Thursday, September 30, 2010

Two Chinas for growth in steel demand?

Many dry bulk owners invested in Panamax and Capesize tonnage seem to expect that China will follow a path similar to Japan or Korea in terms of steel consumption per capita. The critical question to ask is whether it makes sense to look at China as an undifferentiated entity in this matter. The per capital steel consumption in the coastal regions on a standalone basis already surpasses Germany! It may be less growth potential than most observers are forecasting.

Danish Ship Funds, Christopher Rex, divides China into an urban and a rural economic zone.  He notes that approximately 650 million people, of the Chinese population of 1.3 billion people, live in the urban region. The remainder lives in rural China, where food expenditures account for a relativity large share of the disposable income. In rural China approximately 150-200 million people living are living in poverty (using the internationally accepted 1 US$ per day guideline), There is still a long way to go before these individuals increase their steel intensity to a level close to that of the urban regions.

Rex deems it unlikely that the rural regions will develop their steel intensity extensively as long as food expenditure represents a considerable share of their income. The current food inflation exacerbates the situation and suggests that it will be a long time before the rural provinces increase their steel intensity per capita.

The future potential for Chinese iron ore demand is highly sensitive to this issue. Assuming that the Chinese population, in terms of steel consumers, does not consist of 1.3 billion people but rather the 650 million people living in the urban region, this change would obviously double the Chinese steel consumption per capita from its current level of 320 kg per capita (the same as the US) to 650 kg per capita (larger than Germany).

If Chinese steel consumption per capita is 650 kg, few will expect a massive surge in Chinese iron ore imports.

The only saving grace to this situation has been the financial crisis that has limited capital and increased the cost of bank finance for owners to complete their CAPEX needs. Last year roughly 60% of the drybulk new building orderbook was deferred and there may be similar results this year.

A Chinese rebalancing agreement with its trading partners that results in a 20% currency depreciation over a several years would bring market conditions similar to the early 2000's (when China did something similar with its currency) with considerably dampened freight rates. Despite the sharp drop earlier this year in spot Capesize rates, present rate levels remain profitable for dry bulk operators and they remain in a more comfortable position than their tanker owner peers.

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