CRU: Demand Slows as Auto Producers Switch Off

While economic activity in China is recovering, this will take time and the risks of a further outbreak will constrain any reboot of the economy. Also, with consumption low, inventories across the supply chain are high and building.

Outside China, all major steel-producing regions are seeing end-use activity and steel demand pull back with several countries entering some form of lockdown over the last week and others expected to follow. Particularly, the impacts in Europe look more severe, and quickly moving, whereas North America and South America look to be responding more slowly; this is likely to have repercussions down the line.

More steel is being diverted into export markets (e.g. from Japan, South Korea, India) or attempts are being made to curtail domestic steel production (e.g. in Europe). However, it looks like the steel market is heading towards a major dislocation and we expect prices across the value chain to fall.

Economic Outlook: Downgrades Across the Board

We are now expecting Chinese GDP to grow at 2 percent or below this year and, with recessions now forecast in the USA and the Eurozone and sharp slowdowns elsewhere, global growth is forecast to fall to ~1 percent in 2020. Consensus forecasts for China are in the same range, but with at least one outlook suggesting negative growth, despite the fact that more positive comments are coming out of China and some there are still expecting a significant and positive boost to economic activity.

Regional Updates

China: It is feared that the successful containment of Covid-19 (n.b. China has seen no new transmitted cases for five consecutive days) is threatened by a rise in imported cases. Cities have been categorized into three groups depending on virus severity, and policies will be set accordingly (e.g. travelers from the USA and UK will be automatically quarantined in some cities). The Central government message to regional governments is to increase the sense of urgency and prepare policies for an economic downturn, including preferential tax/VAT conditions and the stimulation of consumer spending, and to encourage domestic tourism.

On the demand side, real construction demand is increasing (n.b. rebar daily sales are up, although stocks continue to rise), but many construction sites are still short-staffed, with only 50 percent of workers returned to some cities in east China. Cement plant utilization is only at 73 percent of normal, so still only at levels typical of CNY itself; engineering equipment utilization, which is reflective of infrastructure activity, is also at 61 percent of normal. Manufacturing output saw a double-digit contraction during January and February, but end-product inventories are high—for example, vehicle inventories were 7x higher than normal in February—and it will take a long time for those inventories to be absorbed even if sales do recover. Currently, a fall in auto production of 8-10 percent for 2020 overall does not seem unfeasible. Having said that, sentiment in manufacturing has improved with plants reopening; however, production schedules remain constrained.

Steel inventories continue to grow although mill stocks are stabilizing, or even falling in some cases, while trader stocks are increasing. Mills are renting additional warehouse space to store additional stocks, which may be for their own use or, increasingly, for trader customers to hold stocks.

Steel spot trading saw some improvement last week, although volumes are probably only 50 percent of normal levels and domestic sheet demand has been weaker than that for longs, partly as some traders have been tentatively stockpiling rebar, but more to satisfy short-term demand. Many remain cautious given high inventories and there are large uncertainties and divergent views about H2 2020 activity, so we have also seen traders taking short positions on the expectation of falling prices.

So far, nonferrous metal prices have been much weaker than those for steel, with the physical steel market impacted by a more optimistic steel futures market where there have been high levels of trading. With low levels of physical market trading, futures prices have taken a much greater role in setting physical spot prices. However, we believe the current futures prices are trading more on sentiment than fundamentals and that they will fall. Indeed, October contracts are already down significantly and, more recently, futures prices have been falling across the board.

Overall, steel export prices are down, although longs prices have fared relatively better. Competition in the Asia export market is ramping up, with much billet from Russia and Indonesia moving into China itself, suggesting a disconnect between Chinese domestic and Asia export markets. We have also heard that POSCO is willing to export at low prices and some material, mainly HRC and plate, has been exported to China via traders. On March 20, China increased the VAT tax rebate on exports from 10 to 13 percent, which will support exports of some HRC, structural and wire rod product segments.

