World crude steel production dropped -6.5% y-on-y in July, confirming the trend observed over the past few months, amidst a deteriorating macro environment, a perduring conflict in Ukraine and the zero-COVID policy in China.

The year-on-year drop in production has been across the board with the largest declines taking place in the CIS and Ukraine (-29.1%), Turkey (-20.9%), Japan (-8.5%), the EU (-6.7%) and China (-6.4%). Although seasonality has impacted steel output in some areas such as summer holidays in the Northern hemisphere, the production drop posted in the first seven months of the year reflects a weaker economic environment, impacted by high inflation and rising interest rates, surging energy prices, the Ukrainian conflict and China’s “zero-COVID” policy. During the January-July period, the global crude steel production dropped -5.4% y-on-y, with declines of -5.6% y-on-y in the EU, -6.4% y-on-y in China, -4.9% y-on-y in Japan and -3% y-on-y in the USA. The few countries showing resilience are those whose economies are relatively insulated such as India (+8% y-on-y), Iran (+3.7% y-on-y) and Saudi Arabia (+6.2% y-on-y).

Fall is traditionally a high season for consumption and investment in China, often labelled as ‘Golden September and Silver October’. For the real estate sector, this is supposed to mean two months of strong property sales, however, it looks like this will not be the case this year. All Chinese economic numbers are heading downwards. Property sales are forecast to drop by about 25-30% y-on-y in 2022, construction activity has stalled, and mortgage owners have been reportedly striking on their payments. All these factors are putting the balance sheet of the property developers at risk. The Chinese government is trying to stabilise the situation through a loser monetary policy and, against the global trend, cut interest rates (Medium Lending Facility and Loan Prime Rates). More cuts are forecast in the coming months as well as credit easing measures. However, the policy mix appears moderate in magnitude and Project Blue does not anticipate that the Chinese authorities will revert to aggressive stimulating measures based on infrastructure spending as it has been the case in 2008. With no relaxation of the ‘zero-COVID’ policy expected before the 30th Congress of the Communist Party in October, one should not expect a material economic rebound before the end of the year or, possibly, before the next Lunar New Year.

An indication of the weak construction activity in China is the drop in rebar production of -14.7% y-on-y to 136.3Mt during the January-July period. Electric arc furnaces (EAFs) have been operating at low rates of 30-35%, a situation exacerbated by power rationing. Although low profitability drove blast furnaces (BFs) to shut down their operations and conduct maintenance overalls, China’s pig iron production posted a -4.5% y-on-y decline in pig iron production vs -6.4% for crude steel. BF’s operating rates have been inching up in recent weeks, close to 84%, driven by a slight recovery in profitability, due to lower raw material costs, primarily iron ore. With rebar prices higher than hot rolled coil (HRC), Project Blue expects a production switch in the coming weeks, although much of it may end up in inventories unless demand recovers unexpectedly. Another negative news for the Chinese steel industry is on the export front. The January-July steel exports were 40Mt, a -6.9% y-on-y decline, a trend likely to accelerate in the second part of the year given the weak overseas markets. Meanwhile, a low demand for iron ore, combined with rising shipments from Australia and Brazil, translated into higher port inventories, from 120Mt in June to a current 138Mt. Unless demand recovers materially, the outlook for both steel production and iron ore prices will be dictated by steel mills' short-term profitability.

The outlook for steel production is not better in Europe. Surging energy prices and declining business activity, primarily in Germany and France, increase the odds of a recession in the last part of the year. On the production side, rising electricity prices will severely impact EAFs costs and output, as is the case for electricity-intensive smelting operations, including zinc or aluminium. Production disruptions and demand contraction are likely to dominate the landscape for the rest of the year.

In the US, the steel industry remains reasonably upbeat with regards to its order books, but the Fed appears determined to keep increasing rates until inflation is under control. It is unclear at this stage whether this strategy will be successful or if the US economy will also enter a recession.

With all the three major world engines broken down, the short-term outlook does not look good, and not solely for the steel industry.