Have We Reached Peak Steel Demand in China? We Think Not

Transcription

1 Fixed Income Research Research Analysts Ric Deverell Marcus Garvey Andrew Shaw Ivan Szpakowski ivan.szpakowski@credit-suisse.com Martin Yu martin.yu@credit-suisse.com Have We Reached Peak Steel Demand in China? We Think Not Commodities Research T The Installed Stock of Steel is Still Very Low Over recent months many investors have begun to ask whether the Chinese steel party is likely to come to a painfully abrupt end this year. In terms of the shorter-term dynamics, we remain firmly of the view that Chinese consumption growth will show itself to have bottomed out in H1 this year, before recovering more robustly in H2 (see Chinese Housing and Commodity Demand: Healthy Growth Despite Private Dip). More generally, as the impact of the 2009 stimulus package washes out of the system, many have begun to ask whether Chinese steel consumption may be in the process of finding a level peak, much as was seen in the USA in the 1970s and Japan in the 1980s. While the future is by its very nature uncertain, we consider such a peak highly unlikely anytime soon. China s capital stock (including installed steel) is very low; and The key drivers of steel consumption (floor space added, increased high-rise construction, the general deepening of the capital stock, increased steel use in transport, and infrastructure improvements) are likely to maintain growth for some years longer. After expanding at an average of around 19% p.a. in the period , steel consumption growth has slowed to roughly 11.% p.a. since 2006 i.e., the steel intensity of GDP has already moderated substantially. However, rather than a one-off structural downshift, we expect a continued gradual moderation in the steel intensity of GDP growth, with rises in demand slowing to around 5% p.a. on average through to Exhibit 1: China s STOCK of capital is still very low... Capital stock per capita, US$ at constant 2005 prices Exhibit 2: China s steel consumption yet to peak, but growth rates moderating Finished steel demand, natural log $140,000 7 CAGR : 4.9% CAGR : 2.5% $120,000 $100,000 $80, CAGR : 18.7% CAGR : 11% 2011: 650 Mt 2015: 787 Mt 2020: 891 Mt $60,000 $40, Demand 2005: Mt Forecast $20,000 $ PPP China USA : Mt Source: Credit Suisse, US Bureau of Economic Analysis Source: Credit Suisse estimates, World Steel Association ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES ARE IN THE DISCLOSURE APPENDIX. FOR OTHER IMPORTANT DISCLOSURES, PLEASE REFER TO

2 China s Steel Demand: Is the Party Over? Worries in the near term Over the past few months one of the key concerns for commodity investors has been the near-term outlook for Chinese commodity demand, with the housing sector at the epicenter of those concerns. As we noted in Chinese Housing and Commodity Demand: Healthy Growth Despite Private Dip, while we expect a cyclical slowdown in Chinese commodity consumption over H1 2012, we expect a recovery as the year progresses, with apparent steel consumption increasing by 4-5% 1, copper 8% and aluminum 10% for the calendar year as a whole. leading to questions about structural decline Moving beyond the immediate cyclical prospects, however, a range of analysts and investors have recently begun to question whether China s commodity consumption growth has entered a substantial structural slowdown, with the more extreme analyses suggesting that the nation s commodity consumption may be nearing a level peak, or even facing a decline, as was the experience of the USA and Japan in the 1970s and 1980s respectively, for example. Much of the discussion surrounding changes in the structural pace of commodity consumption in China has been driven by the now clear objective of the policymakers (as embodied in the 12 th 5-Year Plan) to rebalance the Chinese economy away from exports and investment, and towards consumption and efficient, value-adding industry and services. Reshaping China s economy presents a major challenge to Beijing s planners While we agree that this transformation is likely to occur over time, we do not expect there to be step change this year. Indeed, we suspect that such a significant economic transformation may take far longer than most expect. We note that while many focus on the high level of investment as a share of GDP, the savings rate in China is yet higher, reducing many of the normal concerns associated with high investment rates. o It was the fact that investment was higher than savings (that is, they were running current account deficits) that led to problems in many Asian economies in the Asian crisis of While the high level of investment is likely to fall over time, it is notable that its current share of GDP is not materially higher than that seen for a period in several of the other Asian economies during their rapid industrialization. Most importantly, while the rate of investment has been very strong, the level of the capital stock in China remains very low compared to most industrial economies and, more importantly, compared to the needs (recognized in Beijing) of the country s large, and crowded, urban and rural populations. We believe this is a key point missed by bearish forecasters: China s development focus has moved to a quest for improved quality of urban (and for that matter, rural) living, which will require sustained levels of investment to achieve social and political objectives. Images of farmers flooding into China s cities are misleading: of the 20 million people added each year to the urban environment, more than half are absorbed by expanding metropolitan boundaries and infrastructure corridors. 1 Note: consumption, not production. Have We Reached Peak Steel Demand in China? We Think Not 2

