What are the likely short-term effects of the Wuhan virus on steel, iron ore markets?
Just as China and the United States started to reach a deal and trade tensions eased, providing some longed-for certainty, the novel coronavirus (2019-nCov) has again increased fear and uncertainty in the steel and feedstock markets.
Although there may be no impact of the coronavirus on China’s GDP in the long run, we have already passed the point of “no effect” on the market, as raw material prices - iron ore prices in particular - are very responsive to sentiment. The steel raw materials market was already quiet during the Lunar New Year holidays, but the extended break is increasing uncertainty and adding to the bearish outlook in the short term.
Iron ore prices have fallen over the past week, dipping to a two-month low of $84.94 per tonne on Thursday January 30, a decline of $8.50 or 9% from $93.44 per tonne a week earlier. The sharp rise seen in coking coal prices in January has now paused. Fastmarkets is not publishing any Chinese steel price assessments until February 3 due to the extended holiday period, but expectations are that the market will reopen with price falls, following developments in raw materials.
January and February are two of the three weakest months for steel consumption, production, and in turn, raw materials demand in China, at between 4% and 10% below average. It is therefore likely that had the coronavirus occurred outside the holiday period, its immediate effect would have been much greater, with resellers more desperate to sell the stock accumulated in Q1.
On Thursday 30 January, the World Health Organisation officially declared the spread of the “Wuhan novel coronavirus” a global health emergency, which allows the organisation to put travel advisories in place and enable a coordinated international response. The last time this happened was in July 2019 for the Kivu Ebola epidemic, and in 2015-16 for the Zika virus epidemic.
The Chinese government has already imposed restrictions on the movement of people and goods, and extended the holiday period until Monday February 10. The Hubei region is not a major industrial hub, but Wuhan is still an important steel-producing region and a connection point where raw materials pass through the Yangtze and Hanshui rivers to supply iron ore to the Wuhan Iron and Steel Corporation (WISCO), among others. These river transport routes have already been placed under lockdown. At Chinese ports, they are taking strict prevention and control measures to contain the virus spread, which is likely to slow down the loading and discharging rate of raw materials. Some ports in the Hebei province are shut through the extended holiday period, which would stop steel exports, with implications on the wider Asian seaborne steel markets.
Hubei, with its capital Wuhan in shutdown, is among China’s largest steel producing regions:
Given the fast and global spread of the coronavirus so far, a base-case scenario is that the current contagion would take at least the same amount of time to control as SARS - a period of three months, which covered most of the second quarter of 2003.
The SARS spread cost the global economy $40 billion, according to a study published by the National Institute of Medicine in the US. Others suggest a similar value, akin to 1% or $35 billion of Chinese GDP. Fast forward 17 years, however, and a 1% fall this year works out at closer to $140 billion, according to Oxford Economics.
It is certainly the case that industrial activity, which drives steel demand and the economy in general, slowed down in Q2 2003, rising by just 0.9% quarter on quarter, but then accelerated in Q3 by a higher-than-average 3.7%. At a more modest speed, GDP rose at the same time. In spite of SARS, Chinese GDP grew by 10% in 2003, and far more relevantly for steel, industrial activity surged by more than 16% supporting a 29% boom in steel consumption. This boom went on to support phenomenal and unusual profits for global steelmakers a year later, who caught raw material suppliers out temporarily in agreeing to modest price rises. Unfortunately for suppliers this time, there is unlikely to be a steel boom to offset the negative effects of a virus should it be capable of taking 1% of Chinese GDP out of the forecast.
The year of SARS (2003) and the financial crises (2000 & 2008) recorded the sharpest slowdowns in crude steel output:
Iron ore price impact: 3% downward revision of annual average forecast
Many traders had been expecting prices to rise in the short term, once market restocking activity picks up after the Lunar New Year holidays. But the virus outbreak has raised doubts about how much the market can revive. The uncertainty alone in the base-case scenario will intensify bearish sentiment and lead to a further sell-off among traders holding iron ore cargoes, driving prices even lower.
In a base-case scenario, demand for steel raw materials will continue to decrease and pick up significantly only after two months, when activity slowly resumes after the government lifts the restrictions on the movement of people and goods.
In this case, the price downturn would be the sharpest in the next few months. The price drop mostly affects the first quarter with a downward revision of 7%, but it also results in a downward revision of the second quarter by 6%. This infers further price drops below $85 per tonne which we have seen so far, to an average of $81 and $66 per tonne in Q1 and Q2, respectively. We would therefore revise down the annual average for 2020 by 3% to $73 per tonne.
Steel price impact: 2-3% downward revisions to domestic HRC and rebar prices in China
Blast furnaces continue to operate during the Lunar New Year break, which leads to a build-up of stocks through the supply chain. As soon as end-users return to the market, stocks normally start to fall rapidly and stronger demand pushes prices higher. But this year the reopening of many construction sites and manufacturing companies has been postponed, and warehouses and mills will be left holding increased amounts of inventories.
This is likely to dampen the traditional price uptrend over March and April, as steel mills and traders would be willing to offer discounts in order to reduce their stock levels. After initial logistical and operational issues are resolved, prices should stabilize, but a much slower pace of restocking by end-users and lower raw materials prices would mean that hot-rolled coil and rebar prices register annual falls of 2-3%.
