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Cautious steel demand outlook

We have a cautious near-term view on steel prices due to the following:

1)Elevated steel margins

2)Spare installed capacity, which could result in oversupply if utilisation rates increase

3)Growth in sector capex, which could add to excess capacity

4)Demand headwinds as China’s economy rebalances

Renaissance Capital

3 December 2018

Steel

Key upside risks

The key upside risks we see are:

1)Potential reductions in Chinese capacity and increased regulation on capacity additions, which would support prices.

2)Potential demand upside if China’s Belt and Road Initiative (BRI) is successful

Elevated steel margins

Below we calculate the average steel margins for a basic oxygen furnace by subtracting the average raw material requirements plus estimated labour and capex costs from the HRC benchmark price. We note that margins have recovered from their 2015 lows and are now well above historical average levels.

Figure 2:Real steel making replacement cost margins and near-term forecasts
Steel replacement cost margin	Average

Forecasts

06-Mar 06-Aug 07-Jan 07-Jun 07-Nov 08-Apr 08-Sep 09-Feb 09-Jul 09-Dec 10-May 10-Oct 11-Mar 11-Aug 12-Jan 12-Jun 12-Nov 13-Apr 13-Sep 14-Feb 14-Jul 14-Dec 15-May 15-Oct 16-Mar 16-Aug 17-Jan 17-Jun 17-Nov 18-Apr 18-Sep 19-Feb 19-Jul 19-Dec 20-May 20-Oct 21-Mar 21-Aug Source: Bloomberg, Renaissance Capital estimates

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Renaissance Capital

3 December 2018

Steel

Spare installed capacity…

Global utilisation rates have risen by 8 ppts since December 2017 (Figure 3). We believe they could continue to rise, driven largely by Chinese capacity closures and attractive steel margins.

Figure 3: Global steel utilisation rates from January 2008, %

90

% uitilisations

Average capacity utilisations

+1 std dev

-1 std dev

85

80

Average capacity utilisations, 75

77.5

75

70

65

60

55

Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09

Jul-10 Oct-10

Jul-11

Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13

Jul-14

Oct-14 Jan-15 Apr-15 Jul-15

Jul-16 Oct-16 Jan-17

Jul-17

Jul-18

Jan-08

Apr-08

Jan-10 Apr-10

Jan-11

Apr-11

Oct-11

Jan-14

Apr-14

Oct-15

Jan-16

Apr-16

Apr-17

Oct-17

Jan-18

Apr-18

Source: Bloomberg

…could result in oversupply if utilisation rates increase

We calculate 2018E and 2019E steel production as follows: we take the 2018 sevenmonth average utilisation rate of 76% of current global capacity less planned Chinese capacity closures, and subtract global demand, which we forecast to grow at a rate of 0.85% pa over 2018-2019. We calculate steel surpluses in the market in the near term.

Figure 4: Steel capacity utilisation vs global steel production surplus (deficit) since 2008

				Production surplus (shortfall), kt				Utilisation rates(RHS), %
50,000	79%			79%	78%						42,927	42,022	80%
						77%
40,000													78%
			77%				76%
												76%
30,000
			23,440										76%
20,000				14,985							76%		74%
	7,352
10,000		5,488			6,103			3,563
							1,338			72%
kt													72%
0		71%
						-2,091		70%	-2,140				70%
-10,000
									70%
													68%
-20,000
-30,000													66%
										-29,058
-40,000													64%
	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017	2018E	2019E

Note: We calculate production surplus or shortage by taking global crude steel production and subtracting global crude steel demand.

Source: World steel, Organisation for Economic Co-operation and Development, Renaissance Capital estimates

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Renaissance Capital

3 December 2018

Steel

FY19 sector capex to reach highest levels since 2013

According to our forecasts (and Thomson Reuters consensus for companies not covered

– see Figure 5), capex for the steel sector capex will grow by 51% or $8.9bn in CY19 from 2017 levels. We believe this is driven by healthy sector margins and comfortable balance sheets.