3 Crucially, China s pattern of urban development is as much about urban renewal as it is about creating new towns. Most of its urban floor space is old, with inadequate, and in some cases appalling, utilities. China s average urban floor space per capita ignores the overcrowded living conditions of the majority of households. We are in the midst of one of the largest and most sustained removals of slums in modern history. Exhibit 3: China s STOCK of capital is still very low Capital stock per capita, US$ at constant 2005 prices $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $ PPP China USA Source: Credit Suisse, US Bureau of Economic Analysis So, investment will increasingly be directed at new second generation infrastructure, leveraging better technology: put simply, Beijing cannot afford to halt infrastructure development if it is to avert major problems associated with growing congestion, pollution, health and safety. Expenditure in this area is expected to slow in CAGR terms, from levels above 20% p.a. in recent years, but it is implausible that infrastructure spending will stagnate; we expect investment to maintain double digit rates (off a larger base) in the run-up to This includes renewed attention to networks from rail and mass-transit systems (rail length is planned to triple by 2020), water and waste treatment (long-neglected and very high on the social agenda) to power and energy infrastructure (targets far outpacing expected headline GDP growth). To us it is notable that even one of the key advocates of the structural change, the IMF, has its doubts about its likely pace. These concerns have been echoed in our meetings with government officials. o In its recent sustainability report, the IMF noted that both the authorities and the IMF expect the investment surge associated with the stimulus to fade, as construction returns to a more normal pace. o The IMF in its latest forecasts expects investment growth of 9.4% in 2012, and 8.9% in 2013, only modestly slower than was seen in 2011, suggesting very little rebalancing in the near term. The IMF also noted that it does not feel that the policies currently embodied in the 12 th 5- Year Plan will be sufficient to result in a substantial increase in the savings consumption share of GDP. o In this world, the authorities will be faced with the choice of either substantially weaker GDP growth, or the necessity to continue supporting rapid investment growth. The latter course to us seems more probable. Have We Reached Peak Steel Demand in China? We Think Not 3

4 In summary, we do not share the concerns of many investors. While it is likely that the pace of basic material consumption growth will slow gradually over time, this is part of an already established pattern. We do not see a sharp inflection point this year, although cycles often act as catalysts for faster change. We also note that while growth is likely to evolve, the substantial increase in the base should ensure that China continues to make a large contribution to global growth. For example, 10% growth off a base of 100 is the same in terms of absolute increment as only 5% growth off a base of 200. This argument is well illustrated by looking at the contribution of Chinese GDP growth to the global total: In the 1980s, China s GDP growth averaged 10%, with China contributing less than 10% of global growth. In the 1990s, China s GDP growth was also 10%, but its contribution stepped up to nearly 20%. Over , China s GDP growth again averaged around 10%, but the contribution grew to over 25%. Even if Chinese GDP growth slows to 8% p.a. in (substantially slower than in the last decade), its contribution to global growth should continue to increase, to more than a third in the first half of this decade. Exhibit 4: Despite slower growth, China s contribution to global totals is rising China s contribution to global GDP growth Exhibit 5: The consensus has consistently underestimated China s growth Chinese GDP growth relative to consensus forecasts 35.0% 16 Actual S Consensus Forecast S 30.0% % % 15.0% % 8 5.0% 6 0.0% 70s 80s 90s 00s 10s* Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse Source: the BLOOMBERG PROFESSIONAL service, RBA, Credit Suisse Finally, we should remember that the consensus has almost always underestimated the pace of Chinese growth. This was well illustrated just this week when markets were moved by the announcement that the government s target for GDP growth in 2012 had fallen to 7.5% from the previous 8%. History suggests that these targets have little impact on the outcomes, other than perhaps providing a floor. The economy is at greater risk of overshooting this conservative benchmark, in our view, as was the case in the past. As a way of illustrating the arguments underpinning these views, this note focuses on the steel market as an example. Over recent weeks many investors have asked us the question: Has China s annual steel demand (and hence production) reached a permanent peak? Have We Reached Peak Steel Demand in China? We Think Not 4

