Why Arrium Won’t be the Last Aussie Steelmaker to Shut Shop

Bluescope steel
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There’s not much support for Australia’s steelmakers, at least not in Whyalla. Last week, Arrium [ASX:ARI] went into administration. Arrium owns the Whyalla steel mill, based in South Australia. 

It’s not a story I followed closely, but my guess is that a combination of a number of things brought the company down: ageing infrastructure, poor management (the company massed $2.8 billion in debt), and relentless pressure from China’s excess steel capacity.

China’s excess steel production should be a worry for all first world steel production plants. It makes it that much harder for them to compete. But it doesn’t look like improving anytime soon. From the Financial Times:

Significant overcapacity will remain in China’s steel sector even after planned restructuring, industry executives said at the weekend, suggesting no let-up for the beleaguered industry’s plant closures and job losses across the globe.

Luo Tiejun, an official with China’s industry ministry, said at a conference that planned cuts would reduce annual steel capacity to about 1.1bn tonnes by 2020 while domestic consumption was unlikely to exceed 700m tonnes.

“We need to cut [an additional] 200m tonnes for the situation to become acceptable,” Mr Luo said, noting that China also currently exported about 100m [tonnes] of steel annually.

Hmmm. So even after the planned cuts, China will still have the capacity to produce 400 million tonnes of excess steel by 2020. They currently export 100 million tonnes (apparently), which means there is still the potential for 300 million of excess production needing a home.

That’s not great news for Western steel mills trying to compete with cheap Chinese exports.

Given the strategic nature of steel making, I smell a trade war coming on…

The lack of growth in Chinese domestic steel consumption is behind this flood of steel trying to find a home in the export market. Note from the quote above that domestic consumption was unlikely to exceed 700 million tonnes by 2020. Last year, Li Xinchuang, president of the China Metallurgical Industry Planning Association, said that local demand would fall to 600 million tonnes by 2030.

Yet BHP, Rio and Fortescue all invested to expand their iron ore production on the premise that Chinese demand for steel would hit 1 billion tonnes by 2030.

Like the Aussie banks, the effect of easy money tripped up these iron ore majors. And the demise of Arrium is an example of what happens when easy money comes full circle. It won’t be the last.

Greg Canavan,
For The Daily Reckoning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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