Steel Mill Profits: A Decade of Ups and Downs and the Path Ahead

Review and Outlook of Steel Mill Profits Over the Past Decade

Abstract:

1. Over the past decade, steel mills have mostly been profitable (around RMB 500/ton), with the best profits exceeding RMB 1500/ton. Since 2022, the situation has gradually deteriorated, and losses have been incurred since the second half of 2023.
2. The level of steel mill profits mainly depends on whether pig iron capacity is sufficient, but overcapacity does not necessarily lead to continuous losses for steel mills. For instance, during most of 2014-2015, steel mills did not lose money, which is related to the expectations of steel mills. After a long period of decline and losses, steel production becomes cautious. Unless there is a profit and it lasts for a period, the production volume will not increase, and even if there is a profit, steel mills will not produce blindly but produce on demand and maintain low inventory.
3. Looking forward to 2025, steel prices have experienced three years of unilateral decline, and since the second half of 2023, steel mills have been deeply in the red. By 2025, the loss time will exceed one year, and the total inventory of steel will also drop to a low level in recent years. Since mid-August 2024, steel mill profits have continued to improve, but we have not seen a significant expansion of production, and there has been no accumulation of inventory in various links, showing that steel production has entered a cautious state. Therefore, even if we believe that the steel price center will still move down in 2025, steel mill profits may still improve to some extent.
4. Before 2021, the futures market profit was mostly discounted compared to the spot market profit, and then it began to be premium. When steel mill profits are high, the futures market profit is often discounted compared to the spot market profit. When steel mill profits narrow, the discount narrows, and vice versa. Therefore, if steel mill profits improve in 2025, the futures market profit may be discounted compared to the spot market profit.
5. Since 2014, the proportion of iron ore in the cost of steel (only considering iron ore and coke) has fluctuated between 45% and 60% for most of the time. As of November 22, 2024, the cost proportion of iron ore is 57%, which is at a high level in the past decade, and there may be a slight possibility of downward adjustment in 2025.

I. Review and Feature Analysis of Steel Mill Profits Over the Past Decade

(A) Based on the different characteristics of steel mill production profits, it is divided into four stages.

First Stage: 2014 to 2015

1. Feature Analysis

The price of rolled steel and rebar unilaterally declined, and steel mill profits fluctuated at a low level. At the beginning of 2014, the prices of Hebei rebar and hot rolled coil were near RMB 3500/ton and started a unilateral decline, with small rebounds in between, reaching the lowest RMB 1650/ton and RMB 1700/ton at the end of 2015.

Steel mill production profits gradually narrowed, but there was still a profit for most of the time. In the most difficult time in the second half of 2015, the production profit of the steel mill fluctuated near zero.

1. Cause Analysis:

(1) Overcapacity

After the strong stimulus following the financial crisis in 2008, demand expanded rapidly, and high profits stimulated the explosion of capacity. From 2009 to 2014, the steel output increased by 310 million tons, and the capacity growth far exceeded the output. Steel demand peaked at 765 million tons in 2013 and then fell back, with a negative growth in 2014-2015.

(2) Low industry concentration

In 2015, the total crude steel output of the top ten steel enterprises in China reached 275 million tons, with an industry concentration of 34.2%. Low industry concentration can squeeze profits from two angles: first, steel mills produce blindly and the industry is highly competitive; second, the pricing power for raw materials is low, and the cost side cannot decrease proportionally.

(3) Steel mill production is cautious

Overcapacity and low industry concentration can explain the poor profits of steel mills, but they cannot explain why steel mills were profitable for most of the time from 2014 to 2015. The cautious production of steel mills may explain this phenomenon. 2014 was the third year of steel price decline (starting in 2012), and steel mills were mostly losing money for most of 2013. After a long period of unilateral decline and losses, steel mills became cautious in 2014. In terms of behavior, it means that unless steel mills are given a certain profit and it lasts for a period, the production volume will not increase. And even if there is a profit, due to the pessimism of steel mills for the future market, they no longer blindly produce and accumulate inventory, so we see that while steel mill profits turned positive in 2014, inventory also decreased compared to 2013.

