China's pollution crisis and power Rationing
Reducing the extreme levels of air pollution in China has moved to the top of the political agenda for the new government this year. Without reform, China's air pollution could worsen by another 70% in 2015. Figure 1 illustrates that construction and industrial emissions contribute to 20% of PM2.5 levels. We expect measures to address this crisis may have important implications for industrial sector activity. In fact, the forthcoming power rationing in Hebei province highlights that provincial governments may step up their effort to tackle pollution crisis. According to Bloomberg, Tangshan city will shut 199 polluting factories by rationing their power supply from May 20t. Power supply for three ore-sintering lines at Tangshan Steel and two at Guofeng Steel will be cut. Operations won't be resumed until desulfurizing devices are added to satisfy environmental standards. Furthermore, outdated, unlicensed and illegal facilities in Tangshan will also be closed by May 31st. If these measures are implemented strictly, we expect this could support steel prices while depress iron ore demand.
Eoin Treacy's view The caveat on whether these measures will be strictly implemented is one of the more relevant considerations in addressing China's ability to tackle pollution. The central government has had difficulty enforcing its will on provincial administrations not least when profit motivation is pitted against national interest. However, if they succeed in rationalising polluting industries such as steel production the outlook for the global sector could improve as oversupply is reduced.
Within the environmental sector China Everbright broke successfully out of a two-year range in February and continues to extend its advance. The potential for a reversion towards the mean has increased.
Most of the better performers in the steel sector concentrate on specialised products. (Also see Comment of the Day on May 7th). However it is also worth highlighting those which have performed worst because base formation characteristics are increasingly evident. Evraz, Arcelor Mittal, US Steel, Allegheny Technologies, Commercial Metals, Bao Steel and China Steel Corp have all at least lost downward momentum. Breaks in their respective progressions of lower rally highs would raise the possibility that demand is returning to dominance beyond the short-term.
A number of US coal companies in particular have lost downward momentum and an increasing number have base formation characteristics. Peabody Energy, Arch Coal, Consol Energy, Alpha Natural Resources, James River Coal and Oxford Resource Partners have all begun to exhibit signs of renewed demand dominance following a very difficult few years.