5 China s Steel Demand Growth The big question is it over? Intensity of use per person will China peak above Japan s 700 kg per capita? This is not a new question: In , the National Development and Reform Council (NDRC) wanted to cap China s steel production capacity at 300 Mt/y, and in 2005 the government forecast that steel demand in 2010 would be a little over 300 Mt, more than 250 Mt below the level recorded in that year. Debate has run long on the likely pinnacle for steel consumption per capita, with most analysts assuming that China would at least reach the 600 kg per person achieved by the USA at its peak, and possibly eclipse the 700 kg or more reached by Japan at the height of its investment cycle. This compares with a level of 480 kg per person in China in China, with an urbanizing population of 1.4 billion would lift annual steel consumption close to the 1 Bt/y mark on this measure, though picking the time of this anticipated plateau is problematical. This is due to limitations in the comparisons between China and developed nations; China is a continental-maritime economy, with a large population and an urban development pattern entailing very high population density. There are examples useful for mapping intensity of use trends, but it is now clear that China is unique in more ways than it is similar to other nations. For every city dweller associated with high steel use China s richest cities are characterized by steel use per capita of more than 1,000 kg there is a rural resident that consumes little, if any, steel the tyranny of weighted averages. In the case of more developed nations, peak steel has typically arrived at a point when real GDP per capita approaches US$20,000 (on a purchasing power parity basis), more than double the income levels of China in However, charting intensity per capita, while being a useful guide, does not provide a reliable forecasting tool. China s annual steel demand further yet to go In this report we lay out our own views of demand to This encapsulates a view that steel demand in China will approach 900 Mt/y by 2020, and potentially the 1 Bt/y mark by 2025, but that the pace of growth in both tonnage terms and in relationship to GDP growth will continue to slow as part of an already established pattern. Exhibit 6: China s steel intensity of use is below the peaks reached by Japan and the USA Steel use and GDP per capita Exhibit 7: Weighted average intensity of use masks wide differences between China s cities and regions Steel demand and GDP per capita Source: BHP Billiton Steelmaking Materials Briefing, 30 September 2011 Source: BHP Billiton Western Australian Iron Ore site tour, 27 September 2011 We also outline the core assumptions implicit in a belief that steel demand in China has already hit its peak and will grow no further; specifically, this path entails much lower rates of GDP growth and rapidly-receding investment growth, with major implications for social conditions in China. Have We Reached Peak Steel Demand in China? We Think Not 5

6 Accumulating China s capital stock Of all the industrial commodities, steel is the most heavily exposed to investment (rather than consumption) activity. Basically, steel is used in constructing a nation s capital stock of buildings, infrastructure and equipment. Today, 80% of China s annual steel demand is accounted for by buildings (of which homes account for 60%), primary and secondary infrastructure, and the capital goods (machinery and equipment) used in growing the nation s industry, which accounts for almost 50% of GDP. Other sectors such as transport and consumer/metal goods are growing rapidly, but in tonnage terms these still represent more modest totals for steel; unlike the USA, these uses are dwarfed by steel s role in structures. China s accumulated steel stock per person is less than onesixth of that of the USA and Japan China s use of steel has grown by more than 10 times in the past two decades, rising from levels barely above 60 Mt/y to around 650 Mt in In the past 50 years the country has accumulated almost 5 billion tonnes of steel, of which more than 3.7 billion tonnes has been installed in the last decade alone. China s annual steel use today the flow into this stock is 6-7 times greater than that of the USA and Japan/Korea, at their peak. Yet China s cumulative stock of steel is little more than 3 tonnes per person, compared with a level of tonnes per capita in the USA and Japan/Korea. These statistics reveal the key differences between China s economic development and that of other nations China s population is equally split between urban and rural living, though the pace of urbanization is advancing rapidly (at close to 20 million new urban residents each year). The use of steel is overwhelmingly connected to this urban expansion and pattern of renewal and development. Exhibit 8: China s annual consumption of steel is still well below Japan and Korea s levels Finished steel demand per capita, kg (2010) 700 Exhibit 9: and the country s accumulated stock of steel is far below the US and Japan/Korea s levels Finished steel in accumulated capital stock, tonnes per person China USA Japan + Korea 0 China USA Japan + Korea Source: World Steel Association, Credit Suisse Source: World Steel Association, Credit Suisse Most importantly, there is a view that China s capital stock accumulation is near completion. In our opinion this is a myth, apparent to any visitor spending time in China s overcrowded cities and travelling on its congested transport systems and highways. In the following, we highlight a few examples. China is expected to double its urban housing stock by 2025 to around 40 billion square meters: Much more than this will need to be added in terms of new floor space, to take into account the replacement of poor quality housing. In other words, China needs to build more than the total floor space that exists today again in the next years if it is to avoid deteriorating urban living conditions. Have We Reached Peak Steel Demand in China? We Think Not 6