Second Stage: 2016 to 2020

1. Feature Analysis

The price of rolled steel and rebar started an upward trend until the end of 2017, with Hebei rebar and hot rolled coil prices reaching the highest at RMB 4500/ton and RMB 4200/ton, respectively. After that, there was a certain decline in high positions, but the lowest price did not break the level at the beginning of 2014. Steel mill profits first experienced rapid expansion, with the production profit per ton of steel approaching RMB 2000 at the end of 2017, and then declining, falling to RMB 300-500/ton by the end of 2020.

1. Cause Analysis:

(1) Strong demand

In 2015, the policy end set the tone for the de-stocking of real estate, with measures such as reduced down payments, tax exemptions, and monetary resettlement of shantytowns being introduced in turn, driving the sales of commercial housing to rise from March 2015. However, investment was lagging, and it stopped falling at the end of 2015, and the growth rate further increased in 2016. At the same time, infrastructure has also become an important means to expand domestic demand, with infrastructure investment growth bottoming out in February 2016. The two important engines of steel demand have been ignited.

(2) Supply-side reform

At the end of November 2016, the crackdown on steel bars and the shutdown of medium-frequency furnaces became increasingly strong. According to the research data of China United Steel, the capacity of medium-frequency furnaces nationwide is about 80 million tons.

Third Stage: 2021 to 2022

1. Feature Analysis

The price of rolled steel and rebar started an upward trend and broke through the previous high, with the prices of rebar and hot rolled coil reaching the highest point of nearly RMB 6500/ton in the first half of 2021, and then fluctuated and fell, with rebar and hot rolled coil prices falling to RMB 4000/ton by the end of 2022.

The fluctuation of steel mill profits first intensified and then decreased. In 2021, the profit fluctuation range of steel production was between -RMB 500 and RMB 1000, and in 2022, it narrowed to between -RMB 100 and RMB 100.

1. Cause Analysis:

(1) Expectation of crude steel reduction

In 2021, the National Development and Reform Commission and the Ministry of Industry and Information Technology organized a national "review" inspection of steel capacity elimination and crude steel production reduction work, with the specific statement being "resolutely compress crude steel production to ensure a year-on-year decrease in 2021 crude steel production." Since the beginning of 2021, steel prices have been supported by this expectation.

(2) Surge in overseas demand

To cope with the impact of the epidemic, the Federal Reserve has made efforts in both fiscal and monetary policies, and at the same time, after the epidemic, the domestic supply chain was the first to recover, and China's share in global trade has increased, with strong demand for plate materials. In 2021, overseas demand for steel increased by 120 million tons compared to 2020.

(3) Crude steel capacity is no longer a bottleneck

Even with the dual efforts of supply and demand in 2021, we did not see the unilateral expansion of steel mill profits, and the highest value of profits did not break through 2017. The reason is the sufficient crude steel capacity. According to the data from Steel Union, the utilization rate of blast furnace capacity in 247 steel mills in 2021 was 85.5%, a decrease of 4.5 percentage points from 90% in 2020. When steel appears to be highly profitable, it is difficult for policies to strictly control the production of steel mills, so profits are quickly suppressed until losses reduce production to achieve balance.

Fourth Stage: 2023 to the present

1. Feature Analysis

The price of rolled steel and rebar fluctuated and fell and broke through the level at the beginning of 2014, with Hebei rebar and hot rolled coil prices at RMB 3230 and RMB 3450, respectively, as of November 22, 2024.

Most of the time, steel mills are in a loss, with profits mostly between -RMB 500 and RMB 300/ton.

