Evidence is emerging of an unprecedented reshuffle in China's apparently booming steel sector.

A phalanx of Chinese steel makers, including such big names as Baoshan Iron and Steel Co. (Baosteel), Wuhan Iron and Steel Co. and Anshan Iron and Steel Co., are engaged in M&A talks with smaller players.

Baosteel, the nation's No. 1 steel maker, is reportedly negotiating acquisition deals with Ma'anshan Iron and Steel Co. in east China's Anhui Province and Handan Iron and Steel Plant in north China's Hebei Province.

But Shanghai-based Baosteel denied any discussion of merger or acquisition, saying: "We have contacted Ma'anshan about cooperation in technology and management."

Analysts say, however, that Baosteel's cooperation with Ma'anshan is just the first step toward an acquisition.

Baosteel, which now has an annual steel production capacity of around 20 million tons, aims to produce 30 million tons a year by 2009 and is eyeing a long-term target of 50 million tons. The Handan and Ma'anshan outfits have a combined capacity of 13 million tons of steel annually.

Wuhan Iron and Steel, based in central China's Hubei Province, is in merger talks with Echeng Iron and Steel Co. in Hubei, Chongqing Iron and Steel Co. in southwestern Chongqing Municipality and Hangzhou Iron and Steel Co. in eastern Zhejiang Province.

Sources at Wuhan Iron and Steel said that its acquisition of Echeng is "inevitable." The company has also signed a letter of intent for a merger with Hangzhou Iron and Steel.

If Wuhan Iron and Steel does succeed in acquiring the Echeng, Hangzhou and Chongqing companies, its annual production capacity will more than double to 20 million tons.

Anshan Iron and Steel, based in northeast China's Liaoning Province, began talking with Benxi Iron and Steel Co. in Liaoning about acquisition last year. The provincial government is backing the move, but no substantial steps have been taken so far.

Anshan and Benxi produced 10.2 million tons and 7.2 million tons, respectively, last year.

Fragmentation is a "major difficulty" for the steel industry, said Luo Binsheng, vice chairman of the China Iron and Steel Association (CISA). There are more than 2,000 steel enterprises in China.

China became the world's biggest steel producer in 1996. Last year, the nation's steel output reached 222.3 million tons.

Only two enterprises, Baoshan Iron and Steel Group -- the parent of Baosteel -- and Anshan Iron and Steel produced more than 10 million tons last year.

The Baoshan Group, newly crowned as one of the world's top 500 multinationals, ranked No. 8 in the world with output reaching 198.7 million tons last year.

There were 13 steel makers in China that each produced more than 5 million tons last year, accounting for 44 percent of the nation's total steel output, according to CISA.

The government expects the top 10 steel makers in China to control more than 80 percent of the nation's total steel output next year.

Luo said that CISA would actively facilitate M&As between domestic companies.

"Fragmentation is one of reasons for the continued overheated investment in the steel industry," said Wang Xiaoqi, of the State-owned Assets Supervision and Administration Commission.

The government has labeled the steel industry, together with aluminum and cement, as one of the hottest sectors in the overheated economy, with skyrocketing investment driven by strong demand.

In September, Luo Binsheng said that China's steel output will continue to grow in order to feed a booming construction-led economy. He believes that steel output for the year may increase as much as 16.9 percent, to 260 million tons. That means the world's largest steel consumer will continue to import iron ore, said Luo.

The country's 66 steel majors posted combined sales of US$529.9 billion yuan (US$64.1 billion) and profit of US$42.6 billion yuan (US$5.2 billion) for the January-July period, leaping 57.7 percent and 75.6 percent, respectively.

In the same period, Luo said, China imported 20.3 million tons of steel, down 8.3 percent year-on-year. Exports jumped 43.6 percent to 5.9 million tons.

Investment in the steel industry surged 96.6 percent year-on-year to 142.2 billion yuan (US$17.2 billion) during the first half of this year. But many small steel makers and non-steel investors are building low-end, low-tech capacity to keep down investment requirements.

The capacity being built amounts to 150 million tons, half of which comes from privately owned companies.

By the end of last year, production capacity totaled 310 million tons.

Massive lower-quality production will result in waste of badly needed raw materials, serious pollution and wild fluctuations in the market.

Domestic steel prices have been seesawing during the past nine or ten months, although they have returned now to a more reasonable level, according to Luo.

The price rose briskly from last October to a peak in March, then declined to its lowest level in May as the government tightened bank loans and land-use approvals. The price rebounded in June and July, reflecting actual demand-supply interaction.

Hebei, the largest steel-making province with 42 million tons last year, has started to cut excessive low-end steel production capacity. It has slashed 7 million tons of capacity so far this year.

Currently, there are more than 200 steel makers in Hebei, but only 13 have an annual output of more than 100 tons.

Although reshuffling is critical for the industry, it still faces many difficulties.

The biggest obstacles come from local governments and steel makers themselves, said Xu Zhongbo, chief executive officer of Beijing Metal Consulting Co Ltd. The small and medium-size steel makers to create jobs and tax revenues, so the local governments are happy to keep them operating.

At present, the industry employs around 1.3 million people nationwide.

"Transregional M&As will find it particularly difficult to achieve real results as they will affect the interests of different local governments," said Xu.

At the same time, many of the smaller producers are leading the good life in this period of soaring demand, and are less than willing to turn over control.

Steel demand in China grew 19.2 per cent year-on-year to 150.7 million tons in the January-June period, while profits for 66 producers rocketed 83.1 percent, to 37.6 billion yuan (US$4.5 billion).

The nation's steel output reached 124.7 million tons in the period, up 21.1 per cent.

CISA expects demand to climb 14.8 percent, to 307 million tons, this year, while output increases 13 percent to 277 million tons.

A hefty percentage of the steel imported to offset the shortfall will be high-end products that domestic producers are unable to make.

Xu believes that really massive M&As will begin to take place three to five years down the road.

"Besides M&As, we should consider new ideas for the industry's shake-up, such as joint operations between different domestic steel makers," he said. Such moves could benefit participating companies remarkably in terms of sourcing and costs.

Analysts say the most pressing task for domestic steel makers is to accelerate technical upgrading and improve their product mix to place greater emphasis on high-end products, while seeking stable resource supplies.

At present, there are around 20 billion tons of exploitable iron ore reserves in China, which will be able to supply the nation's steel sector for less than 30 years, according to CISA. Producers are being encouraged to move more of their operations offshore.

In February this year, Baosteel signed an agreement with Companhia Vale do Rio Doce to build a steel plant in iron-ore-rich Brazil.

(China Daily October 14, 2004)