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l Global Research l Commodity Outlook | 03:30 GMT 22 November 2011

Steel Chinas 2012 demand forecast


We expect Chinas steel demand to rise 6% y/y in 2012, slowing from 8% in 2011 The property sector will likely expand less quickly in 2012 on funding issues Railway construction is likely to slow significantly in 2012, but auto output should rise

Summary
Following a volatile 2011, Chinas steel demand growth has shown signs of slowing further since September, particularly as economic growth is expected to slow next year. We examine Chinas key steel consumer groups to arrive at accurate forecasts of the countrys steel balance in 2012. In January, we forecast 8% growth in Chinas steel demand in 2011 (see Commodity Outlook, 19 January 2011, Steel Chinas demand growth to slow). This forecast still appears to reflect the demand picture on the ground. Chinas steel demand was particularly supported by the construction sector between February and July, as evidenced by key economic data and steady declines in construction steel inventory. But since August, we have seen weakening demand from the construction sector, along with reports that social housing projects are running out of cash and property developers are financially squeezed. The other three key consumers of steel the machinery, auto and railway sectors have also faced funding, downstream consumption, and export challenges since the summer. We believe that all of these problems will have a deeper impact on Chinas steel demand in 2012. Table 1 shows Chinas steel balance sheet for 2012. We forecast that steel consumption will rise by 6% y/y to 668 million tonnes (mt), compared with 8% y/y in 2011. Output growth should accordingly slow to 7% y/y from 11% in 2011. We expect total crude steel output capacity to rise another 20mt to a record 800mt. Imports will likely fall 9%, reflecting soft demand on the ground, but exports should continue to rise by 15% thanks to Chinas increasing market shares in Asia and the Middle East.
Judy Hui Zhu, +86 21 6168 5016
Judy-Hui.Zhu@sc.com

Table 1: Chinas steel balance


mn tonnes GDP growth, % y/y Consumption % y/y Output % y/y Capacity % y/y Imports % y/y Exports % y/y 2008A +9.6 443 +9 498 +2 660 +32 15 -12 59 -6 2009A +9.2 521 +18 566 +14 700 +6 18 +20 25 -58 2010A +10.4 581 +12 624 +10 740 +6 16 -11 43 +72 2011F +9.2 630 +8 692 +11 780 +5 15 -4 49 +13 2012F +8.5 668 +6 741 +7 800 +3 14 -9 56 +15

Sources: Bloomberg, Standard Chartered Research


Important disclosures can be found in the Disclosures Appendix All rights reserved. Standard Chartered Bank 2011 research.standardchartered.com

Commodity Outlook

Major challenges in the construction sector


We forecast that steel demand from the construction sector will grow 10% y/y to 376mt in 2012 The construction sector continues to be the leading consumer of steel, mainly for government-led infrastructure projects (including roads, bridges and airports), property projects and factory construction (we list railways as a separate sector, as discussed later in this report). In 2011, we estimate that the whole construction sector consumed 343mt of steel, accounting for 54.5% of Chinas total steel consumption. This is slightly higher than our previous forecast of 53.8%. In 2012, we forecast that steel consumed by this huge sector will rise by 10% y/y to 376mt (Table 2), representing 56.3% of Chinas steel consumption. In the construction sector, property projects will continue to be the most important, consuming around 236mt of steel in 2012, in our view, followed by infrastructure projects, which are expected to consume 88mt. We have assumed slower growth in steel demand for property and infrastructure construction (see below).

