
However, the recent surge in billet exports has prompted many scrap-based competitors in SE Asia and elsewhere to use billet rather than scrap and consequently scrap prices have fallen in last 2 months.
If Chinese authorities limit billet exports:
- Scrap prices may rebound elsewhere in the world as EAF mills return to buying scrap rather than Chinese billet.
- This will maintain the structural cost advantage of Chinese long products (even with rebates removed) and should see exports maintained at high levels even as billet exports fall.
- This will also benefit integrated flat product mills in China as they tend to use far less scrap than integrated flat product mills elsewhere in the world, again improving their relative cost position.
Relative cost of steelmaking raw materials vs Chinese steel exports