7 On many measures of infrastructure needs, China is not even half built Doubling China s expressways by 2020 will not reduce traffic density: China has already constructed a network of more than 65,000 km of expressways (multi-lane highways), 30 times more than were installed in Consequently, China s density of passenger cars per kilometer of expressway has fallen from 377 in 1995 to around 300 today (compared to approximately 260 in the USA). China s auto population density is less than 6% (cars per 1,000 people), a level reached in the USA before 1920; rising incomes are resulting in rapid growth in vehicle population in China and, on conservative measures based on government targets, car density per expressway kilometer is expected to rise to almost 550 double US levels by This occurs despite a target of installing an additional 35,000 km of additional expressways. Exhibit 10: China s car production (log level) Log, thousands Chinese Auto Production, Log(thousands) Global Financial Crisis Trendline Enactment of subsidies Expiration of subsidies Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse Rapid growth in urban mass-transit metro systems: Today, 11 of China s major cities have urban metro rail systems. Another 50 cities are said to meet the government criteria of more than 3 million people and GDP thresholds to gain support for subway construction. China has an estimated 1,500 km of subway lines, treble the level of five years ago. This network is expected to double by 2015 and to double again by Rail networks are just one-eighth those of the USA on a per capita basis: Despite recent problems associated with China s passenger rail plans setbacks to high-speed rail ambitions have yet to be fully overcome China has the world s second largest rail network after the USA. With a similar land mass of 9.3 million square kilometers, though, China s 95,000 km is still half that of the US network in length for a population four times larger barely 12-13% of US totals on a per capita basis. Have We Reached Peak Steel Demand in China? We Think Not 7

8 Exhibit 11: Accumulating the capital stock of steel takes decades Finished steel consumption, Mt Exhibit 12: US intensity of steel use per capita did not peak until the 1970s Kg/capita (lhs), Percent (rhs) USA Japan + S. Korea US Steel intensity, kg/capita Urbanisation 100% 90% 80% 70% % % % Years 50 Years % 20% 10% % Source: World Steel Association, Credit Suisse Source: World Steel Association, Credit Suisse Water, water, everywhere, but not a drop to drink! China s Ministry of Environmental Protection states that 400 of 663 cities it has monitored face water shortages, while the Ministry of Water Resources calculates China s per capita water availability at one quarter of the world average. Half the population drinks contaminated and unsafe water. The sector is in line for considerably greater attention from an investment perspective in the next 5-10 years, with wastewater treatment capacity set to double by 2020, based on government targets. Energy infrastructure is a key target for the current 5-Year Plan: As one example, annual spending on power infrastructure is expected to double to RMB1.7 trillion by 2020, largely focused on efficiency improvements and deepening of the national grid. Generation capacity should more than double to 2,000 GW within the next decade. Absolute tonnes vs. percentage growth Steel intensity of use relative to GDP has fallen back from the unusually high levels of Exhibit 14 shows which sectors have contributed to steel demand growth most in the past decade. We have highlighted before that steel demand experienced a period of anomalously high growth from 2001, a year in which major reforms were enacted to open up the private property sector. This golden era appears to have come to an end in 2007, masked in part by the effects of the slowdown which saw steel demand stagnate for the first time in more than 10 years. In , the ratio of steel demand to GDP growth exceeded 2:1, but the ratio has fallen back to an average of a little over 1:1 in We expect the steel intensity of GDP growth to continue to moderate as the gradual economic transformation sought by the authorities takes place. Importantly, however, we do not expect a step change this year, with the transformation likely to be a more gradual process than most fear. Have We Reached Peak Steel Demand in China? We Think Not 8