1. Cause Analysis:

(1) Weak demand

The real estate continues to drag down the demand for steel and even the domestic economy. The downturn in real estate not only directly affects the demand for building materials but also indirectly affects the demand for post-real estate cycle chain products such as home appliances and automobiles. In 2023, infrastructure can still support the economy, but by 2024, local government debt has been raised to an important position, and the physical work volume of infrastructure has declined significantly, leading to a liquidity crisis in building materials. Overseas demand has also lagged in reflecting the negative effects of the Federal Reserve's interest rate hikes, with both domestic and foreign demands weakening.

(2) Overcapacity

Since the supply-side reform in 2016, the large-scale blast furnace has become a trend, and the production adjustment capacity has been greatly enhanced. As of the end of 2023, the crude steel capacity exceeded 1.3 billion tons, while the output was only 1.03 billion tons, and the capacity utilization rate was less than 80%.

In summary, over the past decade, steel mills have mostly been profitable (around RMB 500/ton), with the best profits exceeding RMB 1500/ton. Since the second half of 2022, profits have started to deteriorate, with the highest level only briefly breaking through RMB 500/ton, and the time when profits exceeded RMB 300/ton was very rare, mostly fluctuating between -RMB 300 and RMB 300/ton, with the time of losses starting to exceed the time of profits, especially since the second half of 2023 when steel mills have been deeply in the red.

When demand continues to decline and capacity fails to decrease synchronously, steel mill profits gradually narrow and eventually move towards losses (first stage); both supply and demand exert efforts, and steel mill profits expand rapidly (early second stage), high profits eventually stimulate further expansion of capacity, and demand is often difficult to sustain high growth, leading to supply and demand moving towards balance again, and high profits no longer exist (late second stage); unexpected events lead to another outbreak of demand (the United States' big water release after the epidemic), and capacity is no longer a bottleneck, the absolute price increase does not necessarily lead to the expansion of steel mill profits, as demand cools down, steel mill profits return to a low level (third stage); demand further declines (domestic demand declines in all aspects), supply and demand surplus pressure is highlighted again, and steel mills fall into losses (fourth stage).

(B) Based on the difference in characteristics between spot and futures profits, it is divided into four stages.

First Stage: Second Quarter of 2014 to First Half of 2019

Most of the time, the futures market profit was discounted compared to the spot market by RMB 300-500/ton.

At the beginning of 2014, the futures market profit for rolled steel and rebar was discounted compared to the spot market profit. As steel prices fell, steel mill profits improved, and the futures market profit began to be discounted compared to the spot market and gradually expanded. In the first half of 2016 and at the end of 2017, the futures market profit was discounted by more than RMB 1000/ton compared to the spot market profit.

Second Stage: Second Half of 2019 to 2020

Steel prices and profits both moved down, and there were cases where the futures market profit was either premium or discount compared to the spot market profit, with small amplitudes, mostly between a premium of RMB 200 and a discount of RMB 300/ton.

Third Stage: 2021 to 2023

Steel prices soared, but the center of steel mill profits moved down again, and the futures market profit began to be premium compared to the spot market profit. In the middle of 2021, the futures market profit for rolled steel and rebar was premium compared to the spot market by as much as RMB 1500/ton, and then as steel prices fell, the center of profits moved up slightly, and the premium of the futures market profit narrowed. From the middle of 2022 to the end of 2023, the premium was basically within RMB 500/ton.

Fourth Stage: 2024 to the present

Steel prices have further declined, and the center of steel mill profits has fluctuated at a low level, with both premium and discount of the futures market profit compared to the spot market profit appearing, but with greater fluctuation amplitudes than the second stage.

In summary, the futures market profit was discounted by more than RMB 1000/ton compared to the spot market profit (first half of 2016 and second half of 2017), and the premium was more than RMB 1500/ton (middle of 2021), both of which occurred in extreme situations, and most of the time fluctuated between a discount of RMB 500 and a premium of RMB 500/ton. Before 2021, it was mostly discounted, and then it began to be premium, and in 2024, the premium and discount amplitude narrowed to within RMB 300/ton.

