BRICs and Steel

Its better to be lucky than clever!

When, in 2001, Jim O`Neill wrote a research paper for his employer (Goldman Sachs) he was unaware of the impact the acronym he used would have. In his global economic paper, he wisely forecast a greater role to be played on the world stage by four poor but highly populous nations ;Brazil, Russia, India and China. Since then the aggregate GDP of these four nations has virtually quadrupled to $12 trillion. So, was he right because he was astute or was he just lucky?

In these large populous, poor nations, insufficient infrastructure existed in 2000 to even dream about the levels of output achieved today. In getting to the current position of GDP, a lot of investment has taken place, more importantly, a lot of debt has been accumulated. In fact if you take a look at the global debt accumulated over the period its acceleration and volume are very similar. Global GDP went from $32 trillion in 2000 to $64 trillion in 2010. The big Anglo Saxon economies ran vast trade deficits which were financed by profligate governments not worrying about tomorrow. America and the UK tripled government debt while the citizens did the same. Driving the expansion was a lax approach by regulators on the financial system. The rest is history.

Where do we go from here ?

The biggest single investment a fledgling country can make in terms of employment and output potential is the steel industry. Construction/infrastructure and transportation all rely heavily on various forms. In the production of steel, two main ingredients are essential, iron ore and coal. A large cheap labour force also helps. Luckily for the BRIC theory, these countries had these commodities in abundance. In 1996 China produced 123m tonnes of steel. By 2011 that figure was nearer 700m tonnes. Global capacity is still being added and is expected to grow around 5% annually until 2014. Over the last 5 years the rate of output potential has grown more rapid e.g. South Korea has raised output by 72% since 2008. India has transformed its economy via industrialisation  from 58% agriculture to only 42% today. 61% of its steel output is for construction and infrastructure. The problem now is, total global output capacity of 1,890m tonnes whilst production is only 1,398m tonnes. That would be fine if GDP growth around the world was in good shape,if debt were at a manageable level and consumption increasing. Sadly, none of those factors support current thinking that demand will grow slightly in 2012 and beyond.

Demand is on the wane. In the first 11 months of 2011, global sales were +7.4% but declined 1.1% m o m in November.  In the EU (173m tonnes ann.), November saw a 2.1% decline over Nov. 2010 whilst the annual figure was +3.1%. The EU became a net exporter in August after being a net importer for the previous six months. Imports were 28% lower between May and August. Germany and Spain saw a double digit decline m o m, whilst Italy was up 10% (I expect that to be revised or drop significantly in Dec). With Alcoa (aluminium) and Arcelor (steel) mothballing Spanish production, 2012 looks bleak for them.

China produces around 47% of world steel output. It also has the worlds biggest Iron Ore deposits and is second behind USA in smelting coal. In 2011 output was +8.9%, however,  m o m declines have been evident over the last 6 months with November being the lowest output for 13 months. Of course it is also the worlds biggest consumer (of steel) and with that in mind it is worth noting that the train disaster in Wenzhou froze railway spending from July ( $50bn lost output) losing around 3,000 miles of track construction. With annual GDP growth in the clouds, demand has soared. Construction/infrastructure spending has ballooned over the past decade and accounts for the lions share of output and demand. If the housing bubble is allowed to deflate and the railway ministry cuts 2012 spending by 42% (from $110bn 2010 levels) then demand may well be sluggish at best. Vehicle sales may not help either. In 2009 (incentive induced) sales grew 46%, 2010 + 32% and only +2.5% in 2011. The authorities may see fit to push domestic demand by easing monetary policy but with property and inflation still too high, that may not be just yet. Shipping is an area which will exert downward pressure on demand, see my previous blogs `The perfect storm` and `The plimsoll line is clearly visible` on the subject.

Japan is the third biggest producer (110m tonnes ann.) behind the EU. It has the Yen to contend with. Until its value reflects the economic outlook for the country, see recent blog `Economageddon` the outlook is bleak. It is difficult to assess accurately the current picture due to the post earthquake affects and the flooding in Thailand. However, production in December was down 8.4% on December last year, the biggest monthly decline in 2 years and the fourth m o m decline in a row. 2011 saw a 1.8% contraction overall. Japanese ship yards are struggling with the currency and weak demand. From the worlds biggest player it is now third behind China and Korea. Concerns have been raised that the order backlog could disappear by 2014. The shipbuilders are demanding further price cuts (in sheet steel) to match Chinese and Korean offers.

The Korean production levels (69m tonnes ann.) could be affected by the announcement from the local ship yards that they will order 12% less steel this year. With new orders falling further 2032 will be down as well.

The US car industry accounts for 24% of domestic steel production ( 80 m tonnes), so last years sales increase helped significantly. My recent blog `When is a car not a car?` suggested that a great deal of that sales momentum was down to 2011 capital tax relief.

In conclusion: I am of the opinion that unprecedented debt growth in both public and private sectors drove demand to unsustainable levels. The knock on affect in steel demand was implicit in driving ever more demand for infrastructure spending which in turn drove ever greater demand for commodities. Of course these commodities needed to be transported around the globe. Ship construction grew to record tonnage thus fueling the cycle of more demand. The BRICs along with commodity rich Australia, Canada etc also grew at a frenetic pace. If, as I suspect the debt accumulation is stretched to its limit, global steel production will fall. Capacity utilisation rates peaked in February 2011 at 83% and have since fallen to 71.7%. At some point this year, further mothballing of production will take place thus reducing further the demand for iron ore and coal. If ship owners cannot afford to put their vast fleets on the swing (at anchor) then the supply of steel from scrappage will grow. India currently generates 30% of its steel production from recycled steel. The link between debt and growth cannot be denied, the question is now, can the new world continue its growth trajectory whilst the developed world digs itself out of an almighty mess.

Yes, Mr O`Neill was right to point out the potential but he would not be where he is today had debt not been allowed to get out of control. The global economy could turn very ugly.


Monday, January 23rd, 2012 BRICs, China, Debt, GDP, National Debt, Shipping, Steel, Yen

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