Big Steel is a very big problem for China; Wisco is a large part of an ailing, inefficient industry that Beijing appears unable to discipline

June 19, 2013 5:07 pm

Big Steel has become a very big problem for China

By John Gapper

Wisco is a large part of an ailing, inefficient industry that Beijing appears unable to discipline

Even by China’s standards, Wuhan Iron & Steel is enormous. As we drive along the four-lane highway beside the 22 sq km site – with its eight blast furnaces, hot and cold rolling mills, port on the Yangtze River and Red Steel City workers’ town where 300,000 people live – the scale of Mao Zedong’s favourite steelworks is staggering.

It has its own Guggenheim-like museum, displaying photographs of every Chinese leader, from Mao through Deng Xiaoping to Xi Jinping, the president, and Li Keqiang, the premier, visiting the plant. It dominates the Qingshan district of Wuhan, a rapidly expanding city of 10m in Hubei province that is building a 12-line subway system – and eight satellite cities – to cope.But Wuhan Iron & Steel Company is a big problem. Measured by output, Wisco is in the best of health. It is the fastest growing of China’s top-five steel producers, having gobbled up three provincial competitors and thrust into Guangxi province. It almost doubled its output in five years, becoming the world’s sixth-largest steel group by tonnage, as China’s behemoths havedwarfed the US and European competition.

As a profitmaking enterprise, however, it is a big part of an ailing, inefficient industry that China appears unable to discipline. Despite injunctions from Beijing to rationalise and cut capacity, Big Steel grows ever larger and, as China’s growth slows, is making at least 20 per cent too much steel. Prices are falling and “the industry faces a severe winter”, says one executive.

China’s dominance – it produced about 720m tonnes last year, compared with US output of about 120m tonnes – would have pleased Mao. He prized steelmaking as a symbol of China’s industrialisation, even forcing peasants to make it in their villages during the disastrous “Great Leap Forward” economic and social programme of 1958 to 1962.

But it has become a symbol of China’s struggles with industrial overcapacity since its $586bn economic stimulus in 2008. It worked as intended in preventing the country from crashing but pushed it back toward the state investment-led economic model off which it was trying to wean itself. “It has lost five years of reform,” an economist says.

China would like the problem to be taken off its hands by turning Wisco and the other top five Big Steel companies – including Baosteel of Shanghai and Hebei Iron and Steel – into global companies. It would like other countries to let them go global through mergers and acquisitions. Wisco’s “global market expansion” strategy is prudently vague.

But there is no obvious reason why the US has to allow a Chinese state-owned enterprise to take over US Steel or Nucor, both of which have fallen out of the top-10 global producers. Nor would that solve China’s problem – it would offload it to someone else. China has to tackle the causes of its state-industrial bloating or the economy will suffer.

One can hardly blame Anthony Bolton, the veteran fund manager, for retiring hurt from the Fidelity China Special Situations investment trust this week. Mr Bolton shunned state giants such as Wisco – whose shares trade in Shanghai at a fifth of the value four years ago during the post-stimulus euphoria – but was caught in China’s stock market funk.

“China should delist a lot of state-owned companies because they are lousy,” says Andy Rothman, an economic analyst at CLSA Securities. The problem goes far deeper than poor stock market performance – it speaks to the investment-led model away from which the new leadership under Mr Xi and Mr Li is once again trying to steer.

In a sense, it is already happening. All net new job creation is now taking place in the private sector, while state-owned enterprises trundle along, unloved. But SOEs are vital to provincial economies – the reason Beijing’s strictures often fall on deaf ears – and there is zero appetite for a shake-out on the scale of the late 1990s, when 46m workers lost their jobs.

Insofar as excess capacity is being addressed at all, it is through consolidation. Wisco has swallowed up Ezhou Steel, Liuzhou Steel and Kunming Steel, a process it calls “sustainable growth”. It has struck iron ore deals around the world, from Australia and Liberia to Brazil and Canada.

It doesn’t take a genius to work out what China’s Big Steel groups will try next. “Our intention is to carry out candid and friendly co-operation with companies overseas,” says Chen Yongzhi, director of Wisco’s communications department, who among other things is in charge of a local television station and daily newspaper.

It isn’t the only one. Shuanghui International, a private Chinese pork producer, has struck a $4.7bn deal to buy Smithfield Foods, despite the controversy that breaks out each time a Chinese company tries to acquire in the US. Three years ago, Anshan Iron and Steel bought a 14 per cent stake in Steel Development of Mississippi, with plans to build five mills.

The Anshan deal wasn’t referred to the Committee on Foreign Investment in the US, which examines acquisitions with security implications. Mao believed steel was a strategic resource, but he had some strange ideas, and the US has permitted acquisitions by Russian companies such as Severstal.

Fair trade is the issue, not national security. Wisco is too big to fail – that is why SOEs get low-interest loans from state-owned banks – and Big Steel gets tax breaks and other forms of official support. If a Big Steel company went for the jackpot with US Steel or Nucor, there would be grounds for concern.

Before Big Steel goes global, China has to solve its own problem.