China's steel sector restructuring should not be confined to capacity reductions. An overhaul of the distribution mechanism is also needed. The current model of using traders as the main source of distributing steel has significant drawbacks. Inventories through the supply chain can become excessive. The producers of steel are one stage removed from the users of the product.
This leaves the steel mills with only limited knowledge about the medium and long term demand trends of the companies that it services. The consequences of this lack of information has become apparent in recent weeks, the result - a price collapse.
Apparent consumption of finished rolled steel products increased by approximately 6 percent, year on year, in 2012. In 2013, the gain is expected to be smaller. However, steel production in recent weeks has been much greater than demand as mills speculated on rising consumption after the lunar new year holiday.
For many years, distinguished members of the China Iron and Steel Association have been championing the need for more direct sales between steel producers and their customers. Very little action has, however, developed to make this a reality. The trader/dealer lobby is very powerful and will be difficult to dislodge from their position of strength.
Close relationships between customer and supplier are extremely important in all industries. If these exist, they help to avoid significant oversupply in the market by understanding customer's future order requirements. This is extremely important but not the only reason for a close relationship. It would help the mills to develop steel products specifically targeted to the needs of the end users. This is particularly important in the flat products sector and becoming more significant for steels used in construction.
Such relationships cannot exist if a trader is positioned between the two main parties. What happens, is that the mills concentrate on maximising output at each individual steel plant. This, at times, creates an imbalance between market supply and real demand for individual products. Moreover, the steel consumers become heavily dependent upon traders for supply and channel most of their requirements through them.
The Chinese market is now changing. Double digit growth in steel demand will, almost certainly, be a thing of the past. When China's steel requirement was growing rapidly it was natural for the mills to concentrate on output above all other items.
With future growth rates at near to 5 percent it is now time to reconsider the way that the steel industry meets the needs of the market. Clearly, there is sufficient capacity, in tonnage terms, to meet China's requirements. Some of it is outdated and inefficient. Furthermore, a significant proportion will not be capable of supplying the necessary quality and grades to meet modern demands. Moreover, there will, inevitably, be an imbalance between the current steel product mix and that necessary in the coming years.
It is time to break down the current market mechanism and involve the customers in helping to frame the future development of the steel sector. Restructuring the steel industry cannot be successful if the users of the product are omitted from the decision making process.
The concept of restructuring the industry by producing steel in larger entities is sound. Mergers and acquisitions are the way forward. It cannot, however, be considered just in terms of tonnage. That was acceptable in the last decade but it will not work in this one. It needs more finesse.
The restructuring process should start with:-
"What will be the requirement of the market in the next ten years?'
"What will the priorities in the government's investment plans over the next decade?'
"Which are the technical requirements for a modern steel industry in the future?'
Before any restructuring takes place the answers to these questions are required but cannot be obtained through "top down' financial reorganisation of the industry. It needs close collaboration between suppliers, customers and investors.
It can start with steelmakers talking regularly to users of their products and discussing with them their future requirements. This relationship could be consolidated by the steelmakers obtaining more orders directly from the end users. In turn, this is likely to lead to the mills developing their own distribution centres – perhaps in far off locations near to the customers' factories.