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DE RUEHGH #0070/01 0370942
ZNR UUUUU ZZH
R 060942Z FEB 09
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 7618
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEHBY/AMEMBASSY CANBERRA 0026
RUEHBR/AMEMBASSY BRASILIA 0007
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHAAA/NSC WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 8249

UNCLAS SECTION 01 OF 03 SHANGHAI 000070 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EAP/CM, H 
USDOC PASS BUREAU OF ECONOMIC ANALYSIS 
USDOC FOR ITA DAS KASOFF, MELCHER, OCEA 
TREASURY FOR OASIA/INA/HAARSAGER AND WINSHIP 
STATE PASS USTR FOR STRATFORD, WINTER, KATZ 
NSC FOR LOI, SHRIER 
 
E.O. 12958: N/A 
TAGS: ETRD ECON EIND EINV ELAB PREL CH
SUBJECT: BAO STEEL GLOOMY ON QUICK ECONOMIC RECOVERY 
 
SHANGHAI 00000070  001.2 OF 003 
 
 
Subject:  Bao Steel Gloomy on Quick Economic Recovery 
 
¶1.  (SBU) Summary:  China's largest steel producer, Bao Steel, 
is pessimistic about China's economic prospects through 2009. 
In a February 3 meeting with Bao Steel, Vice President Dai 
Zhihao said that demand in China's steel market remains 
lackluster with no sign of recovery.  Although excess stock is 
finally drying up, prices remain close to fifty percent off 
their July 2008 peak.  Recent incremental price increases in 
steel during the past four weeks are not a sign of increased 
demand, but rather a result of traders' speculation.  Bao Steel 
will benefit little from China's economic stimulus package, 
since it mainly specializes in flat products used in cars, 
appliances and shipbuilding - not long products used in large 
infrastructure projects.  Dai said he was concerned about signs 
of protectionism creeping into the world trading system and 
voiced strong opposition to the proposed Buy American clause in 
the U.S. stimulus package.  End summary. 
 
China's Steel Prices Reach "Ridiculous" Levels 
--------------------------------------------- - 
 
¶2.  (SBU) As a bellwether for the country's heavy industry, 
China's steel production continues to contract at a rapid clip, 
said Dai.  As soon as the 2008 Olympics opened, the demand for 
steel, as well as the price, began to sink.  Beginning in 
October, prices went into a complete nosedive and have now ended 
up at 50 percent of what they were at their July 2008 peak.  Dai 
attributed this rapid price decline to both external and 
internal factors.  The global financial crisis and its 
subsequent spill-over into the real economy forced many Chinese 
firms that manufacture for export to decrease or stop production 
and reduce their inventories.  As a result, demand for steel 
slumped.  Internally, Chinese steel producers were initially 
overly optimistic on China's ability to weather the economic 
storm and kept pumping out steel at normal levels.  Dai said 
that Chinese steel producers believed any effect from the global 
economic downturn on China would be shallow and short-lived. 
When it finally sank in that the global economic downturn would 
have a long-lasting and deep effect on China's economy and 
stocks had been built up too high, steel prices dropped to 
"ridiculous" levels, noted Dai.  As a result of the steep price 
decline, steel distributors have become reluctant to buy more 
steel because they built up inventory when prices were high and 
are not in a position to take on additional risk. 
 
Don't Misconstrue Rise in Steel Prices 
-------------------------------------- 
 
¶3.  (SBU) Dai warned not to interpret steel price rises in the 
first weeks of 2009 as a sign of economic recovery.  There is no 
increase in real demand to support this rise in prices, said 
Dai.  He explained that as demand waned, prices fell faster than 
demand.  Steel producers' margins sank to zero.  Trading 
companies recognized that steel was undervalued, and as credit 
has started to trickle out from banks in recent weeks, traders 
seized the opportunity to buy steel.  The other contributing 
factor, said Dai, is the steel industry's 25 percent supply cut. 
 Bao Steel has followed suit, trimming its output by 25 percent. 
 On a positive note, Dai said that China's overstock of steel is 
close to an end.  (Note:  According to China Steel Association 
figures, steel prices have rebounded somewhat from their low 
point.  The China Weekly Steel Products Price and Price Index 
(combination of all steel prices) has inched up six percent from 
the third week of December to the last week of January.  End 
note.) 
 
No Collaboration Among Steel Producers 
-------------------------------------- 
 
¶4.  (SBU) Dai explained another reason for the rapid price drop 
and overstock of steel - China's steel producers are unwilling 
to collaborate on supply cuts.  "If everyone agrees to shut down 
the same amount of capacity, it would benefit all the players in 
the sector."  However, unlike Japan, it is impossible for all 
the players to settle on a reduction, said Dai.  If Bao Steel 
cuts capacity, other companies will not follow suit but reap the 
benefits of a steel price rebound. 
 
