This is the only story that matters folks…

The Chinese government has implemented strict production cuts intended to head off pollution this winter and further consolidate their steel industry.  The first phase of the cuts to be implemented this week will cut steel production in half in Tangshan, the largest steel-producing city in China.  This could affect up to 20m tons or 7.5% of annual production in a very short time period.  Similar cuts are expected to be announced in Anyang, Handan and Shijiazhuang, three other key steel producing cities.  Also, producers will be mandated to reduce overall coking coal production by 30%.

There are certain things that can be counted on in this world; death, taxes and Chinese stocking rebar ahead of construction season.  The next two charts show not only this phenomenon, but also that current inventory levels are near multi-year lows. 

Chinese Rebar Inventory

Chinese Rebar Inventory

This chart shows Chinese HRC inventory, which has a similar, but much less pronounced winter stocking phenomenon, also shows inventory is at its lowest level in the history of the data series.

Chinese HRC Inventory

So, if Chinese production is curtailed significantly just as demand is set to pick up due to restocking, then what? Do Chinese steel exports fall to zero?  Do Chinese steel imports increase significantly?  Does China end up importing more steel than they export?  What happens to US steel imports?  Can the US get the extra tons needed to bridge the gap between demand and US capacity? How tight could this make the US market?

Is this Chinese policy even reliable?  Will China actually be effective at implementing this plan or will producers cheat?

Chinese Monthly Steel Exports

The answers to these questions will be addressed in the coming months, but if you thought Section 232 was an upside risk, this is the 800 pound gorilla compared to the 232.

This is not a risk that should be disregarded!

Remember this?

Midwest HRC 2004 – 2005

Midwest HRC 2008

All China driven moves!

The Midwest HRC price continues the rally that began in December, 2015 at $365/st.  After correcting 10% from the $660 high set on March 20th, 2017, the TSI Daily Midwest HRC Index has bounced off a low of $591 closing this past week flat at $625, while the October CME Midwest HRC future was down $15 to $590.  

Global and domestic steel industry fundamentals remain strong; however iron ore and scrap prices have been under serious pressure in the past weeks.  This has in turn pressured finished steel prices lower.  A nascent rally in the US dollar is worth watching as stronger dollar can pressure commodity prices lower.

The energy production disruptions caused by Hurricane Harvey have dissipated and oil prices have made new recent highs, now above $50/bbl.  The 2017 hurricane season is expected to boost in steel demand in the months ahead as totaled autos are replaced and communities are rebuilt.  Flat rolled import licenses continue to fall sharply while global differentials remain unattractive leading to expectations of tighter supply in the near future, which should persist into 2018. HRC prices have moved lower and are now approaching support levels. 

October CME HRC Futures vs. TSI Daily Midwest HRC Price

Data continues to show persistently low inventory levels at OEMs and service centers.  August’s ISM report indicated a major imbalance between producer and consumer inventory levels.  Current conditions are ripe for a massive restocking rally. 

So far this month, there have been four regional manufacturing reports.  They all beating expectations indicating the September ISM Manufacturing PMI, expected to be down 1.3 points to 57.5, will not only beat those expectations, but could be up MoM.

The following are the foundation of our current constructive view:

–    Persistently low flat rolled inventory evidenced in the MSCI, ISM and Durable Goods reports

–    Conditions ripe for distribution and customer restocking 

–    A global uptrend in manufacturing purchasing managers indexes

–    A rebounding US energy industry
–    Falling imports volumes expected for the remainder of 2017; shrinking global differentials

Upside Risks:

–        China strict steel capacity cuts/China getting serious about curtailing steel production

–        Low inventory levels/domestic or global restocking

–        Post hurricane development and production bump

–        China pumping up its “old economy”

–        Energy industry rebound

–        Graphite Electrode Shortage

Downside Risks:

–        Crashing iron ore, scrap and finished steel prices

–        Political & geopolitical uncertainty

–        Stronger dollar

–        Domestic automotive industry under pressure

–        Sharp increase in scrap volumes resulting from Hurricanes Harvey & Irma

The table below compares the prices changes of a cross section of steel related raw materials and finished products.  Iron ore and LME Scrap futures have moved sharply lower in the past week, but have held on to a good amount of the rally they have seen since June 1st and have both outperformed Midwest HRC prices.  Midwest HRC prices remain near the bottom of the list.  

As of Friday’s settlement, the September CME Midwest HRC future ended the week down $4 to $620/st.  Q4 dropped $15 to $605.  Q1 and Q2 2018 fell $18 to $602.  That’s a $40 drop in two weeks!

Flat rolled prices were under heavy pressure in Asia, except Russian prices were up 2%.

TSI ASEAN HRC Index was down $20 to $522/st while the TSI North European HRC Index was unchanged.

Imports look to have peaked and are rolling over as expected.

Flat Rolled (blue) and Tube (red) Imports

Flat rolled imports looks to have peaked and are falling fast!

Tube imports have exploded this year, but may have peaked in July.  The chart below includes the drastically revised September forecast of 741k tons.

