Property market puts pressure on iron ore and dry bulk shipping

Transcription

1 Macro comment China, October 30, 2014 Macro Research Property market puts pressure on iron ore and dry bulk shipping China s property market is correcting sharply with prices and construction activity declining, and we believe this is set to continue well into Even though we do not expect a total collapse of the market, our projections for the property sector have severe negative consequences for global iron ore and dry bulk shipping prices. The complicated relationship has several steps: Property sales go hand in hand with property construction investments and construction requires steel, the production of which requires iron ore. Iron ore is produced domestically in China and imported and imported iron ore is typically shipped to China in dry bulk carriers. After analysing this relationship, we conclude that Chinese iron ore import growth could fall to zero in late This could all else equal have a dampening effect on dry bulk shipping prices. We do acknowledge, however, that there are also many other factors than China s property correction affecting dry bulk shipping rates. The relatively tight relationship between Chinese construction activity and global iron ore and dry bulk shipping prices is well-known. In this analysis, we combine our insight into China s property market and the production chain of steel to provide projections for China s import of iron ore and the potential consequences for global iron ore and dry bulk shipping. Relationship between property market and iron ore and dry bulk shipping more than first meets the eye The analysis consists of two parts: the first part analyses the property market and explains why we expect the property correction to continue and for how long; and the second part analyses the impact of the continued property market correction on iron ore and dry bulk. Part 1: Property market correction to continue The housing market is clearly under pressure. Prices fell in all but one of the 70 cities tracked by the National Bureau of Statistics in September 2014, up from only around five cities in Q1. Following strong average price increases above 2 percent each month in the biggest cities in early 2013, the price growth in the big cities is now around -1 percent m-o-m. Huge oversupply of housing units Activity is slowing too. The annual growth rates of both building starts and property sales are at or below zero as developers struggle to sell projects and potential buyers stay sidelined to wait for prices to fall further. The price correction and the activity slowdown were likely triggered by the authorities tightening of regulations and monetary policy in 2013, when interbank rates surged to record levels. However, the correction was somewhat inevitably due to the huge oversupply of housing units. For full disclaimer and definitions, please refer to the end of this report.

2 Oversupply indicated by the monthly figures for homes available for sale The oversupply is, for instance, indicated by building starts, which for many years have outpaced completions and sales. This indicates that some projects are put on hold before they are finished or maybe even before work has started. A little caution is warranted, as building starts are unverified figures reported by the developers themselves, who might want to overstate their activity. Building completion figures are, on the other hand, independently verified. A stronger and timelier indication of the housing oversupply comes from the monthly figures for homes available for sale. From this figure, the housing inventories-to-sales ratio (months of supply) can be calculated, and it shows an upward sloping tendency. Tools available to support property market if needed We do not expect a total collapse of the housing market; authorities will likely do what they can to avoid that. On the other hand, authorities seek to avoid the creation of new bubbles and overcapacity and are trying to move on with the deleveraging and rebalancing process. Thus, authorities will likely refrain from a broad-based easing of monetary policy and allow the property market correction to continue and allow more developers and trust funds to go bankrupt. Meanwhile, authorities will come with targeted measures to control the pace of the correction and to dampen fears of an outright collapse. They will still have tools at their disposal, even though interest rate liberalisation has weakened the power of one of the main tools used in the past, namely lending rate cuts. Monetary policy tightening, as well as the tighter lending and housing market regulations, can fairly easily be rolled back if deemed necessary. Restrictions on individuals home purchases are set on a local level and not by the central government, and many cities have already eased restrictions; for instance by increasing the maximum allowed number of apartments owned per head. The central bank has urged commercial banks to speed up mortgage approval and some of the big state-owned banks have reacted by announcing easier lending conditions and smoother credit approval. House prices will likely continue to go down this year and into 2015 at roughly the same 1 percent a month pace as currently before prices eventually stabilise. This means that house prices will have fallen by percent in late 2015, more or less back to the level. The house sales declines will also continue into early 2015 but could stabilise earlier than prices as the lower prices attract new buyers. Construction activity will, however, not likely recover until late 2015, as the oversupply of buildings needs to be absorbed. 2

3 Part 2: China property to put pressure on iron ore and dry bulk shipping There is a fairly tight yet not perfect relationship between growth in the number of square meters of Chinese property sold and the Baltic Dry Index of dry bulk shipping prices. We take a step-bystep approach The relationship between China s property sector and global dry bulk shipping prices has several steps: 1.) Property sales go hand in hand with property construction investments. 2.) Construction requires steel and the production of steel requires iron ore. 3.) Iron ore is produced both domestically and imported, primarily from Australia and Brazil. 4.) Imported iron ore is typically shipped to China in dry bulk carriers. To identify both the direct and indirect relationship between the property construction and iron ore imports, we would ideally use a comprehensive input-output model for China s economy. Unfortunately, we do not have access to such a model. Instead, we analyse each step at a time. Property construction growth set to slow but not turn negative Property sales are a quicker indicator than property construction investments. Recently, sales have fallen on an annual basis but construction of new buildings is still growing at a positive rate. This is due, among other things, to the authorities many social housing projects (also dubbed affordable housing) which alleviate the negative effect of sales of commercial property on construction activity. To a large extent, social housing construction is independent from prices and demand for commercial housing, and even tends to move opposite commercial housing construction as authorities use social housing as a tool to support the economy during bust periods. Our projection of continuing falling sales into early 2015 and a stabilisation thereafter translates into growth in property sales reaching a trough around -40 percent y- o-y in early 2015 and increasing to -25 percent thereafter. This suggests that construction investment growth will fall to between 5 and 10 percent y-o-y in late 2015 (see chart). 3

