|Return to Gunpowder|
|This Issue—Volume 3, 2007|
The recent announcement from China’s Ministry of Finance of the rate changes to some 83 steel items this week highlights some fascinating economic/political issues. Consider that the changes amount to a 5–10% export tariff on steel semis like plates, sheets and wire, but a higher 10–15% on more basic raw materials like ingots, billets and pig iron.
The official line of the Ministry is the changes are being introduced to help even out the balance of trade. One interpretation is that the move might appease western politicians who claim China’s currency is over-valued and something needs to be done to reduce America’s ballooning trade deficit. Given this, China’s Ministry of Finance probably figured out that they could kill two birds with one stone. One, China will likely be able to avoid de-valuing its currency because US politicians will perceive this move as being a conciliatory step on the part of the Chinese and will have some effect in terms of American firms sourcing less raw materials from China. But second, it will also play into the hands of American’s “squeakiest-wheel-gets-the-grease” industry—US steel producers—and will keep this strong lobby group quiet in the long run up to the next election.
But let’s delve a little further. We believe the effect will be disproportionate. We expect minimal change to the volume of the semi finished items. Here, the tariffs are set at a moderate 5-10% and the slightly higher value add premium inherent in semi finished products will allow both Chinese producers and overseas consumers to absorb the tariff increases more readily. And what they can’t absorb they will simply pass onto consumers in what is a strong market for steel products.
However, we would expect that the more dramatic effect will be felt on the volume of raw material products where the value-add is lower and neither producer nor consumer has the same ability to absorb cost increases. Even China will struggle to remain the lowest cost export supplier after increases of 10-15%. We would expect supply and demand factors to kick in favoring other sources of supply that were marginal before. So is China really trying to balance the trade books? We don’t think so. Like many developing countries before them China is using the export tariff system to discourage investment in some sectors of the economy and encourage development in others.
The effect of choking off exports of raw materials will increase the availability of these metals on the home market, lowering domestic costs and boosting the competitiveness of raw material consumers. These companies will then be better able to compete on the world stage in selling higher value add products—products that bring a much better return for China Inc than basic commodities. Will this balance the trade flows? It probably won’t in the medium term—if anything it will exacerbate China’s position as the lower cost supplier of choice for machinings, castings, forgings and finished metal goods to the world.
Incidentally export tariffs were also raised on many non ferrous metals including Tungsten and Molybdenum. Given this, businesses can expect a rise in US Tool steel surcharges during the third quarter. As a significant player in the production of these metals, a reduction in Chinese exports will result in price inflation elsewhere as consumers scramble to access the available alternatives. Ultimately, the biggest domestic winner in this Chinese / US scheme are special interest lobbies in the US the industries they protect—not general manufacturers at large. ●
is Managing Director of Aptium
Global where he leads the firm's practice in
Europe and Asia.
A colleague of mine passed on an insightful and largely overlooked piece of information the other day. Namely, that the value of the metal in a Nickel has surpassed its face value for the first time ever. 75% of a Nickel coin is made of Copper (yes, this does sound counter-intuitive). So when the price of copper exceeded $ 3.50/lb, Nickel was theoretically worth more melted down than as a coin.
Now, before you going breaking state law and launching a side smelting operation, let me say the reason I raise this point is merely to illustrate how much the price of Copper has increased over the last few years. No surprises here. I hear many a non ferrous metal buyer say, but for those not daily in the cut and thrust of the commodity markets, it deserves note that Copper has risen from a little over $1/lb in 2000 to $3.50/lb earlier this year—a 350% increase! Every year some investment expert somewhere has said the bubble will burst but the price has risen inexorably upwards. Why? Helped by some speculative fund support, true, but it’s broadly down to supply and demand.
The supply is limited. Three of the largest suppliers of refined copper Chile, Zambia and Peru account for over 50% of the world’s production and in spite of considerable investment capacity, production increases have not kept pace with world demand. For the first time in some while, consumption exceeded production in the 1st quarter of 2007 and mines are operating at over 88% of capacity. Allowing for strikes which are frequent in South American mines, seasonal hazards and infrastructure problems the mines are running pretty much at capacity.
So where is the demand coming from? Well, it’s not just China. Europe’s consumption increased 8% year on year. India’s rose even more and China? Oh yes. China increased 35% from 2006 to 2007.
In line with an easing in metal commodity prices everywhere Copper has come off its highs of the spring and is now trading at $3.25/lb. Not surprisingly predictions of where the market is going are all over the place. Bulls are predicting a return to $3.50/lb sighting continuing increases in demand by the developing four of China, India, Brazil and Russia. They point to the continuing tightness of supply and the decrease in LME stocks over the last 6 months.
The ICSG (International Copper Study Group) on the other hand is predicting the market will go back into over supply later this year and prices will fall to $2.73/lb late this year and $2.30/lb on average in 2008. Though LME stocks have fallen relentlessly, there is also an increasing amount of metal held off warrant, largely invisible to normal reporting, which could have a depressing effect on the market. In addition, new production is gradually being brought on stream. China has invested heavily in Zambia and is planning to spend some $900m over the next 4 years in addition to new mines in Tibet and elsewhere. Certainly suggesting China is taking the long view on this market securing supply sources for decades to come.
Where do we think it will be this time next year? We’ll send you a commemorative coin set to the closest estimate (without going over). Your correspondent is placing his pin on $3.10/lb. Personally, I don’t see this market going South big time. But let’s hear it from our readers. We’ll announce the winner in December’s Gunpowder. Send your “bids” by e-mail to email@example.com. ●
Stuart Burns is Managing Director of Aptium Global where he leads the firm's practice in Europe and Asia.
This newsletter is published by Aptium
Global Inc a direct material advisory firm based in Chicago, IL.
With offices in the UK, China, India and a network of global associates,
Aptium Global works with small and medium sized manufacturing companies
to save money on direct material purchases. Smaller companies face the
same cost pressures as the Fortune 500, yet often lack budgets for cost
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