(The following statement was released by Fitch rating agency)
China has accounted for as much as 80% of global growth in metal demand in recent years, driven by its extensive investments in infrastructure and real estate projects. As the Chinese authorities seek to rebalance its economy away from fixed-asset investments (FAI), the country's growth in demand for metals will likely slow. At the same time, the increasing importance of consumption as a driver of economic growth will shift Chinese demand for metals towards those used in consumer products.
In the Q&A below, Singapore-based Su Aik Lim and Hong Kong-based Laura Zhai of Fitch Ratings' Industrial Team explain how China's role in the metals sector will change.
Q. How will Chinese demand for metals change as the authorities take steps to rebalance the economy away from investment and towards consumption?
We expect demand growth for all metals to slow down as fixed-asset investment growth decelerates in the long term. While a short-term increase in investment may result in a spike in demand, a sustained price improvement will be difficult to achieve because longer-term demand remains weak.
For steel, demand has been damped by the slowing FAI growth and product substitution. With this in mind, the Chinese steel industry, which has traditionally mostly produced steel for use in construction, will have to invest in product development to supply steel that can be used in a wider range of applications.
For base metals, China's economic rebalancing will create sustainable demand growth for metals used in consumer products. While aluminium will benefit from such a structural change, over-capacity remains an issue. Copper is probably the only bright spot in the long term with China's increasing focus on energy efficient products, which require higher copper usage per unit. Per capita consumption for the metal is still very low at over 5.5kg compared with developed nations' peak consumption of well over 11kg. Although copper prices have been muted due to an increase in supply, we do not expect this effect to last beyond 2015 or 2016.
Q. What companies and metals will thrive in a more consumption-oriented economy?
Steel companies that have offerings used in consumer products, such as Baosteel Group (A-/Stable), will do well. Market leaders in each of the main steel product categories are expected to survive the industry restructuring. For example, China Oriental (BB/Stable), a leader in H-section steel, will likely tap its cooperation with ArcelorMittal to strengthen its position and ride out the shake-out of the steel industry.
Metals such as aluminium and copper will benefit given their applications in automobile, household appliances and other consumer products. In the case of aluminium, prices continue to be supported by marginal cost producers in China, therefore companies with access to lower power prices such as China Hongqiao Group (BB/Stable) will continue to do well. As for copper, although there will be an increase in mined production in the near term, rising development and production costs for new deposits are likely to reduce new supply after 2015 and 2016. Demand will continue to grow and mined supply will not be able to meet needs in the long term, with the result that China will continue to rely on imports of mined concentrates.
Q. While China has been an important factor in global demand growth, how has its share of supply changed?
For the Chinese steel industry, although there is severe excess capacity, it will continue to be highly dependent on iron ore imports because domestic iron ore production is not sufficient to meet the needs of steel plants. Although more Chinese companies are investing in overseas iron ore projects, these assets are either smaller in size, of poorer quality, or in joint-venture structures where the Chinese parties do not have control over sales.
For the base metal industry, Indonesia's proposed restrictions on export of bauxite will not have much of an impact in the long run because bauxite is readily available from other sources.
China's zinc supply will be the wild card at a time when a number of sizable Western mines are due to be depleted in the coming years. China has abundant zinc resources and zinc production has been increasing at more than 10% a year over the past five years. There is limited information on China's zinc mines because they are mostly small scale, privately held operations, and many industry reports fail to account for production growth in their forecasts. If we assume that Chinese zinc production rises just 5% per annum in the next few years, China alone could add close to 90,000 tonnes of zinc to the market by 2016, adding to an estimated net new mine production of 40,000-70,000 tonnes from the rest of the world.
China's reliance on copper concentrate imports will remain strong because most of the copper deposits in the country are small while the larger ones are located in areas that are difficult to mine. Its copper smelting industry, though, has begun to face overcapacity issues, which will put downward pressure on domestic copper prices.
Q. Why has overcapacity remained such a major problem despite government controls?
For the steel industry, changes by the central government could result in smaller, more pollutive and inefficient steel producers being forced out the industry. However, this will likely take a long time because local governments have little incentive to push for closures of one of their larger employers, especially if there are no alternative plans to redeploy the workers. Furthermore, the financial positions of most Chinese steel makers have weakened after five years of poor profitability and this will probably slow the industry consolidation necessary to solve the overcapacity problem.
Overcapacity problems in the aluminium industry also stemmed from the misalignment of interests between local governments and the central government. Although the central government has tried to curb capacity expansion in the aluminium sector since 2003, local governments continued to add smelters to boost local economic activity because they were assessed on their contribution to GDP growth. The recent increase in new aluminium smelters is driven by access to cheaper power prices in the west and incentives from the central government to develop the western region. It is likely overcapacity will worsen in the near future, with aluminium production capacity in China expected to reach 40m tonnes by 2015, up from 28m tonnes in 2012.
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