Our miners are choking on Chinese smog

Beijing's efforts to rein in smelting industries have met great local government resistance. Whether they'll be more effective this year is a big question for Australian miners.

Graph for Our miners are choking on Chinese smog

Smoke is discharged from chimneys at an oil refining and chemical plant of Sinopec in Qingdao city, east Chinas Shandong province. (AP photo)

China’s worsening smog problem is one the hottest topics of discussions on local media as well as at gatherings of provincial legislatures. Debates at these usually docile places have become animated as party-appointed legislators demand action to solve China’s blackening sky.

Though the ruling party routinely ignore proposals from its rubber stamp parliaments, the environmental issue is such a popular cause that they can no longer afford to brush it aside.

Mayor of Beijing, Wang Anshun, told local legislators last weekend that he would “serve his own head on a plate” if he failed to resolve the environmental problem.  Despite the theatrical language, the seriousness of the issue is beyond doubt.

Not to be outdone, the governor of Hebei province, home to a quarter of China’s steel production, also warned local officials that anyone who dares to defy Beijing’s order not increase steel or coking coal production – even just one extra tonne – would be fired on the spot.

You may be sceptical about party officials’ promise to their rubber stamp parliaments, but futures markets for coking coal, iron ore and steel products in China took it seriously. Prices dropped and especially for coking coal – a key ingredient for steel-making.

What China decides to do about its worsening environmental problem will have serious repercussion for Australian miners like BHP Billiton, Rio Tinto and Fortescue Metals. Despite China’s slowing economy, demand for Australian iron ore -- the biggest export earner -- has been holding up well due the country’s excessive capacity.

Beijing has been trying to curb this issue since 2005 without much success. During this time, Chinese steel production has more than doubled, from 470 million tonnes a year in 2005 to about one billion tonnes in 2013.

Its output is seven times larger than Japan’s, the world’s second largest producer.

China’s excessive capacity is not only holding up demand but also squeezing the steel industry’s already razor thin profit. Between January and November last year, the industry only made a collective profit of 16 billion yuan, or $3 billion.

Its profit margin was about 0.48 per cent, the worst performer of all industrial sectors in China. Actually, if you strip away its side businesses such as raising pigs, growing vegetables and providing plumbing services, it was only 0.17 per cent.

Why do they put on new capacity when demand and profit are declining?

We have to understand how local Chinese officials get promoted in order to answer this question.  Forget about communism, the ruling ideology of the party is GDPism and that means growing your local economy at all costs.

Performance of local GDP is the most important component of local cadres’ KPIs. As a result, they compete ferociously for investment projects and are especially keen on large industrial projects that involve a lot of investment and high output.  And steel industry is one of the favourites.

Local governments often provide cheap land, subsides and financial guarantees to lure investors. They also turn blind eyes to producers’ poor environmental records. Consequently, China has built massive over-capacity in many sectors including steel, aluminium, wind turbines, solar panels and ship building.

Beijing’s efforts to rein in these rapidly expanding industries have been met with great resistance from local governments. Are they going to be more effectively in curbing excessive capacity this year? This is the big question for Australian mining industry.

There are three reasons I think they will make a difference this year.

Firstly, the worsening environment problem is putting a lot of political pressure on Beijing and local governments to tackle big polluters. Though we may take officials’ solemn promises to serve their heads on a plate with a pinch of salt, it is also clear that the environment has become a big galvanising social issue that they cannot ignore.

Even an authoritarian state has to respond to public demand.

Secondly, the powerful Organisation Department of the Communist Party of China, which is responsible for promoting officials, is changing rules to make cadres more mindful of environmental and excess capacity issues.

That is a powerful incentive for officials to change their behaviours as their careers are dependent on it.

Last but not least, Beijing’s effort to rein in the local debt problem will certainly make banks more reluctant to lend to industries already under pressure from Beijing to reduce their capacity.

Ultimately, China will have to find a delicate balance between structural reforms -- closing down inefficient factories and tackling environmental issues -- and maintaining growth, which involves propping up troubled industries (Beijing reforms race rising debt, January 21). 

Follow Peter Cai on Twitter: @peteryuancai

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