Northeast Asia: In both Japan and South Korea, domestic demand is very poor. In Japan, March is typically one of the strongest months for manufacturing as many businesses and households make final purchases and use available budgets in the current fiscal year and this has a positive influence on steel demand, but not this year. Japanese steel producers initially saw reduced demand in February as Japanese-owned auto plants in China closed and this has continued into March. Honda and Nissan plants in Hubei province closed in February and remain closed, whereas Toyota, Mazda and Mitsubishi have been able to restart their Chinese production lines in mid-March, but with reduced capacity. In the domestic market, while some auto producers had to partly halt production (e.g. Nissan), the majority of car plants are still operating and we have heard they are trying to produce as many units as possible before year-end, notwithstanding poor end-user demand, and most production is going into stock. However, auto production and other manufacturing sectors are facing supply chain disruptions as many parts and components are produced in China and there is very little reserve stock to keep production at normal levels. As a result, many manufacturing companies are desperately looking for new suppliers and contracts are being negotiated with parts suppliers from the wider Asia and the Americas. Having said all this, there are some question marks on the actual strength of manufacturing and steel output.

Demand for steel long products in Japan has been dramatically impacted by a labor shortage, as a large share of workers in the sector are Chinese and they have not returned after CNY. Initially, Japan was planning to attract more foreign workers, primarily from China, but also from other Asian countries, such as the Philippines, but work visas for workers from other countries have now been suspended.

While weak demand does not seem to be affecting production decisions to the same extent as in other countries currently, we expect this to change from April onwards. End-product stocks are expected to lift in March and businesses will be more inclined to reduce production as the new financial year begins. As such, we expect Japanese steel demand and production to be much more affected in Q2.

Manufacturing and construction output is down in South Korea and so steel mills are seeking outlets in the export market, but there are expectations of a potentially sharp stimulus that could help recovery. Even lower export prices are expected from both Japan and South Korea in the near term.

Southeast Asia: Malaysia has gone into lockdown, initially for the period March 18-31 and this has led to the suspension of infrastructure activities and auto production; port activities are less restricted. Currently, activity in the auto sector is expected to resume only after March 31, but this may be optimistic. Mining has also been affected and the closure of manganese ore mines in the country is causing supply concerns for Chinese steel producers. We have heard that Malaysian ferroalloy plants have been asked to close, but there are lobbying efforts to stay open. There are also rumors that BOF plants have been asked to shut down, but this is unlikely while the lockdown remains at only 14 days.

In the Philippines, there are now restrictions on movements within country. At ports there, all vessels docked will still be unloaded/loaded, but there will be delays for vessels still on the water, which will mainly impact April shipments. As of yet, there are no lockdowns in other countries in the region. Governments are pushing ahead with stimulus measures, but these are focused mainly on “vulnerable” sectors and funds are being diverted from infrastructure to virus mitigation. Singapore has increased its restrictions on people entering the country to reduce the number of imported cases of Covid-19. As a result, construction and manufacturing have slowed across the region and flats demand is particularly poor.

Construction sites in Vietnam that are near outbreak centers have been impacted by shutdowns and, specifically, the Hoa Phat 2 Mt HRC project has been delayed as Italian and Chinese commissioning engineers are not available. More generally, force majeure is being enacted by plant suppliers and this will impact the many steel projects in the region. In Thailand, budget approval had previously been delayed and we were already expecting funds for state projects to also be delayed, but Covid-19 will now ensure that these delays will be pushed further out.

Japanese and South Korean price premia for steel deliveries into the region are falling and Chinese offers have lowered in response. There is additional downside risk to prices from Indian and Russian material that has a low cost base that may be diverted into the region as European and Middle Eastern import demand dries up.

India: The country’s one-day voluntary curfew (observed on March 22) precedes a flurry of lockdown announcements by various states, in a bid to contain COVID-19 spread. As many as 80 Indian cities have been locked down until at least the end of March, sharply affecting manufacturing and construction activity across the country.  

The rally in Indian steel prices witnessed since December 2019 is unlikely to be sustained in the near term. The country’s steel market activity has come to a grinding halt following the lockdown measures, while production continues in these uncertain times due to complexities (both operational and economical) involved in curtailing steelmaking operations.

We have recently published a CRU insight “COVID-19 lockdown takes the sheen off Indian steel market” looking at details behind the variety of restrictions imposed as a part of these virus containment measures and the impact on steel demand and prices.

