HONG KONG, July 8 -- China's drive to consolidate its fragmented steel sector is set to forge a handful of global giants, turning up the heat on top producers including ArcelorMittal and enabling it play hardball with material suppliers such as Rio Tinto.
Explosive expansion in the past few years has made China the top producer in the $500 billion global steel industry, with the nation now accounting for about half the world's total output after ramping up production to fuel its rapid growth.
But that massive output is spread over some 3,000 steel mills, from state-owned giants like Baoshan Iron and Steel, to much smaller private backyard smelters, prompting the government to mount a new push for consolidation.
"There is no discipline," said Chris Park, a senior analyst at Moody's Corporate Finance Group. "Steel mills suffer very often from oversupply, price correction and margin loss too."
Chinese mills still lag global peers in product diversity -- an issue consolidation will help by allowing them to spend more on product development to pursue big western customers now served by global giants such as ArcelorMittal, Nippon Steel and South Korea's POSCO, he added.
After a previous consolidation drive largely stalled earlier in the decade, Beijing in June issued a new policy document aimed at putting more than 60 percent of domestic capacity in its top 10 mills by 2015, up from 44 percent in 2009.
"The state council is not really satisfied with the speed of the industry's consolidation," said David Ko, Head of the iron and steel sector of KPMG China, explaining Beijing's reasons for issuing the new policy document last month.
BIGS BECOME BIGGER
Analysts say the new consolidation should benefit market leaders like Baosteel, Angang Steel and Wuhan Iron and Steel as the restructuring will see the current market leaders driving consolidation, cutting costs and tapping fresh markets.
One area where they could benefit is on iron ore pricing, an area where most of the cards are now controlled by the world's top three suppliers, Brazil's Vale and Australia's BHP Billiton and Rio Tinto, which collectively control two-thirds of the $88 billion global seaborne iron ore trade.
Despite its size, China's fragmented steel industry plays a following role on global ore prices, which since the breakdown of long-term contracts, now largely follow spot prices.
"A more consolidated industry will lead to higher discipline and if there are fewer players, it will be easier for them to negotiate," said Josephine Ho, an analyst at Nomura.
The new giants could also wield more power in setting global steel prices for the auto and construction sectors and other big users. Construction alone, much of it for home building, already accounts for about half of China's demand.
"China's top three steel companies will control close to a quarter or about 30 percent of the supply globally eventually based on its plan," Ho estimated.
Beijing's June policy document is just the biggest in a number of signs that signal the government is determined to complete consolidation this time. It said outdated capacity must be eliminated and no new projects will be approved until the end of 2011. Allowing the yuan to appreciate more, and the cutting of a 9-percent export tax rebate also suggest the government's determination to consolidate the sector, analysts said.
In a sign that steel makers are finally heeding the call, Liaoning based Anshan Steel is now merging with Panzhihua Steel, parent of PZH Steel, and Benxi Iron and Steel to create a mill likely to become the country's largest.
Baosteel Group, the nation's No. 2 steel maker and parent of Baoshan Iron and Steel, is buying smaller mills like Guangzhou Steel, with an aim of nearly doubling its capacity to more than 66 million tonnes by 2015.
Chinese leader Hebei Iron and Steel, industry leader at home and the world's No.2 mill after ArcelorMittal, is also in talks to buy Shijiazhuang Steel.
"They are very determined to get things done," said KPMG's Ko.