China's massive stimulus and US steel companies

China's CNY 4 trillion (US$586 billion) stimulus programme made its economy the envy of the world. Chinese steel prices bottomed in March and imports of base metals soared in the second quarter. How will Chinese stimulus spending affect the United States steel market? Are US steel companies likely to benefit from Chinese demand? Here we break down China's stimulus spending and highlight how Chinese demand is affecting US producers. The numbers seem to suggest that Chinese stimulus demand is helping to stabilise the world steel market, which in turn benefits US steel producers and their peers around the globe.

An analysis of Chinese stimulus spending
According to the details provided by the central government, over 60% of the $586 billion stimulus package will go into infrastructure construction, including railways, roads, airports, power grid investments, rural infrastructure, and earthquake zone reconstruction. Another 9% goes into rural infrastructure spending such as paving roads and building bridges. The rest of the stimulus spending will be directed to the provision of welfare and environmental programs.

Of all infrastructure projects, railroads should experience the biggest investment boost. The country's railway system is struggling to keep pace with the growth of the economy. China's per capita railroad length is one of the lowest in the world, at 58 kilometres per million people, a far cry from the United States' 765 kilometres per million people and the European Union's 482 kilometres.

With the announcement of the stimulus program, the government allocated CNY 800 billion ($117 billion) for railroads, in addition to the CNY 1.25 trillion ($182 billion) set aside in the nation's 11th Five-Year Plan. With this incremental $117 billion, the Ministry of Railways is planning to expand the nation's railroad network to 100,000 kilometres by 2010, up from 78,000 kilometres as of 2007 and an incremental 10,000 kilometres compared with the previous plan. This would create demand for another 5 million-10 million tons of steel, depending on the amount of infrastructure construction needed along the railroads. For example, the high-profile Beijing-Shanghai high-speed railway alone would consume 5 million tons of steel due to the need for many bridges along the rail line.

Another destination of public spending is highway construction. Although the Chinese government spent significant resources in building the nation's highway network over the past two decades, the country's 1.9 million kilometres of highway network is far from sufficient for an area of over 9 million square kilometres. Along with the $586 billion stimulus programme, the Ministry of Transportation announced CNY 5 trillion ($730 billion) of investments in highway, waterway, and port construction over the next three to five years. This would imply an additional CNY 1.7 trillion ($248 billion) investment on top of what was stipulated under the current 11th Five-Year Plan. Most of that additional investment would go into highway construction, considering that China has a decent port system. This would imply roughly another 20 million tons of steel to be used in highway construction.

Impact on US steel producers
Considering that China consumed 500 million tons of steel in 2008, the incremental steel consumption directly caused by the stimulus infrastructure spending doesn't appear impressive at all. The spill-over effect to the economy is probably the more important objective--as people get employed, they spend more, and a lot of this additional consumption would be necessities such as refrigerators and washing machines, and even apartment homes. Those would drive additional steel demand.

Nonetheless, the speed of China's stimulus spending definitely helped stabilise the steel market. In fact, stabilisation of the Chinese steel market is a nontrivial effect since China consumes and produces over 30% of the world's steel. For example, import competition has remained in check in the US: from January to May, steel imports excluding oil country tubular goods (OCTG) were down 47% year over year. This brought a bit of relief to domestic producers who were experiencing a 50%-60% drop-off in production rates.

In the first half of 2009, Chinese infrastructure demand has moved parts of the steel market. In particular, low-grade steel products and ferrous scrap recovered faster than other steel grades due to Asia's construction steel demand. Low-grade steel products, such as rebar, are used mostly in highway construction. Steel billet and ferrous scrap are widely used in steelmaking. As international demand picks up, more US companies are taking advantage of the export market. Nucor, for instance, exported 9% of its production to overseas markets in Africa and South and Central America during the first half. This is close to last year's 10% level, despite a significant strengthening of the dollar. West-coast ferrous scrap recycle Schnitzer Steel saw a 40% surge in ferrous scrap sales volume in the first half of 2009 from late 2008 levels. Higher export scrap prices pushed domestic scrap prices much higher in June to July. As a result, Midwest steel producer Steel Dynamics anticipated its scrap recycling operation to become profitable in the second half; we think this is a reasonable expectation.

Excluding low-grade steel, where demand is firmer, other steel products have only recently seen an uptick in demand as the US domestic restocking process is underway. However, we have not yet seen the impact of the US stimulus, and companies do not expect material spending to occur until early 2010. While Chinese demand has helped stabilise the supply and demand balance in the world steel market, US steel mills still need to count on domestic demand to really recover their profitability.