Shanghai, 22 July 2011: Reuters

China's steel production could maintain its breakneck pace in the second half of 2011 as a construction boom buoys demand, putting it on track for another record year despite the government's credit curbs. China, which makes nearly half the world's crude steel, is expected to produce at least 700 million tonnes this year as mills cash in on rising prices, with apparent consumption up nearly 9 percent so far in the first six months.

That means China's demand for iron ore, the key raw material to make steel will remain strong, keeping spot prices, which have more than tripled since late 2008, high. Makers of long steel products used in construction are capitalising on Beijing's campaign to build cheaper homes and a push to boost infrastructure, particularly in the country's less developed western regions, with profit margins recovering to double digits from the low levels of last autumn.

The construction sector seems to be the only bright spot in China's economy. Output of the country's manufacturing industry, also a key user of steel, shrank in July for the first time in 12 months, reflecting the impact of monetary policy tightening.

To try and cool asset prices, China aims to build 10 million low-cost houses this year, with the bulk of the construction only expected to begin in the second half. The housing plans, coming on top of other infrastructure ventures including water conservancy and high-speed railways, mean China's daily crude steel output, which averaged a record high of around 2 million tonnes in June, will stay close to record levels in the coming months.

The project is boosting demand during the summer months, when construction activity normally thins before recovering in September. "Strong demand from social housing and infrastructure investments have driven long product mills to run at near 100 percent utilization rates, and the bull-run may extend to the coming months," said Wang Dezhi, an analyst at Orient Futures in Shanghai.

GOING LONG, NOT FLAT

Based on China's June steel output of 59.9 million tonnes or nearly 2 million tonnes a day, production for 2011 could hit a record 729 million tonnes, up more than 16 percent from 2010. China's pace pushed global steel production to a record daily rate of nearly 4.3 million tonnes last month. In the period from January to June, Chinese output stood at 350.5 million tonnes, up 9.6 percent from a year ago, with apparent consumption of 334.2 million, up almost 9 percent on the year.

Given the massive size of China's steel sector, with an estimated capacity of at least 800 million tonnes -- more than six times larger than No. 2 producer Japan -- demand does not have to grow by leaps and bounds to sustain strong output.

"You don't need demand to really go nuts in order to maintain the kind of run rates that we saw in the first half of this year. Even relatively stable, slightly subdued but not bad demand will hold things up," said Graeme Train, analyst with Macquarie.

The construction of 10 million affordable housing units this year would mean an extra 25 million to 30 million tonnes of steel demand, said analysts, enough to entice mills to produce more long steel products like rebar and wire rod. With 30 percent of the project believed to have been launched or completed in the first six months, there could be 17.5 million to 21 million tonnes of additional steel demand in the second half of 2011.

Rebar, used to reinforce concrete in buildings, is the single biggest item in China's steel product mix, accounting for 16 percent of the total, followed by wire rod, at 13 percent. Rebar futures in Shanghai , which spot traders track, surged to a record high above 5,100 yuan ($790) a tonne in February and have stayed near that level since, hitting 4,925 yuan on Thursday. Traders expect rebar futures to break 5,000 yuan again by mid-August.

High demand for rebar has pushed producer profit margins up as much as 13 percent this year from as low as 2 percent to 3 percent last October and November, when stateenforced power curbs slashed Chinese steel production, according to estimates from Bank of America-Merrill Lynch, citing Chinese government and industry data.

From late March to date, average rebar margins ranged from 8 to 13 percent, beating average margins for hotrolled coil of between 4 percent and 6 percent, according to data from BoA-Merrill Lynch.

But weak manufacturing demand in China has hit the earnings of leading mills like Baoshan Iron and Steel , which posted a 22 percent fall in first-quarter profit, and Wuhan Steel , which is also facing razor-thin margins. Flat products like cold-rolled coil normally sell at around 900 yuan more than rebar based on current costs, but weak manufacturing demand has halved the gap, a Shanghai-based trader said.

With profit margins normally higher, China's leading steelmakers have been encouraged to switch to high-end flat products in recent years. The shift has cut long product supply and helped push up prices.

"The reason we're in a little bit of a shortage of long products is because every steel mill for the last five, even up to 10 years, has been converting production into flat, because flat makes up to 25 percent gross margins," said Scott Laprise, a China steel analyst with CLSA.

HOPES AND RISKS

Analysts are not pinning all their hopes on social housing, since construction of these units, tasked to local governments, could be delayed if they have funds difficulties, given current worries over some local government debt going bad.

"I don't think social housing was everything for steel in the first half. The same in the second half, we will see infrastructure construction and commercial housing as well," said Judy Zhu, analyst at Standard Chartered.

She added that steel demand could suffer if housing sales were weak, causing a funding crunch and forcing developers to delay projects. Beijing has been taking aim at property prices, limiting the number of homes people may purchase in some cities and ordering banks to limit their loans to the sector.

That has come on top of interest rate rises and other monetary tightening aimed at containing inflation, which has made it harder for mills and their customers to obtain loans.

"One of the things that credit tightness has done is to take the upside out of commodities because nobody aggressively builds steel inventory," said Macquarie's Train. "They don't chase prices all the way up, so prices stabilise at a high level."

But expectations that the tightening might be nearing its end suggest construction steel demand can only get stronger.

"The Chinese government will loosen its grip on credit to move ahead with construction projects, and the whole construction sector alone may consume nearly 100 million tonnes of crude steel in the third quarter," said Du Hui, analyst with Qilu Securities.

That compares to construction demand of around 84 million tonnes in July-September last year.

Construction, including property development, accounts for around half of China's steel demand, with the rest coming from machinery, car manufacturing, home appliances and shipbuilding. "It means a lot for steel demand and prices between July and September which used to see a seasonal lull and now we're not seeing that," said Du.

Ends --

By Manolo Serapio Jr. and Ruby Lian - for Commodities Now.