Industry Trend Analysis - 19th National Party Congress: Implications For Mining & Metals - NOV 2017

BMI View: China ' s 19 th National Party Congress reaffirms our previous expectations for the mining and metals industry of the country for the upcoming years. In line with our core views, SOEs will remain the backbone of the industry, supply-side reforms will deepen with greater capacity cuts, and heightened environmental protection will boost prospects for copper, lithium and cobalt.

The 19th National Congress of the Communist Party of China (CPC) was kicked off by China's President Xi Jinping on October 18 and speeches and presentations throughout the week-long congress provided key insights into the country's political and economic trajectory over the next five years. Our inferences for the metals and mining industry from the 19th National Congress match our previous expectations and are in line with our existing core views for the country for the coming years. This article lays out the four main issues touched on at the congress that are applicable to the mining and metals industry, including state-owned enterprises (SOEs) remaining the backbone of the industry, smoother and more rigorous supply-side reforms of inefficient sectors, heightened environmental protection and relaxed foreign ownership requirements.

Profitabilities On The Rise Again For SOEs
Chinese State-owned Enterprises In The Coal & Metallurgy Sectors - Return On Equity (%)
Source: Wind, BMI

SOEs To Remain Sector's Backbone

State-owned enterprises (SOEs) will remain the backbone of the mining and metals industry, as displayed by the importance given to the state sector by the President at the 19 th national congress. Xi mentioned reforms of SOEs through the use of mixed ownership structures, as well as supply-side reforms that will result in better profitability for companies as inefficient and outdated facilities are shut down, business and operating costs are cut and debt is reduced. This approach has already been implemented for multiple steel and aluminium SOEs in 2017. For instance, Baoshan Iron & Steel, a listed subsidiary of China Baowu, saw its net profit rise 65% y-o-y in the first six months of 2017 aided by the disposal of inefficient assets, while Maanshan Iron & Steel shifted its production emphasis to high value-added products and saw a 260% increase in net profit over the same period.

More Aggressive Reforms Would Affect Actual Production
China - Steel Production Growth
Source: China Customs, BMI

More Rigorous Supply-Side Reforms Ahead

Supply-side reforms of inefficient and oversupplied industries (especially coal, steel and aluminium) will now progress at a smoother and more rigorous pace. This is part of President Xi's plan to refocus economic growth away from heavy industry towards the service sector, something we have been anticipating for a few quarters now. Thus far, the government's closure of production facilities on overcapacity grounds has mainly targeted idle capacity. Moreover, cut production in western provinces has at least been partially offset by new smelters and mines in eastern provinces. For instance, China steel production has grown by 5.7% y-o-y during January-August 2017, despite a ramp up in reported cuts to overcapacity. With a renewed focus on reducing overcapacity and deepened reforms mentioned at the national congress, government officials could start shutting down active capacity from facilities that are inefficient or polluting.

China's Copper Consumption To Hold Up With Green Shift
Amount Of Copper Required Per Vehicle Type (kg)
Source: Visual Capitalist, BMI

Heightened Environmental Protection To Hurt Coal While Copper, Lithium, Cobalt Benefit

Environmental protection will be heightened, leading to more consolidation of coal and steel companies while improving prospects for lithium, cobalt and copper miners, due to the use of these latter three commodities in electric vehicles and renewable energy systems. At the party congress, Xi reiterated pledges to tackle climate change. Hebei Province, which borders Beijing, has already started to limit steel and aluminium production to reduce air pollution. Additionally, on September 28, the government announced a new requirement for automakers with annual sales of more than 30,000 vehicles to meet a minimum sales quota of 10% for New Electric Vehicles, which include electric, plug-in hybrid and fuel cell vehicles, starting from 2019. This will increase to 12% from 2020 onwards.

Poor Competitive Landscape Amongst Peers
Asia - Mining Competitive Landscape Scores
Scores out of 100, higher score = more attractive market. Source: BMI Mining Risk/Reward Index

Relaxed Foreign Ownership Requirements Will Not Increase Mining FDI

Relaxed foreign ownership regulations mentioned during the national congress that apply to certain mining sectors will not necessarily result in increased mining FDI. While these will result in better, though not absolute, safeguarding of foreign investors' interests with regard to ownership rights, high barriers to entry will remain with the sector continuing to be dominated by SOEs that benefit from economies of scale and tremendous government support in terms of low-cost funding and preferential contracts. It will thus remain difficult for potential foreign investors to justify the economics of undertaking investment in a sector that largely lies in the hands of a few state-backed players. More generally, the attractiveness of China as a top FDI destination is also threatened by rising wage demands, while centralised economic policymaking means bureaucracy remains a key obstacle to doing business within the country. In the event of legal disputes, we do not expect Chinese authorities to give preference to foreign investors over citizens, despite improving ownership laws for foreigners (see ' Relaxed Foreign Ownership Requirements Will Not Increase Mining FDI ' , September 20).

Substantial Upside Risks To Metal Prices Depending On Future Capacity Reduction Drive
Global - Industrial Metal Price Growth
e/f = BMI estimate/forecast. Source: Bloomberg/BMI

Potential Impacts For Global Metals Prices

On their own, the greater commitment to capacity cuts could provide a dramatic boost to global metal prices, given that China is the world's largest producer of metals (see ' Scenario: Metal Price Rally Just Getting Started? ' , September 18). For context, China accounted for an average of 47.4% of global refined copper, aluminium and steel production in 2016, as well as an average of 24.3% of global mined copper, bauxite and iron ore output. However, this is contingent upon how strictly the government follows through on their aggressive capacity reduction plans, especially as unemployment levels start to rise and social issues become challenging for local authorities. Additionally, price gains would be curbed if demand for metals suffers even more than production due to a reorientation away from construction sector stimulus.