The property sector faces problems in residential and social housing


The property sector will continue to be the major contributor to construction steel demand, but we have concerns about residential property and social housing plans We expect steel demand growth in the property sector to be 12% y/y in 2012, versus 14% y/y in 2011. The property sector consists of commodity buildings (including offices and residential houses for sale) and non-commodity buildings (including hospitals and schools). Fixed asset investment (FAI) in this sector has been fairly stable since H22009 (Chart 1). Between February and October 2011, FAI growth ranged from 27-29% y/y on a three-month moving average (3mma) basis. The latest data for October showed 34% y/y growth on a 3mma basis, which is a very strong reading, in our view. This data suggests that the construction of real-estate projects has not yet been affected by strict restrictions on the purchase of residential properties implemented in Q2-2011, although residential transaction volumes have been dropping. One possible explanation is that construction activity in non-residential projects and for all non-commodity uses is holding up well. Our database shows that in the commodity building sector (buildings for sale), floor space under construction for residential use rose 9% y/y on a 3mma basis in October (the slowest pace since July 2010), but for non-residential use (including offices), it rose by a faster 17% y/y on a 3mma basis (Chart 2). In the non-commodity building sector, floor space under construction surged 61% y/y on a 3mma basis in October. Table 2: Breakdown of Chinas steel consumption
mn tonnes Construction Machinery Auto making Railways Metal fittings Home appliances Shipbuilding Petrochemicals Containers Electricity Others Total 2008E 219 80 25 24 15 10 10 6 6 5 43 443 2009E 269 83 37 43 14 11 9 6 4 8 37 521 2010E 309 89 47 51 14 14 9 6 4 8 30 581 2011F 343 95 48 49 13 13 9 7 5 8 39 630 2012F 376 98 51 48 13 15 9 6 4 9 39 668 % of total consumption in 2012 56.3 14.6 7.6 7.3 1.9 2.2 1.3 0.9 0.6 1.3 5.8 100

Sources: NDRC, Standard Chartered Research


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Commodity Outlook

We note that growth in floor space starts for commodity building has been trending down since September (Chart 1). The latest data up to October suggests that growth slowed to an 11-month low of 14.4% y/y on a 3mma basis. This highlights downside risks to FAI in the property sector next year. For steel demand, we believe the major challenge in the property sector in 2012 will be delays in starts of commodity buildings for residential use, as developers have been reporting tight cash flow since September after restrictions on new home purchases caused sales volumes to tumble. Construction of other types of buildings is unlikely to be affected, but the possible contribution from social housing should not be overestimated. Social housing will be challenged by under-funding In 2010, the government started construction of 5.8mn social housing units to improve home supply for low-income groups. The 2011 target is to start another 10mn units. According to Jiang Weixin, minister for housing and urban-rural development, 9.86mn units had been started as of end-September, with the remaining 140,000 units to be started by end-November. Plans for social housing had earlier boosted hopes for steel demand, but the experience of the last two years suggests that meeting these targets does not necessarily provide material support for steel demand. One of the key points to remember is that local governments have included not only new construction but also upgrades of existing housing in their social housing plans; we believe upgrades are not steel-intensive. The latest newswire reports suggest that construction of new social housing in north eastern and northern China has been delayed by a lack of capital. Around 9mn social housing units started in 2011 will only be completed in 2012. The question, then, will still be how to finance these projects. In 2011, we estimate that only 20-30% of the funding needs for 10mn units were met. In 2012, construction will likely be considerably lower than planned if the funding issue remains. We have factored this into our 2012 forecast for steel demand from property. We understand that next year Beijing plans to review the quantity and quality of th social housing included in the 12 Five-Year Plan (2011-15). It previously planned to build 36mn units of social housing between 2011and 2015, but this could be revised down after the review. Overall, we believe that credit tightness will continue to be a problem in 2012, particularly for residential projects (for commodity use), Although we have assumed that credit will become less tight towards the middle of 2012, property developers could still push back projects in the next 12 months. Chart 1: FAI and floor space starts % y/y, 3mma
45 40 35 30 25 20 15 10 5 0 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 Floor space starts for commodity building (RHS) FAI in property (LHS) 120 100 80 60 40 20 0 -20 -40

Chart 2: Floor space under construction % y/y, 3mma


120 100 80 60 40 20 0 -20 -40 Feb-06 Commodity building, nonresidential Feb-07 Feb-08 Feb-09 Feb-10 Commodity building, residential Feb-11 Noncommodity building