Government Stimulus of Little Consequence to Bao 
 
SHANGHAI 00000070  002.2 OF 003 
 
 
--------------------------------------------- --- 
 
¶5.  (SBU) Dai was cautious on any immediate effect from 
government's stimulus package, saying any effect would not be 
noticeable until the end of the first quarter.  He believed if 
external financial conditions fail to improve, steel prices may 
drop again.  "The worst might be yet to come," he said.  The 
Government's stimulus package will also have little direct 
impact on the company.  Bao produces relatively fewer long 
products, which are used in reinforced concrete, buildings and 
bridges.  Demand for these products has seen some rebound in 
demand due to government investment in infrastructure.  However, 
the company produces a relatively larger amount of flat 
products, which are used in appliances, ships and autos.  Many 
of these products are produced for export and still face 
dropping demand.  Regarding Bao Steel's primary client 
industries, he explained electronic appliance exports are 
falling rapidly, client shipbuilders around the globe have had 
no new orders in the past two months, and the auto industry in 
China may see more declines if China's auto bailout measures 
fail to have any real effect.  Moreover, the main winner in the 
stimulus is railway steel, which Bao Steel does not produce. 
Maanshan Steel, Angang Steel, and ShouGang Steel are the main 
railway steel suppliers in China. 
 
Industry Consolidation - Let the Cards Fall Where They May 
--------------------------------------------- ------------- 
 
¶6.  (SBU) The Chinese Government is still encouraging 
consolidation in the steel industry - but it now has to walk a 
fine line, said Dai.  If it pushes too hard on consolidation and 
steel mills are shut down, unemployment will increase, 
particularly in areas that may be heavily dependent on the 
industry.  However, because the steel industry has been so 
profitable over the past 10 years, a plethora of small steel 
mills have opened their doors in China, which not only increased 
capacity but also created fierce competition.  The Chinese 
Government pushed the industry, especially the smaller players, 
to consolidate for years.  Dai said the current financial crisis 
provides the perfect opportunity to "crowd out" the smaller, 
inefficient players. 
 
Cash is King 
------------ 
 
¶7.  (SBU) According to Dai, Bao Steel has a large amount of cash 
on hand and is prepared to acquire other steel companies at a 
"reasonable" price.  The company has made numerous attempts in 
the past and sometimes failed.  Now the time is ripe for 
buyouts, said Dai.  For example, Bao Steel intended to acquire a 
Ningbo steel mill last year, but the plan was scrapped when the 
Ningbo company demanded an unreasonably high price.  Since the 
economic downturn, the same Ningbo firm returned to the 
negotiating table - this time offering a much lower price for a 
buy out.  Dai said Bao Steel is patently opposed to any 
Government measures that would bail out the industry.  It is 
time for the smaller, inefficient companies to exit, said Dai. 
 
Skeptical on Overcapacity 
------------------------- 
 
¶8.  (SBU) Dai was skeptical that China's overcapacity problem in 
the steel industry would be resolved in the near future.  Too 
many local governments were propping up steel mills to ensure 
local economic growth.  It is impossible to fully put into 
production China's 600 million ton annual capacity, said Dai. 
He noted that the steel industry was not the only one in China 
to face this overcapacity dilemma - shipbuilding and the auto 
industry face similar challenges. 
 
Views on China's Economy 
------------------------ 
 
¶9.  (SBU) Dai was pessimistic on a quick V-shaped recovery for 
the Chinese economy.  Since people in China have not experienced 
a severe economic downturn in more than 30 years, he said they 
tend to be overly confident in China's economic capacity and 
overly optimistic that the country can quickly bounce back.  Dai 
felt the slowdown could last longer than people expected, 
explaining that over the past 30 years China built much of its 
 
SHANGHAI 00000070  003.2 OF 003 
 
 
economy on heavy industry, and it is now heavy industry that is 
now taking a large hit.  He also expressed doubt that GDP growth 
could meet the Central Government's eight percent target for 
¶2009.  Based on his long experience in the steel industry, he 
added that he had never seen it so bad.  However, he praised the 
Central Government for reacting quickly to the downturn by 
releasing a substantial stimulus package.  Without the stimulus 
package, the Chinese economy this year would  be much worse, 
said Dai. 
 
Exporting the Misery 
-------------------- 
 
¶10.  (SBU) As China's steel industry has stumbled, the pain has 
spread to many other countries, Dai explained.  For example, Bao 
Steel imported approximately 75 percent of its iron ore - about 
one third from Brazil and two thirds from Australia.  Dai said 
Bao Steel has substantially decreased orders from both 
countries.  He added that Bao Steel contemplated major 
investments in both countries earlier in the year and is very 
lucky that neither of the deals was concluded before the 
economic downturn - otherwise the company would now be strapped 
for cash.  Decreasing orders from China has hit mining companies 
hard, forcing them to make substantial cuts in output, close to 
six percent globally.  Bao Steel buys most of its iron ore from 
three large mining companies:  BHP Billiton, Rio Tinto and Vale. 
 Of the three, Rio Tinto is in the worst shape because of 
enormous debts the company racked up prior to the credit crunch. 
 Bao Steel has a long-term contract for iron ore with BHP 
Billiton, which is relatively better off. 
 
Dismay over Signs of U.S. Protectionism 
--------------------------------------- 
 
¶11.  (SBU) Dai angrily dismissed "Buy American" provisions in 
the U.S. economic stimulus legislation as clearly protectionist. 
 Although Bao Steel does not export steel to the United States, 
Dai believed that other Chinese steel producers would likely 
push for "similar protectionist measures" should the provisions 
be approved.  Dai noted his concern that President Obama might 
give in to the U.S. steel industry's union.  "You save one 
industry and destroy many other industries", noted Dai.  "Steel 
is the food for all industries, including manufacturing, 
machinery and automobiles."  Dai further explained that U.S. 
steel prices are already among the highest in the world, and if 
the U.S. Government "persists with protecting the domestic steel 
industry," its downstream consumers in the United States will 
suffer. 
CAMP