China Is Punishing American Companies By Not Addressing This Issue

China wants to deal with its steel overcapacity, but solving the problem may be bigger than even this authoritarian regime can handle.

Apr 13, 2014 at 11:07AM

Big U.S. steel makers like Nucor (NYSE:NUE), U.S. Steel (NYSE:X), and AK Steel (NYSE:AKS) have long complained about foreign steel being dumped into the U.S. market. China has been one of the more contentious issues on that front. Although the Chinese government has said it wants to reign in its steel industry, it may have a harder time than it hopes.

Too much steel
Although China isn't the only country accused of dumping steel into the U.S. market, it is one of the biggest problems. Nucor CEO John Ferriola noted in his company's third quarter conference call that China has "at least 300 million tons" of excess capacity. Meanwhile, AK Steel and U.S. Steel have been highlighting a couple of dumping case wins in recent conference calls. While those cases may not explicitly include China, excess capacity in one country has a clear impact on other nations in the global steel trade.

(Source: 螺钉, via Wikimedia Commons)

China, however, isn't oblivious to the problem. As a nation it's still developing relatively quickly compared to the United States. However, growth has slowed recently and China's citizens are increasingly concerned about pollution. So, China has called for old and dirty steel mills to shut down.

That's music to the ears of steel mills like U.S. Steel, Nucor, and AK Steel. According to ArcelorMittal USA's CEO Mike Rippey, "U.S. steelmaking facilities are running at only 77 percent capacity." It's expensive to operate a steel mill, so running at such low capacity levels is a big blow to profitability. For example, U.S. Steel and AK Steel have both bled red ink for half a decade.

No easy fix
You might think that an authoritarian government like China's could quickly take control of this situation. However, that may not be the case. For example, "Mr. Han," a shopkeeper in Tangshan, an important Chinese steel hub, recently told Australia Network News (ANN) that, "They start the factory again after the officials leave." That won't help the overcapacity issues that Nucor has been highlighting.

Slag

(Source: Alfred T. Palmer, via Wikimedia Commons)

Market forces, however, might lend a helping hand. Xu Zhongbo, of Beijing Metal Consulting, told ANN that, "Since the beginning of this year, state owned enterprises lost money and 80 per cent of private steel mills began to lose money." With China's new willingness to accept bankruptcies, it's likely that at least some steel mills will be allowed to go under. But, Zhongbo noted that, "This situation will continue for the next three to four years." If U.S. Steel and AK Steel are any example, it could go on for another five years...

For example, Zhongbu earlier told The Chicago Tribune that China is "only closing steel mills that are already dead." Smaller unprofitable mills are basically the ones being targeted. And industry watcher Wood Mackenzie believes there's so much extra capacity in China that closures won't actually curtail overall production. The company is calling for record iron ore imports into China this year.

Bad for you, bad for me
While continued overproduction in China could be a blessing for supplier in the iron ore and met coal space, the same isn't true in the global steel industry. If there's another "three to four years" to go before China's overcapacity is sopped up, AK Steel and U.S. Steel may still have some bleeding to do before they're done.

In the end, you should probably expect oversupply issues to dog the steel industry for at least a few more years. U.S. Steel and AK Steel, which have been losing money, are probably best avoided by conservative investors. Nucor, which has only lost money once in the last decade, is a better bet.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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