Sources: CEIC, Standard Chartered Research


GR11NV | 22 November 2011

Sources: CEIC, Standard Chartered Research


3

Commodity Outlook

Infrastructure sector is set to remain stable


The outlook for new infrastructure projects is mixed, but airports and subways will likely outperform We assume that steel demand from infrastructure projects will grow 8% y/y in 2012, compared with 10% y/y in 2011. Chart 3 shows FAI growth in highway, urban public transit and air transport up until October on a 3mma basis. FAI growth in highway and public transport has been on a downtrend since July, but investment in air transport remains strong and has been accelerating since August. While many projects begun in the previous two years will likely continue, supporting steel demand growth, we believe it will be challenging to bring new projects online in 2012. There are exceptions: we expect the development of airports and subway systems to outperform in 2012 and beyond, as fast-growing demand for public transport has significantly outpaced capacity. For example, the municipality of Beijing plans to further expand its airport and subway system by 2015. Airports and related infrastructure are steel-intensive. Beijing Capital International Airport is expected to handle 120mn passengers per year by 2015, double its current capacity. Chongqing also plans to expand its airport to become the largest in western China. Shanghai Pudong International Airport, one of the citys two airports, has its expansion plan on display in the arrival hall.

Machinery production faces downward pressure


A deteriorating export market could put downward pressure on machinery production We have a conservative view on steel demand from machinery makers in 2012, mainly owing to the possible downside risks to machinery exports against the backdrop of the European debt crisis, as the EU is a major business partner. Our 2012 steel demand forecast assumes 3% y/y growth in demand from machinery production, down from the 6% estimated for 2011. This sector will therefore account for 14.6% of Chinas steel demand in 2012, down from 15.1% in 2011. Chart 4 shows that y/y growth in four machinery products has trended down throughout 2011, while Chart 5 shows that Chinas exports of selected machinery products including lathes, reaming machines and electric motors and generators have significantly decelerated since August. We believe the risks will remain to the downside, particularly in H1-2012, and that steel demand from the machinery-making sector should not be overstated.

Chart 3: FAI in selective infrastructure projects % y/y, 3mma


300 250 200 150 100 50 0 -50 Feb-06 Highway transport Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 Urban public transit Air transport

Chart 4: Output of selected machinery products % y/y, 3mma


200 150 100 50 0 -50 -100 Jan-08 Jul-08 Jan-09 Packaging machine Jul-09 Jan-10 Metal cutting machine Jul-10 Jan-11 Jul-11 Harvest machine Locomotive

Sources: CEIC, Standard Chartered Research


GR11NV | 22 November 2011

Sources: CEIC, Standard Chartered Research


4

Commodity Outlook

The problematic railway system


Railways face debt issues and project delays We view Chinas railway system as a separate category of steel consumer. We estimate that railway building contributed 7.9% to Chinas total steel consumption in 2011, but its contribution will likely fall to 7.3% in 2012, as we expect a 2% y/y decline in steel demand from railway projects because of a significant slowdown in construction following the disastrous train crash of 23 July. According to official reports, the accident was caused by a malfunction of the automation system. In August, Beijing conducted a review of all ongoing rail projects as well as projects in the pipeline. It suspended approval of all new projects and decided to implement a th more scientific review of the 12 Five-Year Plan (20111-5) for railways. Previously, the Ministry of Railways (MoR) had planned to expand its railway network to 99,000km by end-2011 and to 120,000km by 2015. The MoR has not yet released its revised plan, but we expect the previous target to be revised down significantly. That said, Chinas long-term commitment to develop its railway system should remain unchanged, although with a safer and slower approach. Against this backdrop, railway construction has caught our attention again lately, after numerous reports of project delays and cash problems. FAI in the railway sector has fallen steadily since June 2011 (Chart 6), after exploding in 2009 and staying stable in 2010. The MoR has been through a difficult time, particularly since July. Owing to the difficulty in acquiring bank loans resulting from tight monetary policy and the train crash in July, the MoR raised CNY 160bn (USD 26bn) from the bond market this year to support construction, with interest rates increasing. The massive amount of borrowing on the MoRs balance sheet has raised concerns among commercial banks. According to the MoR, enterprises attached to the ministry saw a debt/asset ratio of 58.53% in H1-2011. Tight cash flow has led to a widespread suspension of railway construction. According to a senior railway engineer, 80-90% of railway projects had been suspended as of end-October, affecting more than 10,000km. 50% of the suspensions are high-speed-rail projects. The latest newswire reports suggest that Beijing has agreed to help the MoR raise CNY 200bn to resume construction, CNY 150bn of which will be from commercial banks (this is not yet certain, in our view, so we expect funding issues to persist). Beijing also reportedly agreed to raise another CNY 100bn from the domestic bond market between October 2011 and April 2012. To encourage subscription, the Ministry of Finance has slashed the tax rate by 50% for any income generated by MoR bonds issued between 2011-13. Chart 6: FAI in railway transport % y/y, 3mma
200 Reaming and miling machine 150 100 50 Lathe 0 -50 -100 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10 Feb-11