Lower impact scenario
Steel and raw material prices are volatile and react quickly to news, so one can argue that the current price dip in iron ore prices reflects an overreaction to the dramatic news and media reports. The actual impact from the coronavirus on fundamentals may prove as limited as SARS was in 2003 and this would ultimately lift prices back up as buyers resume orders they had delayed. Chinese mills would make up for lost time and by the end of the first quarter, they would have overcome the troublesome start to the year.
The Chinese have in some ways learned from the past events of the SARS virus when the government’s focus was on controlling information and it lacked transparency. This time, the authorities have acted more quickly and decisively to isolate patients to contain the spread of the coronavirus, and there has been quicker international cooperation. This could help limit the economic impact to the first quarter this year. Although the restrictions will slow down activity in the first quarter, this impact could later be offset in the following quarters as restrictions are lifted and business picks up. So, in the long run, the impact on prices could be very limited.
Iron ore price impact: 1% downward revision of annual average forecast
In a low-impact scenario, we would expect the government to lift the lockdown after a shorter period and there would be a resumption of feedstock restocking within about a month. Feedstock demand would still continue to decrease for a couple more weeks, but then rise again as market activity slowly resumes.
This would lead to a 2% downward revision of the Q1 forecast to $85 per tonne, but the price impact of the demand slump would be limited to the first three months and not impact Q2. The annual average for 2020 would only be downwardly revised by about 1% to $75 per tonne.
Steel price impact: annual price forecasts are not impacted
Stock levels in the Chinese steel market are generally lower compared with other major markets. Whereas distributors tend to plan for at least two months of inventory on hand at any time, in China, official stocks at 40 warehouses worked out in our calculations at less than 10 days, in spite of the surge in both real and apparent demand last year - the latter rose to 884 million tonnes, more than 7% higher year on year.
According to Fastmarkets research estimates, last year combined steel (industry) stocks held by mills and warehouses in China fell by 9.6% year on year, with falling prices disincentivizing suppliers. If construction and manufacturing firms in most regions of China start reopening after February 10, they will need to have their steel requirements fulfilled relatively quickly, as their inventories, not included in our figures, would also have been depleted prior the Lunar New Year break. As a result, we could expect that after a period of initial uncertainty, which could push prices down, strong end-user demand will ensure a price recovery in Chinese domestic HRC and rebar prices.
If during the quarantine period mills rather than warehouses end up holding more stocks than usual, it will take more time for material to move through the supply chain and we can even see some short-term market tightness, which could push prices even higher than previously forecast.
Higher impact scenario
Should the authorities be unable to control the spread within weeks, it poses a considerable risk to the steel industry and feedstock demand. The amplified restrictions on people movement will hinder the workforce from reaching the construction workplaces, and as steel production in Wuhan is at a standstill, it further weighs on steel and iron ore demand. The city has been placed under the largest quarantine in history, and with an additional 15 cities in the region being closed off in the past few days, there is an increasing risk that the virus may not be easily contained and could even turn into a global epidemic.
Although the government has acted quicker than at the beginning of the SARS outbreak, in this scenario, we assume the timing of the lockdown of Wuhan city was still less than optimal as a great number of people had already left the city for the holidays. This would result in a much larger contagion as the virus will have had time to spread undetected.
Before the contagion, there were already mounting downside risks to steel and iron ore prices due to weaker demand in the Chinese market. The coronavirus outbreak is therefore likely to constitute a more bearish risk compared with the SARS spread in 2003, when the Chinese economy was booming. China is more dependent on consumption to drive its economy today than it was a decade ago and the virus spread is only reinforcing the headwinds, with GDP growth dipping to a 30-year low in 2019.
Iron ore price impact: 8% downward revision of annual average forecast
In a high-impact scenario, we anticipate a lengthened lockdown of Wuhan and the 15 other cities, with even more cities likely to be quarantined. Demand for steel raw materials would decrease and not recover within four months, when activity gradually increases among the steel mills as workers return to the sites and the logistics problems fade.
Steel raw materials demand would shrink considerably in the first half of the year, with the price impact reaching into the third quarter of the year. In this scenario, we would downwardly revise our forecast by 15% in Q1, 13% in Q2, and by 1% in Q3. The overall impact on the average price for 2020 would be downward revision of 8%.
Steel price impact: 4-5% downward revisions to domestic HRC and rebar prices in China
A significant and prolonged slowdown of manufacturing and construction activity across all major cities in China would push HRC and rebar prices down and prevent a price recovery until late in the second quarter of the year.
Wuhan is an automotive hub, with a number of car manufacturers and suppliers of parts. Even if car producers in other parts of China restart operations while Wuhan remains under lockdown, they could still be impacted because of the just-in-time manufacturing system and its reliance on an extensive supply chain. This is bad news for the Chinese automotive industry, which only started to recover at the end of last year, after motor vehicle production growth rates sunk to negative double-digits in 2018 and the first half of 2019.
Construction was the main driver of Chinese demand last year and a sharp drop in new building starts in the traditionally busiest period of the year would have implications for rebar suppliers for months ahead. As a result, we could see domestic HRC and rebar prices in China settling 4-5% lower on an annual basis than previously forecast. If some of the Chinese ports reopen before domestic industrial activity resumes fully, steel producers would have to turn to exports and increased supply would further undermine prices in the seaborne market, having a knock-on effect on steel producers in Asia.
Iron ore price forecast scenarios:
Steel price forecast scenarios:
This article has been written by ourteam of analysts at Fastmarkets, who are responsible for providing an independent view on market developments and forecasting their future performance.