4 Steel consumption likely to start falling Almost all of China s steel is domestically produced. Imports of steel have been roughly constant in absolute terms since the middle of the last decade while production has sky-rocketed. This has sent imported steel s share of total steel production down from above 10 percent to below 2 percent. Thus, for our purposes, it is fair to ignore steel import. All steel is not used in the property construction sector Another more problematic assumption is that all steel is used in the property construction sector. Of course other sectors use steel as well, especially car production, shipbuilding and infrastructure investments, and a non-negligible amount of steel is also exported; but property construction is the biggest steel consumer. This is supported by the fact that total steel production is much more tightly correlated with property investments than other sectors investments or production. 4

5 The projection of construction investment growth slowing to between 5 and 10 percent y-o-y corresponds (all else equal) to growth in steel production falling to around -5 percent y-o-y in late 2015; that is, falling production. However, the fall might be alleviated somewhat by continued strong infrastructure steel demand as the authorities also use infrastructure investments (for instance high-speed trains) as a tool to control economic activity. Iron ore import likely to stay flat or fall slightly Steel is produced from iron ore, which is either imported or domestically produced. Only imported iron ore affects global iron ore and dry bulk shipping prices directly. The iron content of imported iron ore is much higher (on average close to 60 percent) than of iron ore mined in China (on average 26 percent). At the same time, Australian and Brazilian miners produce at much lower costs, giving imported iron ore a huge competitive advantage. More than half of Chinese steel is produced from imported iron ore (see left-hand chart). The unit for iron ore in the chart is the amount of steel the iron ore can produce. Thus, domestically produced iron ore volume is multiplied by 0.26 and imported volume by 0.6. The figures do not add up perfectly to total steel production. Apart from data limitations, this can be explained by that far from non-negligible inventories of iron ore that have piled up in China (see right-hand chart). In addition, the average iron content of domestic iron ore has decreased markedly from around 50 percent ten years ago, which the chart does not take into account. Given the structure of the Chinese iron ore and steel sectors described above, one should not expect a perfect fit between growth in steel production and iron ore imports. Still, the fit is not that bad (see left-hand chart below) and the relationship suggests that our projection of steel production falling up to 5 percent y-o-y in late 2015 corresponds to iron ore import growth falling slightly below zero in late

6 Also lower domestic iron ore production What cannot be seen from the left-hand chart is that the lower steel demand implies not only lower imports of iron ore, but also lower domestic iron ore production. This can be seen in the right-hand chart. The turquoise area is steel from domestic iron ore which is set to decrease. This of course reflects lower demand, but domestic supply may be cut too. Many Chinese miners are non-profitable and make losses at the current price level, as global iron ore prices have plunged recently since domestic and foreign iron ore mining capacity has been expanded heavily in the past year or two. If prices stay low or even fall further, many unprofitable Chinese mines will likely be forced to close, leading steel producers to substitute domestic iron ore for imported. Some argue that closures of domestic iron ore mines will even lead to increasing iron ore imports despite the lower steel demand. This is not the case in our base case scenario, but we have produced an alternative scenario where as much as half of domestic iron ore mines close down, corresponding to the thin blue arrow in the right hand chart above. In this scenario, imports of iron ore will not fall but continue to increase, but at an annual growth rate of only a little above zero and still much lower than the roughly 15 percent y-o-y that has prevailed in the past year. Halt of the longlasting trend of increasing Chinese iron ore import Thus, it seems fair to conclude, that the effect of the property market slowdown via lower steel demand on iron ore imports is that import volumes will stop increasing and stay rather flat until late Downward pressure on dry bulk shipping prices A halt of the long-lasting trend of increasing Chinese iron ore import is likely negative for dry bulk shipping prices. However, dry bulk vessels do not solely transport iron ore to China. They also ship for instance coal and grains around the globe and dry bulk shipping prices of course depend as much on supply of shipping services (fleet size) as on the demand for shipping. The number of vessels and total capacity has been increasing for years. Still, the fit between Chinese iron ore imports growth and the Baltic Dry Index (a measure of dry bulk shipping rates) is acceptable (see chart below), and it suggests downward pressure on dry bulk shipping rates. 6

7 Obviously, there are limits to how low dry bulk shipping rates can go, and that limit might already have been hit. At some point, the revenue from shipping a unit of dry bulk exceeds the variable operating costs of vessels, fuel, and crews, meaning that it should be more profitable (or less loss-making) for shipping companies to simply not sail at all. Shipping companies revenues are already under pressure and many are experiencing losses. The continuing property market correction in China will seen in isolation put additional pressure on iron ore imports and dry bulk shipping, highlighting the risk of lower shipping rates going forward despite our house view of higher rates on average in 2015 than this year. Of course, other factors than just China s property market play a role too. Bjarke Roed-Frederiksen, , bjro03@handelsbanken.dk 7

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