The ferrous complex was weak across the board Friday June 18, 2021 as spot fell, paper fell more overnight and steel eased:
A rising DXY is proving a headwind.
In news, let me show you some material from Bloomberg that needs unpacking:
There’s a simple reason why no amount of work meetings and control orders are likely to prevent 2021 being another record-breaker for steel: Much of this year’s demand is already locked in.
Consider the shape of the annual construction cycle. Every year, China builds around 9 billion square meters of property — roughly enough to cover the whole of Lebanon or Puerto Rico in an unbroken layer of real estate. Activity on a building site is time-consuming, and starts early in the year. By the end of April, work on about 80% of the total annual floor space was already under way:
That means we can already have a pretty good idea of the size of China’s new estate in 2021. Barring unprecedented restrictions and reversals, the year-end total is likely to be somewhere near to 25% above the 8.2 billion square meters under way at the end of April — about 10.2 billion square meters.
That’s not the only relationship that holds fairly constant. The amount of steel required in construction is reasonably stable, determined by structural requirements, building codes, and engineers’ attempts to use materials thriftily. Typically, China consumes about 28 kilograms of steel reinforcement bar for every square meter of property it puts up each year. On that basis, the country will need about 286 million metric tons of rebar this year, of which 87 million tons has already been produced.
That suggests there will be little let-up in steel production across the balance of the year. On those numbers, the average monthly requirement over the rest of 2021 will be about 25 million tons of rebar — record levels for China’s steel industry.
Sounds very bullish. This in particular “286 million metric tons of rebar this year, of which 87 million tons has already been produced”. So we’ve only produced one-third of the steel China will need for property in the first five months of the year.
The problem for the analysis is that it is confusing stock and flow in Chinese construction. The 9bn square meters of floor area under construction is the stock metric. For the last decade, the flow measurement of floor area starts per annum has been bouncing above and below 200bn square meters per annum:
So, how can an annual flow of 200bn square meters of starts per annum translate into a 9bn per annum stock of floor space under construction now? Do Chinese highrises take 5 years to erect?
In a sense, yes. Floor area completions are much lower than starts and always have been. This has resulted in an ever-rising stock of construction even though the flow of starts has actually ebbed and flowed.
Our theory for why this is the case is that China has a vast inventory of effectively complete but unoccupied apartment buildings. These are finished structures that have no fit-out so they never register as completed in NBS statistics and remain in the floor area under construction numbers.
The true floor area under construction number is likely much closer to annual new starts (as is steel demand).
The reason for the recent booming steel market despite lower starts in 2020 is that all of the early-year projects that were delayed by COVID resumed right alongside a stimulus-led surge in new builds. This has effectively created a “pig in the python” for demand that should pass relatively quickly:
The crossover to lower year-on-year steel demand from realty should begin somewhere around the point at which 2021 year-to-date starts fall below 2020 and that is the next month or so if trends hold:
Adding to a falling steel demand outlook for realty is slowing infrastructure, which fell to zero year-on-year growth in May as local government drastically undershoot their 2021 borrowing quotas (though that will probably improve somewhat from here).
In short, if we are correct, then H2 ’21 will begin a decline in Chinese construction sector steel demand that continues deep into 2022 at a minimum.