Below are HRC, CRC and HDG prices and differentials using pricing from SBB Platts.  There were big shifts lower in HRC and CRC differentials this week.  The lack of deals made in the May through July period due to the Section 232 Investigation and now the closing of the import price window supports our belief that imports will decline precipitously in the near term and stay depressed until early 2018 at the earliest.

HRC prices continue to be under serious pressure in China and East Asia.  US Midwest prices fell 1.6%.  HRC was up 2% in Brazil.

Chinese CRC prices were down 2.6%, but the CRC market saw less volatility than HRC.

No change in HDG.

AISI Steel Capacity Utilization Rate and TSI Daily HRC Price

The AISI capacity utilization rate rose 60 basis points to 74.9%.

Raw materials were taken to the proverbial woodshed last week.

The correction in ore and scrap futures has been sharp and fast!

The iron ore curve has shifted lower MoM with the curve flattening.

Chinese rebar prices were under pressure as well as the Turkish rebar price.  NW European and US rebar prices saw gains of 2%.

The Federal Open Market Committee concluded its September policy meeting last Wednesday announcing no change to the fed. funds rate.  More importantly, the FOMC announced it would begin to reduce their balance sheet starting in October by gradually decreasing the reinvestment of maturing securities.  Expectations of a December rate increase of 0.25 basis points has increased from as low at 20% in mid-August to 63.2% as of Friday.

The September Philadelphia Fed. Manufacturing Survey printed 23.8,  up from 18.9 in August and beating expectations of 17.1.

August housing starts  of 1.18m annualized beat expectations of 1.174m and July data was revised higher to 1.19m from 1.155m  August building permits of 1.3m annualized beat expectations of 1.22m while July permits were revised higher to 1.23m from 1.223m.  August existing home sales of a 5.35m annualized rate missed expectations of 5.45m and were down from 5.44m in July.  The rest of last week’s economic data is below.

The S&P 500 settled near all-time highs.  Europe and Japanese stock indexes were higher.  The Shanghai Property Index was down almost 2%.

S&P 500

Steel stocks were mixed with BOF mills all down with iron ore.

AK Steel

RIO and BHP were unchanged while CLF and VALE were down 3.8% and 6.4%, respectively.

LME aluminum was up 3.5% while LME nickel fell 6%.

LME 3 Month Rolling Aluminum Future

LME 3 Month Rolling Nickel Future

The US Dollar Index was unchanged with the Japanese yen down 1.25%.  The Indian rupee, Canadian dollar and Turkish lira all fell over 1%.

US Dollar Index

Japanese Yen

Canadian Dollar

Turkish Lira

The November WTI crude oil future closed up 0.44% to $50.66/bbl.  The US rig count dropped one rig. Production continued to rebound just under pre-Hurricane Harvey levels.  Crude oil inventory added almost 1% while the sum of crude, distillate and gasoline inventory was down 0.4% on draws in distillates and gasoline.  Natural gas fell 2.15% to $2.96/mbtu.  Natural gas inventory gained almost 3%.  The average gas price was down 2.5% to $2.58/gallon.

November WTI Crude Oil Futures and November Crude 15 Delta Put Volatility

Aggregate Energy Inventory (Blue) vs. WTI Crude Oil Futures

D.O.E. Crude Oil Inventory

D.O.E. Crude Oil Inventory Perspective (1982 – Present)

Baker Hughes US Rig Count

D.O.E. Crude Oil Production

D.O.E. Crude Oil Production Perspective (1983 – Present)

The 10 year US Treasury yield gained 5 basis points to 2.25%.  Rates were up marginally across the board.

U.S. 10 Year Bond Yield

German 10 Year Bond Yield

The list below details some upside and downside risks relevant to the steel industry.  The bolded ones are occurring or look to be highly likely.  The upside risks look to be in control.

Upside Risks:

–        China strict steel capacity cuts/China getting serious about curtailing steel production

–        Low inventory levels/domestic or global restocking

–        Post hurricane development and production

–        China pumping up its “old economy”

–        Energy industry rebound

–        Graphite Electrode Shortage

–        Weaker dollar

–        Flatbed trucking availability/transportation supply constraints

–        Section 232 Investigation

–        President Trump’s agenda

–        Infrastructure bill/long-term solution to highway spending bill

–        Unplanned domestic supply side disruptions

Downside Risks:

–        Crashing iron ore, scrap and finished steel prices

–        Political & geopolitical uncertainty

–        Stronger dollar

–        Domestic automotive industry under pressure

–        Sharp increase in scrap volumes resulting from Hurricanes Harvey & Irma

–        Sharp and persistent drop in oil and iron ore prices

–        US domestic producers bringing back on capacity

–        Higher interest rates slowing residential construction and auto sales

–        Tightening financial conditions pressuring auto sales driven by sub-prime financing

–        Chinese restrictions in property market

–        The Chinese Financial Crisis

–        Unexpected sharp China RMB devaluation

–        Increasing import differentials

–        Economic downturn, especially in China or Europe reverberating to U.S.A.

–        Weak demand in housing or automotive