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Steel Futures Surged to 5-Year High, Bullish Run Likely to Continue

Steel rebar futures in China surged by 1.5 per cent on Monday to hit the highest since 2013, extending a rally since early July boosted by rising spot steel prices following recent step-up of restrictions over steel production and the government’s pledge to increase infrastructure spending to prop up the economy.

Tougher Environmental Protection Measures to Strain Steel Supplies

Recently, China released the plan for steel production restriction in Beijing, Tianjin and Hebei province, under which, major steel producers in the region such as Tianjin, Shijiazhuang, Tangshan, Handan, Xingtai, Anyang will reduction production activity by 50 per cent in the coming winter and other cities will cut production by no less than 30 per cent.

The State Council on 2 July unveiled a bold pollution-control plan called “blue sky” plan which expands pollution controls to 82 cities across China. Under the new plan, polluters will receive punitive charges with the introduction of a national pricing system for carbon emissions and the contamination of water, besides other stringent measures.

In addition, in the city of Hangzhou in eastern China’s Jiangsu Province, the local government has decided to steel production by 50-100 per cent to improve air quality. The city has been the most polluted city in the region.

As environment protection measures continue to tighten, steel makers are expected to see diverted destiny. “Some companies will be forced out the industry and some companies in the most polluting cities will be eliminated,” said Li Lijian, deputy head of China Iron and Steel Association.

As local governments have started to introduce supporting measures for the ambitious plan, the enforcement of environment protection regulations will only tighten, making steel production remain in a dwindling cycle, said Yao Jin.Meanwhile, as the world’s second largest economy is crimped by trade tensions and domestic slowdown, the government has pledged more infrastructure spending to boost the economy.

China’s social steel inventory declined further in July but at a slower pace. As of 20 July, total steel inventory in the 29 major cities fell to 8.298 million tonnes, down 433,000 tonnes compared to 29 June and 9.355 tonnes less than a peak in 9 March.

Steel inventory in 20 major Chinese cities declined by 3.3 per cent month-on-month in July to 9.29 million tonnes, according to data released by China Iron and Steel Association.

Steel rebar inventory has declined for four straight weeks as of the end of July, indicating a strong demand in spite of recent bad weather, said Zhang Guichuan, analyst at the CISA.

The Politburo of China’s Communist Party recently decided to increase fiscal spending to prop up the economy crimped by a slowdown of domestic demand and escalating trade tensions with the United States, which echoed the message from a meeting of the State Council chair by the Premier Li Keqiang last month, which pledged fiscal policy easing.

Looking forward, steel market is expected to strengthen further in August boosted by lower inventory, production restrictions, resumption of construction projects that have been suspended due to high temperature and rainstorms in summer as well as policy signals from the State Council and the Politburo, said Wang Gouging, director of Lange Steel Information Research Centre.

Steel Companies’ earnings report show their net income increased 15-20 per cent in the second quarter compared to the first quarter and surged 200-400 percent compared to one year earlier, which their price-to-earnings ratios remain at 4-5 times, which will boost a rebound of their share prices, according to a research note of China Merchants Securities.

Continued resilient steel demand and record low inventory are expected to drive steel prices higher in the third quarter,  to repair the valuation of steel producers, according Shenwan Hongyuan Securities.

Risks have been accumulating as steel prices have been rising for more than four months, said Chen Kevin, chief analyst at Lange Steel Information Centre.

Increasing margins in the sector will further boost steel production and on the other hand, rising steel may form pressure on steel demand at some point, said Chen.

However, some analysts also expressed cautious over the momentum of steel prices in the remainder of the year.

Steel prices in the second half will dependent on the relative strength between downward pressure arising from a possible economic slowdown and support from steel production restrictions and fiscal stimulus, said  Zhu Hao, commodity analyst at the Orient Securities.

China has started to impose restrictions not only in heating seasons but in non-heating seasons as well, which means we are unlikely to see significant drop in steel supplies in the coming winter, so the downward room is limited, said Zhu. He forecasts steel prices to peak in August and to fluctuate around the level in the remainder of the year.

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