How is China’s New Power Strategy Impacting the Steel Industry?

The liberalisation of China’s power markets, which permits manufacturers to charge market prices to commercial and industrial clients, substantially impacts energy-intensive industries that formerly had fixed power bills.

The following is an analysis of the policy shift, which sectors will be most affected, and what it means for the Chinese economy.

What is the most recent change in China’s electricity policy?

China has announced that starting Oct. 15, coal-fired power stations would charge market-driven electricity pricing to commercial and industrial users as the country’s energy crisis worsens.

This comes after China’s State Council said on Oct. 8 that coal-fired power prices could fluctuate by up to 20% from base levels. These measures, taken combined, provide some respite to power generators who have had to cut back on production this year due to rising operating losses.

According to the state planner, some high energy users may face price hikes above the 20% increase to drive improved energy usage efficiency.

Previously, more than half of all commercial and industrial power customers in China had fixed-price contracts with grid operators; thus, the move to 100 per cent market pricing for the industry is a huge transformation in China’s power landscape.

Fixed prices will continue to apply to residential and agricultural customers, as well as public welfare schemes.

What is the reason for China’s shift?

Thermal coal provides 54 per cent of China’s electricity, and utilities have struggled to meet post-pandemic electrical demand this year as increased safety checks at domestic coal mines curtailed supplies just as demand from industry and manufacturing grew.

As a result, coal prices in China have risen roughly 200 per cent year on year, making it uneconomical for most power plants to generate energy in recent months. Check out more details on this.

As a result of reducing coal-fired power, power shortages erupted in various sections of China, particularly key industrial hubs on the east and south coastlines, where much of China’s massive manufacturing industry is headquartered. Find out more details here.

Which industries have suffered as a result of the power cuts?

Several industries, including chemical factories and cement manufacturers, fertilisers, and even shopping malls, were impacted by the recent power outage, which prioritised residential service over the business.

Power-hungry industries such as steel, aluminium, cement, and chemical companies are projected to experience higher and more volatile power costs globally in the future as manufacturers pass on some increased costs to consumers and increase power supply, replacing prior fixed-cost arrangements with market-based pricing.

What effect will this have on crucial metal output?

According to the country’s steel association, because of recent power restrictions and government requests for energy consumption reductions, production costs at Chinese steel mills have climbed, particularly at electric arc furnaces.

Since September, steel mills have slowed or suspended output due to a power supply shortage, “significantly increase companies’ costs”, and hurt profitability, according to Qu Xiuli, vice-chairperson of the China Iron and Steel Association (CISA).

Because of high coal prices for generators and a lack of supplies, the world’s second-largest economy has been hit by power cuts, with industries ranging from upstream metal makers to downstream fabricators shutting down operations as the government pledged to prioritise household power usage. Find out more.

Last month, daily crude steel output dropped to the lowest since December 2018, according to official statistics from the statistics agency.

According to Mysteel consultancy, capacity utilisation rates at electric arc furnaces (EAF), which need twice as much power to manufacture a tonne of steel as blast furnaces, fell more than 20% year on year at the end of September before rising somewhat in October.

At the news conference, CISA deputy secretary-general Huang Dao stated that energy consumption and production controls provide significant problems and pressures to steel makers, particularly EAFs, due to potential future hikes in power rates.

Electric arc furnaces in China produce about 10% of the country’s total steel output. The country plans to increase the share to 15%-20% by 2025, as short metallurgy saves energy and reduces emissions while reducing China’s reliance on imported iron ore.

“If taking account of green electricity, the advantage of lower carbon emissions from EAF production is much more obvious than blast furnaces,” Huang said.

Qu anticipates the impact of power restrictions on mills to improve next year as Beijing ramps up efforts to boost coal supply, while the long-term goal of developing electric arc furnaces remains unchanged.

However, electric arc furnace manufacturers could produce more high-value-added products like special steel and structural steel to offset increased costs through higher sales prices, according to Qu.

According to analysts, China’s world-leading steel sector may be obliged to reduce output from electric arc furnaces (EAF), which account for around 15% of total steelmaking capacity in the country.

Electric furnaces use electricity to operate and produce fewer emissions than traditional blast furnaces, but they require a lot of power.

“The broad storey is that there will be an increase in steelmaking costs, more so for EAF. This could amount to around 4.5% of current rebar prices, which are currently at (5,860 yuan per tonne),” says Li Wang, a senior steel analyst at CRU Consulting.

China is also limiting standard steel output until mid-March next year to minimise smog, which could push steel prices even higher.

According to CRU analyst Ross Strachan, China is also the world’s leading aluminium producer, but power constraints have prompted over 2.9 million tonnes of energy-intensive Chinese aluminium capacity to be stopped in recent months.

Aluminium prices in China have already risen 50% this year as a result of this, and any further power-fueled supply restraints should keep the market afloat.

“Aluminium prices are already at record highs, and these measures on the main input cost will just add to those high costs,” said Paul Adkins, managing director of AZ China, a China-based aluminium consultancy.

“The downstream industry is already hurting with the combined effects of power shortages and high electricity prices, and this will make it worse.”

What will be the economic impact of these increasing costs?

Higher power and commodity prices drove China’s factory gate prices to 13-year highs in August, and they may now continue to rise as utilities pass on higher energy costs. Read more.

According to Ting Lu, Chief China Economist at Nomura in Hong Kong, “We estimate the new pricing scheme could raise power prices for non-agricultural businesses by around 10% which, in turn, may add 0.4 percentage points to China’s GDP deflator (the ratio of nominal GDP over real GDP) when rising power prices pass through to the rest of the economy.”

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