Europe: Auto production in Europe has temporarily paused, with all OEMs suspending operations. These closures are to be full shutdowns and are expected to continue for significant lengths of time. Other manufacturing facilities have announced closures, including shipyards. It is not clear if Italian construction activity has been suspended, but there are requests from industry associations to suspend all construction operations. In Austria, more than 20,000 construction workers have been laid off in the past week, and a total of at least 50,000 people have been laid off across the economy. Germany is expected to go into full lock down soon, and larger production projects are either delaying their start or halting activity for a short period. It has been reported that most smaller scale projects are still proceeding as planned, but a broader shutdown in the near future may inhibit this. Some retailers such as Ikea may run out of certain components soon, forcing production lines to halt as these bottlenecks are created. Overall, the impact on steel demand will be immediate and significant, and we have already heard reports of steel buyers delaying or cancelling purchases.

A significant volume of steel capacity is being idled in response to this fall in demand. Several Italian EAFs producing primarily steel long products have been idled in the last two weeks—and this is now spreading both beyond Italy and to producers of flats: ArcelorMittal is idling blast furnaces and halting flats rolling mills and other producers are set to follow. As in China, these reductions to supply will lag those to demand and we expect inventory to build over the next weeks.

North America: Multiple states are moving to lockdowns; schools are closing and people are working from home where possible or are out of work completely. Unemployment is expected to rise, with estimates suggesting a surge to >10 percent unemployment rate in the coming months. The consensus across banks is for a 14-24 percent economic contraction in Q2. Auto makers are shut down for the next two weeks at the very least. The longs market has yet to be impacted, but states such as Pennsylvania have ordered the cessation of construction activity and metals manufacturing.

Currently, April order books look good and are well-priced for both spot and contract business; however, with shutdowns happening and an urge for buyers to back away from the market, service centers are beginning to look like they have too much inventory. With two-months’ supply on hand now, which is expected to grow to five months’ of supply in the low buying environment, we expect limited new orders to the mills. Steel mills are pushing for significantly lower scrap prices, and we think steel spot prices are set to collapse.

Currently, the question is when will a full lockdown be implemented (n.b. potentially by the end of this week) and how quickly can this slow the spread of the virus. There are a lot of people who simply have not been tested. Current estimations suggest that the USA will pass the number of infections in China before end-March.

South America: There is still no official lockdown in Brazil, but some states and cities are cancelling school, closing shopping malls and theatres and implementing working from home. A shutdown of auto plants is planned to start from April 1 to at least April 22; GM, Mercedes, Fiat and VW are all preparing to shut down and temporary layoff programs are being negotiated with the government. Unemployment is expected to surge. Local economists are already predicting -1 percent GDP growth for the year as a whole (n.b. down from 2.5 percent in January), while the Brazilian real has weakened against the U.S. dollar from ~R$4 to R$5.

Steel mills haven’t yet reduced production, or stopped, but most are revising production targets and raw material demand. Service center prices have been stable versus the beginning of the month and mills were even considering a price hike for April, but participants don’t believe it can stick. The weaker real is behind mills argument to increase prices, but demand conditions will set the tone. Vale has already said that it may have some iron ore supply issues related to Covid-19, but nothing is firm so far.

The trend in new cases looks similar to that seen in Europe, with 621 cases confirmed on March 20 and the first case detected on Feb. 26. Brazil has seen a 30 percent daily increase in cases over the past week. Currently, the main question is when/if there will be a total lockdown in the country.

Middle East: The lower oil price will ultimately impact government revenue and spend, therefore, project demand will fall, especially in the Gulf Co-operation Council (GCC) countries. Talks in the GCC on austerity measures have already begun and only essential projects will go ahead. On the whole, this means that housing projects will mainly be impacted, as infrastructure projects are considered more essential. Saudi Arabia is still saying that it will complete its “Saudi Vision 2020,” but this position is looking increasingly untenable.

Africa: The low oil prices will have an impact on the Algerian, Nigerian and Angolan economies. A decline in tourism because of travel restrictions will also impact the Egyptian economy.

CIS—Russia: So far, Russian steel demand has been little impacted by Covid-19 and domestic steel mill margins are still good. As such, there is not yet additional export pressure from a supply/demand perspective.

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