When it comes to providing stimulus to meet growth targets, you can’t bet against China. But when it comes to cutting output, things can get obscure… literally.

A new report by Greenpeace East Asia and Chinese consultancy Custeel says that despite China’s high-profile efforts to tackle overcapacity, China’s operating steel capacity increased in 2016. The report states that 73% of the announced cuts in capacity were already idle — in other words the plants were not operating. Only 23 million metric tons of cut capacity involved shutting down production plants that were operating.

Meanwhile, some 49 mmt of capacity that had previously been suspended was restarted, and 12 mmt of new operating capacity came online. That means that China added 37 million metric tons additional operating capacity in 2016.

After falling in 2015, Chinese crude steel output is now rising again at a healthy clip — it was up 4% on the year in the fourth quarter. Meanwhile, hot-rolled coil prices in China rose near 70% for the year. Despite resilient output, demand growth has been much more significant. As a result, Chinese steel exports have fallen double digits for four consecutive months.

Can Just Promises Sustain Rising Prices?

Sentiment in the steel industry is also bullish thanks to expectations of lower output this year. In January, China unleashed its boldest reform plan so far for its bloated steel sector, saying it will eliminate all production of low-quality steel products by the end of June.

Eliminating excess steel capacity and restructuring the industry has enormous environmental significance because the steel industry is the second-largest emitter of air pollution in China. This is another reason to believe Beijing will strengthen its supply-side reforms this year.

However, according to the report most of the capacity elimination target set for the 2016-2020 period has, technically, already been achieved in 2016, meaning that capacity elimination in 2017-2020 will be much more modest unless targets are increased. Meanwhile, a 21 mmt capacity increase is still in the pipeline from new projects, and there is at least 42 mmt of existing idle capacity that could be used to fulfill the capacity elimination targets.

Two-Month Trial: Metal Buying Outlook

These numbers give us reasons to doubt on what China can deliver this year. China is now under pressure to demonstrate progress on capacity cuts. But financial and legal incentives to keep marginal firms running will cause regulators to struggle to enforce capacity cuts. Chinese steel mills are so hard to get rid of as they are often a key source of local tax revenue and employment.

What This Means For Metal Buyers

The sustainability of the ongoing rising trend in steel prices will much depend on China. Buyers will need to keep a close eye on how much growth can China deliver and how much of the promised production cuts will actually materialize this year. The problem is that growth without controlling steel out will only translate into severe air pollution.

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