Figure 5: Steel peer group historic and forecast capex, $mn

AK Steel

Nucor

US Steel

Steel Dynamics

NSSMC

AMSA

ArcelorMittal

Tata Steel

Hyundai Steel

NLMK

China Steel

ThyssenKrupp

Posco

Gerdau

Severstal

JSW Steel

MMK

Evraz

35,000

30,000

25,000

20,000

15,000

10,000

5,000

0

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018E

2019E

Source: Bloomberg, Thomson Reuters consensus estimates (for all bar NLMK, Evraz, MMK, Severstal, AMSA ) Company data, Renaissance Capital estimates

91mnt of steel capacity may come online soon

New global investment projects could add around 52mnt of steel capacity in 2019-2020, while a further 39mnt is in the planning stages for possible launch during the same period. Thus, a total of 91mnt of steelmaking capacity (5.4% of 2017 global steel production) could come online during the period.

The OECD forecasts India to lead steel capacity growth in 2019, with a planned 5mnt, followed by Algeria with 2mn t. With the exception of India, which targets BOF capacity, all countries target Electric Arc Furnace (EAF) capacity growth.

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Chinese commodity intensity could decline

We believe China’s gross capital formation/GDP is significantly higher than developing and developed economies at 43%.

Figure 6: 2016 gross fixed capital formation/GDP by country, %

45%	43%
40%
35%		30%	29%
30%
				25%	24%	23%
25%							21%
								20%	20%
										16%
20%											16%
15%
10%
5%
0%	China	South Korea	India	Australia	Japan	Canada	Russia	South Africa	USA	UK	Brazil

Source: World Bank

Renaissance Capital

3 December 2018

Steel

Chinese fixed asset investment peaked in 2010

Figure 7: 1960-2016 Chinese gross capital formation

Figure 8: 1960-2016 US gross capital formation

50%

45%

40%

35%

30%

25%

20%

15%

10%

											44%				43%		48%	44%	24%		24.3%											23.6%
39%						38%		33%					34%						22%	Average, 22%				20.2%						20.0%							20.4%
Average, 36%
																			20%
																			18%
		24%																	16%
	15%																		14%
																			12%
																			10%
1960	1963	1966	1969	1972	1975	1978	1981	1984	1987	1990	1993	1996	1999	2002	2005	2008	2011	2014	1960	1963	1966	1969	1972	1975	1978	1981	1984	1987	1990	1993	1996	1999	2002	2005	2008	2011	2014

Source: World Bank

Source: World Bank

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Renaissance Capital

3 December 2018

Steel

Demand headwind as China’s economy rebalances

A drop in Chinese per capita commodity consumption to US levels would result in significant demand contraction. This would in turn cause oversupply in many commodities, which would need to be balanced through capacity closures. We calculate that 28%-plus of steel and steelmaking materials would have to exit the market to balance this potential oversupply.

We calculate 28% oversupply in steel if China’s per capita commodity consumption were to contract to US levels

Figure 9: Potential oversupply/(shortfall) resulting from contraction in Chinese per capita consumption to US levels

	40%	35%	35%	35%	35%
						28%
							25%
	20%							17%	15%
										5%			Shortfall
	0%
				Over-supply							-3%
	-20%
												-25%
	-40%
	-60%												-49%	-50%
		Iron ore	Manganese	Met coal	Stainless steel	Steel**	Nickel	Copper	Aluminium	Gold*	Thermal coal	Platinum	PGMs	Oil

*Based on 2015 consumption data.

**Based on CRU estimated consumption data (over-supply limited to 35%).

Source: World Bank, CRU, GFMS, BP, WGC, PRB, Renaissance Capital

Declining Chinese hot metal production offset by ROW

CRU forecasts Chinese hot metal production to decline at an average annual rate of 1.1% in the next five years (2018-2022) or by 46mnt. However, CRU expects global hot metal production to grow at a 0.5% CAGR driven by India at 5.2% .

According to CRU, China’s share of hot metal production may decline to 58% in 2022 from 63% in 2017. However, India could grow from 5.1% in 2017, to 6.4% in 2022.

Figure 10: Hot metal production, mnt

CY	2016	2017	2018E	2019E	2020E	2021E	2022E	CAGR 2018E-2022E
China	850	820	811	796	788	780	774	-1.1%
India	64	66	72	76	80	82	85	5.2%
JKT	141	139	142	144	145	147	148	1.3%
Europe	103	107	109	111	112	113	114	1.3%
Global	1,320	1,293	1,309	1,315	1,320	1,321	1,324	0.5%
YoY growth	1.85%	-2.05%	1.24%	0.46%	0.38%	0.08%	0.23%

Source: CRU

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