Covid-19 May Elevate Downside Risks for Steel Sector – Ind-Ra
India Ratings and Research expects the Covid-19 outbreak to increase downside risks for the steel sector in the near term, with the already modest domestic steel prices impacting the operating margins. However, the magnitude of the impact would depend on the evolving severity and duration within China and spread of virus to other parts of the world. Certainly, the quantum of global supply imbalance could be substantial, as alone China produces and consumes more than half of the global steel production. China’s steel output, despite ongoing curtailment efforts, could outpace the receding steel consumption demand, resulting in an inventory pile-up and pricing pressures. China’s steel output has not seen severe cuts in the north-eastern steel-making heartland provinces such as Hebei, Liaoning and Shandong, where each province have large capacities of around 100 million metric tonnes. Moreover, keeping the blast furnace capacities, constituting 90% of China’s total steel capacity, idle is not possible, while China has witnessed a severe impact on steel demand due to a weak construction activity and an overall consumption slowdown. The demand-supply imbalance could also aggravate if the virus outbreak in other large steel producing nations, such as Japan, South Korea, India, and the US, worsens. Presently, Indian producers’ plant capacity utilisation has not been directly impacted, as there are no exports to China and no direct imports of raw materials from the country. Indian steel producers export only around 8% of their total production; hence, any larger spread of coronavirus in the world (other than China) could only affect that much. India’s top five export destinations in 9MFY20, constituting 45% of the total exports of INR415 billion, are Vietnam (15%), UAE (8%), Italy (7%), Belgium (6%) and Nepal (6%).
Ind-Ra’s Base Case Scenario: As per Ind-Ra’s base case scenario, Covid-19 could impact China 2020 steel demand growth by about 100bp, which could mean a surplus of around 10MT over the year largely skewed over February-June 2020. China’s local steel demand has reduced drastically in 1Q20, creating an inventory pile-up of about 20% yoy higher, leading to steel price pressures globally and restricting any major price increases in India over March 2020. Largely, the Chinese steel demand would be delayed but not disappearing, while the expected stimulus measures would support the demand pick-up in 2H20. Ind-Ra’s base case assumptions of the impact factor in the present situation of the outbreak and the agency assumes the virus impact would recede globally by April 2020. We shall revise our assumptions if the situation changes considerably and the virus keeps spreading beyond April 2020.
Ind-Ra Stress Case Scenario: In a pessimistic scenario of the spread of virus going beyond April 2020 up to June 2020, China 2020 steel demand growth and global steel demand growth may be impacted by 200-300bp and 200bp, respectively. As in such a scenario, other large consumers may have a severe virus impact on their local steel consumption as well. It would keep the steel prices depressed even in 2H20 while Ind-Ra is unable to ascertain such a situation at this point in time and even fiscal stimulus may not provide for a recovery. It could create a larger surplus globally of around 40MT with price risks of about USD70/tonne in 1H20. China steel exports in 2H20 could also bump up, subject to port logistics availability, as producers would try to offset their domestic demand and profit losses over 1H20.
China Steel Market: The China steel market would continue to witness a demand-supply imbalance, which could result in price fluctuations continuing over March-May 2020 in the range of USD30-40/tonne, while a price recovery would only come up with an appropriate government stimulus. Freight on Board (FOB) China (2.5mm) hot rolled coil (HRC) steel prices have softened to USD470 in February 2020 while they remained steady in January 2020 at around USD503/tonne, after firming up strongly over November-December 2019 from the lows of USD428/tonne in October 2019. As a precedence of such an epidemic crisis, the outbreak of severe acute respiratory syndrome in 2003 had led to a correction of commodity prices in the range of 5%-15% over the period of SARS escalation in March-May 2013.
India Steel Market: In 2Q20, Indian steel producers would face pricing pressures of about USD30/tonne related to import price parity with a lag, which could result in margin pressures of USD25/tonne in the base case scenario. China FOB HRC steel prices witnessed downward price fluctuations over February 2020 of around 8%, while Indian steel prices could still stay firm in the interim supported by the domestic re-stocking and strong seasonal consumption. Hence, the spreads of China FOB prices and Indian domestic HRC prices have widened over February-March 2020, but are not sustainable any more. Moreover, margin pressures could aggravate with iron ore cost pressures building up with new iron ore premiums in place. Indian HRC steel prices have firmed up by about INR2,000/tonne in February-March 2020, despite cost & freight India prices (from China) dropping by about USD30/tonne. Ind-Ra expects the spot price gap could start compressing though only gradually. (Long-term spread average of USD60/tonne, USD100/tonne as of March 2020). Indian steel HRC prices have consistently increased over November 2019-January 2020, resulting in a cumulative increase of 12%.
Limited Risk on Supply Glut from Imports: China steel exports to India have been reducing since anti-dumping duties came in force in February 2016. Also, any supply glut of imports from China is partially protected by the anti-dumping duty kicking in at USD489/tonne, while free trade agreement nation imports from Japan and South Korea can definitely pose additional risks on the domestic balance and prices. Also, transport and logistical challenges amid the virus outbreak would restrict a near-term increase in steel exports from China.
Moreover, large global steel consumers have increased the shield of protection over the years; hence, any exponential increase in China steel exports, as happened over 2014-2016, would not be possible.
Source : Strategic Research Institute