„The Party leads“

During the London Metal Exchange Week (LME Week), which takes place every autumn in London, stakeholders in the metal exchange meet. This is not just to celebrate the exchange and themselves, but also to exchange ideas and thoughts about pressing issues. The glamourous highlight is the LME Dinner, attended by more than 1,500 members of the exchange and their guests, and is held in a huge two storey ballroom, with evening suit or gown as the dress code. During the whole LME week, there are numerous meetings and presentations which provide for a professional exchange of ideas.

One of these presentations which will be looked at in more detail here is the annual Base Metals Research Breakfast held by the French Bank, Société Générale. As well as providing a fundamental and technical analysis of the industrial metals, the event this year was enriched by a presentation given by the Chinese economist of the bank, Wei Yao, under the humorous title of “Enjoy the stability while it lasts”. Since 2012, Wei Yao has been recognised as being one of the most acclaimed economic experts on China. China, as the second biggest economy in the world, and also the biggest consumer of most raw materials today, plays a big fundamental part in analyses of the future development of commodities and industrial metals prices. In addition, China, in many areas, is an important supplier and producer of commodities.

Wei Yao’s lecture was especially interesting with a very precise summary about the Party Congress of the Communist Party of China which takes place only every five years. At the Congress, the Party and State Head, Xi Jinping, spoke in a three and a half hour speech about his vision for a strong China and its place in the world. Concerning the future development of China, Xi Jinping, despite all progress, also sees contradictions in terms of risks and dangers, which he would like to tackle in his renewed period of government. At the same time, the security of the power of the party and its own freedom of action play a decisive role. Since the advances made will, in the opinion of non-too few observers, lead very strongly back to the person and personality of Xi Jinping, a lot of thought is being made already now about what will happen after his time.

The strategy which has been presented can be compressed into four economic principles and seven significant reform topics. The four principles are: the unlimited leadership of the Party, stability is more important than growth, the management of risk and the safeguard of power. The important reform topics can be described as follows. As well as the reform of state owned enterprises, where the priority is also about the adjustment of ownership structures, and also a consolidation of state owned companies, which should lead to capacity reductions, the fight against environmental pollution is here first and foremost and is paramount. This is a very important issue for the Chinese people and should therefore really be offensively tackled and given the highest priority.

This will have an important influence on the production and supply of certain primary commodities as well as having a lesser influence on the commodity demand in China. As well as being able to take the example of stainless steel, the production of nickel pig iron (NPI) and graphite electrodes (see also below) must be also taken into account. Also, furnace technology, which has so far been designed for primary commodities, should really move more towards technology for scrap usage so that it can be optimised in years to come. It should be assumed that replacement and new investment will successively pave the way in the future for the electric arc furnace (EAF) technology to replace the blast furnace technology which dominates today’s stainless steel production in China. This will have consequences for scrap demand, both in quantity and quality in China, and also have effects on the relative valuation of scrap. Decisive in this is, above all, the principle that growth no longer has exclusive priority.

An additional reform is aimed at concentrating on reducing the Chinese economic debt. The social security systems of old age insurance and the health system should also be improved. A restraint on the over-heated property market is also included in the main points of the reform plan. Amongst industrial reforms, there is a sub-reform for the brand “Made in China”, for further development of the internet and for deregulation of certain sectors.

Under the slogan “Go-out”, reforms are combined in the area of infrastructure with the foundation of an Asian Infrastructure Investment Bank, regional economic cooperation, international participation and partnerships, as well as the Belt & Road Initiative. The headline “Open-up” is about the liberalisation of capital accounts and the opening of certain domestic markets. As can be taken from the summary, the Chinese government is now becoming very open about problems and risks. This is indeed a considerable and qualitative change to times gone by when such sensitive issues were only too keenly swept under the carpet. So it would seem that the expectation of something really actually changing is certainly realistic.

With all this optimism, it must not, however, be forgotten that standing over all of this is still the principle “The Party leads” which therefore, despite overall confidence, still leaves a considerable risk, especially concerning the economic activity of non-Chinese participating with China. The other newsworthy topics of the LME week concerning nickel were summarised very aptly in a publication made by the Chinese Banking and Broker House ICBC Standard Bank. Currently, nickel supply and demand are still governed by stainless steel production with a share of around 70%. At the moment, however, it can be presumed that sentiments and prices are being supported a lot by an expected revolution in electric mobility, where nickel demand could be given a big boost by the battery technology.

