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Not all the demand for steel is real [ClearOnMoney]
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Not all the demand for steel is real

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Commentary

Not all the demand for steel is real

23 Jan 2011 by Jim Fickett.

High commodity demand is being read as a sign of strong recovery, especially in emerging markets. But part of the demand is due to measures that pull demand forward.

Much is being made of the current high demand for commodities. The rising price of iron ore, for example, has been frequently in the news lately. On Friday the World Steel Association released steel production numbers through 2010, with a very strong rise in 2010:

World crude steel output increases by 15% in 2010

World crude steel production reached 1,414 million metric tons (mmt) for the year of 2010. This is an increase of 15% compared to 2009 and is a new record for global crude steel production.

Unsurprisingly, this was read as a sign of strong economic growth in emerging markets:

Global crude steel production touched a new record in 2010, driven by growth in emerging regions and improving manufacturing in the developed world

It is not very surprising that in 2010 a combination of a bounce after the panic, plus widespread stimulus, caused a sharp rise. What is more interesting is the overall growth in the last few years, and the question of how much of that growth is due to a solid, long-term rise in demand. Here is the growth since 2004, according to the World Steel Association:

The rise in production from 2004 to 2010 was 342 million tons, or 32%, or 4.7% per year, compounded. I suspect a substantial fraction of that is demand pulled forward, first by the bubble in the early years of this decade, and then by recent stimulus measures.

For example, according to a July 2009 OECD presentation, about half of all steel demand comes from construction, and the construction boom in China might account for something like 100 million tons – nearly a third of the total rise in the last six years. There is, of course, abundant evidence that much of the infrastructure, office building, and residential construction in China is either completely wasted or is pulling forward demand from far into the future. The effect is less pronounced elsewhere, but stimulus programs are no doubt causing more to be spent on infrastructure now than will be the case in coming years.

Shipbuilding is probably quite a small fraction of the total steel market, but it does provide, in one corner of that market, a remarkable illustration of market excesses that may be supporting a short period of high demand, but could be followed by much lower demand. During the boom years orders poured in for new ships. Ships take a long time to construct, and there is now a great excess of deliveries. In analyzing the recent volatility in the Baltic Dry Index, the Financial Times wrote last week:

The Baltic Dry Index, the index of the cost of chartering dry bulk ships, fell on Tuesday to just 1,432 points, the lowest rate since February 4, 2009, when the market was still recovering from a near-collapse in trade during the financial crisis.

Daily average earnings in the short-term spot market for Capesizes, the ships worst affected, have plummeted from $46,284 a day on October 27 to $9,537 now. …

Michael Bodouroglou, chief executive of New York-listed Paragon Shipping, says the looming crisis is different from past market slumps, when lack of demand in the market sent rates falling.

This time, an oversupply of ships is creating the problem. A further 241 Capesizes are due to be delivered this year, after 210 deliveries last year took the world fleet to 1,000.

According to an earlier article, part of the problem is that the Chinese decided to capture market share by selling, on a huge scale, at a loss.

According to data from Clarksons, the fragmented Chinese shipbuilding industry became the world’s biggest in the first half of 2010 by all three key measures: newbuild contracting, delivery, and the size of the overall order book. China has the same advantages Japan and Korea enjoyed in the past: low labour costs, steel supply and an abundance of coastal land. The difference is that Beijing is willing to bear almost unlimited losses in pursuit of dominance.

[Chart shows number of lossmaking shipyards in China rising from about 80 in 2006 to about 150 in 2010.]

It is very hard to tell how much all these excesses have impacted steel demand overall. But it is clear that the impact is substantial. Are emerging markets really growing faster than developed ones? Yes. Is commodity demand really due to that growth? Well, to some extent. But it would not be very surprising to find that the durable commodity demand has been significantly overestimated.