Should Overcapacity be a concern for the steel industry in the region?

Posted on 02 October 2020

ASEAN’s steel industry is facing new production capacities which may worsen the current overcapacity problem in the region. The in-flux of proposed investment from China of up to 50 million tonnes of production capacity in several ASEAN countries as well as investment from other countries in the form of joint ventures with local companies will add up a total of 151 million tonnes of production capacity estimated. Total overcapacity overhang will be more than 60 million tonnes.

Comparing to the steel demand growth of an average 4-5% per year within the region, it will take about 20 years for demand to catch up with this capacity level. (See more details in Newsletter August 2020 issue). Moreover, with the covid-19 situation, steel demand slowed down and that would take an additional 2-3 more years on top of the 20 years. The serious issue of demand catching up with proposed capacity has been highlighted by SEAISI over the past couple of years.

Of course, there will be rebuttals that the projects can be phased. Yes, they can. But note that the highlighted overcapacity in excess of 60 million tonnes only comes from integrated mill projects. As those in the steel industry are aware, once a blast furnace is installed, there is no such thing as operating at low capacity. For economies of scale, blast furnaces usually must be run at full capacity. And that’s where the problem will start. 

So, why is this happening? Generally, many countries are interested in Foreign Direct Investments (FDI’s). FDI’s are viewed very positively as these bring many benefits to the country receiving the FDI. 

When the market is under capacity, the FDIs will add value to the industry. The investment (in the form of manufacturing capacity) will be able to serve existing demand, to substitute import, and to provide income tax returns to the governments. New investments are envisaged to further add value into the country in many other ways such as providing employment and upgrading of skills of the local people. 

 

What happens when the ASEAN countries are facing overcapacity at the same time? First, when in an over capacity situation, the new investment will lead to a severe competition in the industry. Local steel producers (together with the new investment) could face severe financial losses within domestic market and this will threaten the sustainability of the steel industry in the country. A clear example is already unfolding in Malaysia, which is one of SEAISI’s case studies to be presented at the upcoming e-Dialogue end of October.

Second, such a situation also threatens the regional steel industry, because the new investment will start to export to the ASEAN region, which is already facing overcapacity. For example, with a new player entering Malaysia’s overcapacity long products market, Malaysia’s export of wire rod rose significantly since 2019. The volume in the first five months of 2020 was 1.6 million tonnes was an increase from 185,000 tonnes in the same period of 2019. Around half of the volume was exported to ASEAN member countries. The bulk of wire rod added production will overtake some market share within the country and export market in ASEAN region. 

In short, when the regional steel mills start to face financial losses through such severe regional competition, it may lead to job losses, business closure and lower government tax revenues. In such a case, is the FDI still adding value as earlier thought? 

Because of the serious implication of such an FDI in an overcapacity market as well as an oversupplied regional market, the actual hope that the FDI adds value may not be real after all. It could end up being a loss of value to the industry, the country and its people. As such, Authorities should examine the long term impact of regional investments, before making the decision to accept new FDIs when the local and regional markets are in an overcapacity situation.

Source : SEAISI