Numerous talks and discussions were made in London concerning this issue, and as if to order, the nickel price climbed to new heights on the LME. It could even, for a time, break through the barrier of USD 13,000.00/mt. But then there was profit taking bringing a consolidation of prices to around the USD 12,300.00/mt level. Nevertheless, because of the abundantly ample warehouse stocks on the exchange, and also held by producers, trade and consumers, there is at this moment in time no shortage of nickel required for battery production and other uses.

Consequentially, the ICBC Standard Bank is of the opinion that nickel’s movement in the markets is more of a short term nature, led more by investors than by consumers. The Shanghai Futures Exchange (SHFE), which has a certain reputation of having more of a casino mentality, seems to play a leading part in this development. Yet, in the strategic analysis made by ICBC, there is certainly an amount of fear that the availability of nickel, looking at the long term perspective, and its availability in the right form, can become a genuine issue. Just as the process of lateritic ores to nickel pig iron pushed the cost curve of nickel on aggregate down, there could now be a countermovement developing. Whether this would lead to a division of the nickel market is controversial and has not been discussed sufficiently. Leading analysts are, however, tending more to another opinion.

It is not anything new to say that there are price differences between nickel dealt on the LME (in regard to exact specifications and trademarks see: http://www.lme.com/Trading/Brands/Approved-brands) and other forms of nickel, including stainless steel scrap. The background to this is that today, either the premium or the discount made on the LME nickel price is supposed to represent the individual differences in quality as well as reflecting supply and demand. This is why stainless steel scrap, at the moment, is being traded with a discount to the LME nickel price. This is, however, not laid down as fact. For example, round about the middle of 2007, stainless steel scrap, because of the tightness of the market where nickel units were concerned, was being dealt at times with a premium over the LME nickel price.

So it would not be at all surprising if certain advantageous parameters for stainless steel scrap could create a more positive price valuation due to present changes in preferences in societies in regard to environmental concerns and carbon dioxide emissions. And it would also be more surprising if an increased demand in primary nickel, for example out of the battery sector, would not cause rising prices, not only in nickel but also in nickel in other forms. This is all the more so because today’s dominating stainless steel production already does not have the amounts of nickel available which will be needed in the future for the production of batteries. Therefore, scrap and other forms of nickel will have to be concentrated up on.

Should scrap, however, at the same time become more preferred and in demand not lastly due to environmental concerns in China and the rest of the world, then a tightness in supply is already a given situation, and at some point in time, the available scrap amounts will never be enough to cover the whole of the commodity needs of the stainless steel industry. This is unless there would be clear reduction in production. But this cannot be reckoned with. At the end, it will be the market which decides which price the producer and end consumer are prepared to pay for a cleanly produced “green” steel and which raw materials are used for this purpose.

It is sufficiently well-known that stainless steel raw materials show a high volatility from time to time, more recently though, graphite electrodes have become a talking point. Graphite electrodes are used in electric arc furnaces for the production of steel and serve as a conductor of electric energy to bring the materials, such as stainless steel scrap, to the smelting point. Since the middle of the year, the spot prices for graphite electrodes have just about exploded, having risen from under USD 5,000.00/mt to USD 40,000.00/mt. There are many reasons for this development.

One reason is that there is a supply deficit, since during the Chinese heating period (October/November until March) the graphite producers there have limits put on production due to environmental measures. This means that the electrode producers outside of China have to more or less work to the limits of capacity. Another reason is that the price of needle coke, one of the important starting materials for electrode production, has risen sharply. Furthermore, there are also foreign trade restrictions still in place regarding the import of Chinese graphite electrodes. According to opinions of analysts, this means that up to the year 2020, it is not economically viable to use electrodes from China. In the medium term, the increased demand from the field of lithium ion batteries could present a rising risk in needle coke prices.

Depending on purchasing strategy, long term against spot, steel producers are affected in differing types of ways. In the medium and long term, however, all these effects as described will be of concern to all producers and lead to higher steel prices, since these costs will be passed on to the customers. It is being estimated that this will have an influence of up to USD 75.00 per ton on fluid steel.

Although market observers expect that the very high prices being paid at the moment for graphite electrodes will fall again after the Chinese heating period ends next year, it is still not expected that, because of the medium term effect from the battery market, these will fall considerably below USD 15,000.00/mt in 2018. For this reason, it is more than understandable that stainless steel will become more expensive: The price increases which are signalled should not give rise to long discussions, they are long overdue!