In general, when steel mill profits are high, the futures market profit is often discounted compared to the spot market profit. When steel mill profits narrow, the discount narrows, and vice versa. When steel mills are mostly in a loss state, the futures market profit is often premium compared to the spot market profit, and the greater the loss, the greater the premium. Therefore, if steel mill profits improve in 2025, the futures market profit may be discounted compared to the spot market profit.

II. Contribution of Different Raw Materials

Based on the characteristics of the composition of the futures market profit, it is divided into three stages.

First Stage: From 2014 to Early July 2018

The futures market profit for steel slowly bottomed out and then rose rapidly, but the proportion of iron ore in the cost of steel (only considering iron ore and coke) fell unilaterally, from 68% at the beginning of 2014 to 38% in early July 2018.

Second Stage: From July 2018 to Mid-July 2021

Steel mill profits fell unilaterally until the end of 2020, then rose rapidly, with the proportion of iron ore cost increasing from 40% to 58% in July 2019, and then maintaining between 50% and 60%.

Third Stage: From Late July 2021 to Early September 2021

Steel prices peaked and fell, fluctuating around RMB 5700/ton, steel mill profits fluctuated and rose, reaching the highest level in the past decade in early September 2021. The proportion of iron ore cost fell unilaterally and rapidly, from 60% in late July 2021 to below 35% in early September 2021.

Fourth Stage: From September 2021 to the present

Steel mill profits fluctuated and fell, then lingered at a low level, and the proportion of iron ore cost gradually increased, from 40% in early September 2021 to 55% at the end of May 2023, and then fluctuated slightly up and down to the present.

In summary, since 2014, the proportion of iron ore cost has experienced two rounds of upward and two rounds of downward movements. During the upward process, steel mill profits have all declined, and during the downward process, they are more inclined to rise. The highest value of the iron ore cost ratio appeared at 68% at the beginning of 2014, and the lowest value appeared at 35% in early September 2021, mostly fluctuating between 45% and 60%. Moreover, the highest value of the iron ore ratio in the three peaks has become lower and lower. As of November 22, 2024, the iron ore cost ratio is 57%, which is at a high level in the past decade.

III. Summary

Based on the above research, the following conclusions are drawn:

1. Over the past decade, steel mills have mostly been profitable (around RMB 500/ton), with the best profits exceeding RMB 1500/ton. Since 2022, the situation has gradually deteriorated, and losses have been incurred since the second half of 2023.
2. The level of steel mill profits mainly depends on whether pig iron capacity is sufficient, but overcapacity does not necessarily lead to continuous losses for steel mills
3. For instance, during most of 2014-2015, steel mills did not lose money, which is related to the expectations of steel mills. After a long period of decline and losses, steel production becomes cautious. Unless there is a profit and it lasts for a period, the production volume will not increase, and even if there is a profit, steel mills will not produce blindly but produce on demand and maintain low inventory.
4. Looking forward to 2025, steel prices have experienced three years of unilateral decline, and since the second half of 2023, steel mills have been deeply in the red. By 2025, the loss time will exceed one year, and the total inventory of steel will also drop to a low level in recent years. Since mid-August 2024, steel mill profits have continued to improve, but we have not seen a significant expansion of production, and there has been no accumulation of inventory in various links, showing that steel production has entered a cautious state. Therefore, even if we believe that the steel price center will still move down in 2025, steel mill profits may still improve to some extent.
5. Before 2021, the futures market profit was mostly discounted compared to the spot market profit, and then it began to be premium. When steel mill profits are high, the futures market profit is often discounted compared to the spot market profit. When steel mill profits narrow, the discount narrows, and vice versa. Therefore, if steel mill profits improve in 2025, the futures market profit may be discounted compared to the spot market profit.
6. Since 2014, the proportion of iron ore in the cost of steel (only considering iron ore and coke) has fluctuated between 45% and 60% for most of the time. As of November 22, 2024, the cost proportion of iron ore is 57%, which is at a high level in the past decade, and there may be a slight possibility of downward adjustment in 2025.

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