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China steel price decline caps near-term upside

HRC price falls ~15% WoW on fear of govt. action

China domestic HRC and seaborne iron ore prices have corrected ~15% WoW, reversing the sharp price gains seen in the first fortnight of May. The correction has come after Chinese govt authorities expressed concerns over rising prices, vowed actions against price manipulation, and initiated measures to cool down the commodity markets. This surprise government action has poured cold water on the commodity rally and likely capped prices in the near term.

Following this correction, China’s domestic HRC is now at a 17% discount to regional price, against an average premium of 9% in the past 10 years. Therefore, we expect weakness in China prices to also percolate down to regional prices in the coming weeks. However, India HRC price trades at a discount of ~20% to import parity, which should cushion against any potential weakness in regional steel prices.

Threat of action by Chinese government on rising commodity prices…

* China’s National Development and Reform Commission announced late last week that it would intensify the monitoring and supervision of the commodities market as well as its warning to the market, coupled with imposing targeted measures to safeguard the market stability.

* Chinese authorities had earlier increased trading limits and margin requirements for iron ore futures on the Dalian exchange – after iron ore prices surged ~23% post the Labor Day holidays. Following the surge in iron ore, steel prices in China also surged 17%/22% to USD1,041/t / USD980/t for HRC/rebar. Government authorities summoned steelmakers in the largest steel-producing belt of Tangshan to discuss the rising steel prices, threatening strict action against manipulation.

* The Chinese govt. seeks to stabilize prices through various measures, including a) ramping up production in domestic iron ore mines and b) ensuring higher availability of steel domestically by removing import duties and export rebates. Furthermore, the Chinese Cabinet stated it would step up the coordination between monetary policy and other policies to maintain stable economic operations.

…leads to correction in steel prices; poses risk to regional prices

* As a result of these factors, China’s domestic HRC/rebar prices have corrected by 15%/13% from the recent peak to USD886/t / USD850/t (Exhibit 1). As a result, spot spreads for HRC/rebar stand at USD215/t / USD184/t, down ~37% WoW (Exhibit 3).

* Historically, China’s domestic HRC prices have been at a ~9% premium to its export price and a just 4% discount, adjusted for 13% VAT. However, post this correction, China’s domestic HRC is now at a ~17% discount to export price (USD1,060/t) – which is unsustainable, in our view (Exhibits 5,6).

* We expect weakness in Chinese prices to percolate down to regional prices in the coming weeks.

* India HRC price trades at a discount of ~20% to import parity, which should cushion against any potential weakness in regional prices (Exhibit 8).

* India HRC price currently trades at INR65,800/t (USD900/t), a discount of ~20% to import price. While we expect the discount to narrow once domestic demand improves, such a high discount should cushion against the likely correction in regional steel prices.

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