Railway plans for 2011-15 could be revised down

FAI in railway fell to the lowest level in many years

Funding will be another issue

Chart 5: Exports of selected machinery products % y/y, 3mma


80 60 40 20 0 -20 -40 -60 -80 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Dec-10 Apr-11 Aug-11 Sources: CEIC, Standard Chartered Research
GR11NV | 22 November 2011

Electric motor and generator

Sources: CEIC, Standard Chartered Research


5

Commodity Outlook

These efforts indicate that the MoR has gained government support to continue its projects, which has helped to improve confidence. However, it is widely estimated that the MoR needs a total of CNY 400bn (compared with the CNY 200bn Beijing has th agreed to help provide) to resume all projects. The 12 Five-Year Plan suggests that the MoR needs CNY 700bn per year between 2011 and 2015. While the amount of capital expenditure can be revised down, it is still difficult for the MoR to raise money given its huge debt (nearly CNY 2trn in 2010).

Auto production has the potential to rise in 2012


We expect steel demand from automaking to rise 5% y/y in 2012 We expect steel demand from the auto sector to rise by 5% y/y to 51mt in 2012. As Chart 7 shows, Chinas auto production has been decelerating since January 2010. The downtrend was particularly sharp in April and May after Japanese automakers in China suspended output because of a shortage of components from Japan following the March earthquake. Meanwhile, Beijing raised the purchase tax for cars with small cylinder capacity to 10% in January 2011 from 7.5% in 2010. This led to a 2% decline in sales of cars with a cylinder capacity of less than one litre in January-October, compared with hefty 57% y/y growth in 2010. In 2012, we expect Chinas auto production to grow 5-6% y/y, with auto producers planning to expand output in line with the structural rise in domestic demand.

Conclusion
Challenges are short term, but growth is long term We expect Chinas steel consumption growth to gradually trend down from 2012 onwards, although our long-term view is that demand will not peak until 2020 (at the earliest). Such a slowdown in steel consumption is in line with our GDP forecasts and reflects very close links between steel and the macroeconomic picture in China. Some of the major challenges outlined in this report represent short-term worries rather than long-term uncertainties. For example, even if railway construction declines in 2012, China will undoubtedly continue to develop and upgrade its railway network. We expect China to continue to be one of the worlds most important steel markets.

Chart 7: Automobile production is decelerating Insert chart title here


2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 Jan-02 Dec-02 Nov-03 Oct-04 Sep-05 Aug-06 Jul-07 Jun-08 May-09 Apr-10 Mar-11 Sources: CEIC, Standard Chartered Research
GR11NV | 22 November 2011 6

140 120 Output , '000s units (LHS) Output, % y/y, 3mma (RHS) 100 80 60 40 20 0 -20 -40

Commodity Outlook

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GR11NV | 22 November 2011

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