9 Exhibit 13: The relationship between GDP and steel demand growth has changed over time Ratio of steel demand to GDP growth in Exhibit 14: Reflecting a rising return on the capital stock of steel that is installed in structures Finished steel demand by sector in China , Mt Forecast Other Metal Goods Consumer Goods Transport Capital Goods Infrastructure Construction Source: NBS, World Steel Association, Credit Suisse estimates Source: World Steel Association, Credit Suisse estimates Specifically, after tracking at a rate of around 1.1:1 with GDP growth since 2007, following the surge earlier in the decade, we expect the ratio to slowly fall further over coming years, to average in the years to 2016 and around 0.4 thereafter. Assuming GDP growth of 7-8% over this period, this would suggest annual compound growth rates of a still healthy 5%, albeit down from the 11% p.a. seen in o Looking further ahead, we assume that steel demand growth slows even further to 2-3% p.a. as we approach In tonnage terms, this translates into a decline in average annual incremental growth from more than 50 Mt/y in to Mt/y in and easing to 20 Mt./y by Doubtless we will experience sharp year-on-year variations around this trend-line. This would translate into slightly higher tonnages at the crude steel production level (beyond the question of likely trade in steel products). In addition to the macro parameters outlined above, these forecasts are underpinned by our sector analysis: During the boom, China s steel demand was largely accounted for by construction buildings were responsible for more than 55% of the total cumulative use of steel in , followed by capital goods (16%) and infrastructure (11%). Construction was still the most important driver of demand in , but its contribution fell below 50%, while capital goods accelerated its contribution to 23%. Steel s smaller end uses have also become more important since the boom. In aggregate, transport, consumer durables and all other uses have increased their share of cumulative use and are expected to contribute more than 20% of demand totals in the course of the 12 th 5-Year Plan ( ) these sectors are an important target for value-added revenue from steel producers. Have We Reached Peak Steel Demand in China? We Think Not 9

10 Five key driver s of steel demand growth In reality, there are many influences that dictate the rate of the flow of steel into core applications. We examine five of these seen as critical for determining the point at which steel demand peaks. An end to growth in steel would require a sharp change and stagnation in some, if not all, of these key drivers, impacting the flow into China s capital stock. These are: Rising floor space per capita and replacement of old urban housing are key drivers of annual growth in new floor space High-rise living comes with high steel intensity per square meter Driver 1: Increases in the amount of floor space added. Dominated by residential accommodation, new floor space installed has increased every year since 2000, with one exception (2008). On that occasion, growth accelerated sharply in the following year, and we postulate that any slowdown in H will trigger a later catch-up phase again, albeit at lower pace than in The net flow of people into the urban environment is but one aspect fuelling growth in floor space additions; there are a number of contributing factors: Average floor space per capita is expected to rise from 30 sqm to a government target of more than 40 sqm. Rising disposable income and changes in the nuclear family are influencing these patterns, as is high-rise development. Demolition of existing old floor space (usually of poor quality) with new, higher-quality units has many years to run. Less than one-third of China s urban floor space is by any sense of the word modern. Replacing poor quality, over-crowded dwellings is a key priority of government in the next decade. An expected doubling of China s urban residential housing stock to more than 40 billion square meters in masks the removal and replacement of an estimated 3% of existing urban floor space each year. Cyclical variations in this activity will be a feature of this trend, reflecting, for example, current shifts in policy and financing structures. The increase in supply of housing to meet greater mass needs is likely to result in a period of sharper acceleration in floor space additions, but probably beyond Driver 2: High-rise living is driving rapid increases in steel intensity of construction. China s cities are characterized by high population density and a preference for high-rise living. China today has more than 160 cities with populations greater than 1 million. The larger cities have an urban density of more than 20,000 people per square km, 4-5 times denser than London, Los Angeles, New York and Tokyo. High-rise living brings economic benefits (not least, sparing increasingly scarce arable land) in such cities, but comes with far higher steel intensity. Exhibit 15: Urbanization rates are forecast to increase from 50% to 64% by 2025 Urban population in China, % of total Exhibit 16: accompanied by rising floor space per capita Urban residential floor space per capita, square meters Source: UN Source: NBS, Credit Suisse estimates Have We Reached Peak Steel Demand in China? We Think Not 10

11 China s megacities will see a rapid increase in very high-rise (>30-storey) units in the next years, representing almost half the floor space installed. Even in smaller cities, lower rise (less than 6-storey buildings) will be relatively uncommon. Steel use per square meter of high-rise buildings exceeds 100 kg; in tenements of 7-15 floors it is typically kg/sqm. Steel intensity of commercial buildings is usually higher, and is also rising. Net increases in average steel intensity of construction of more than 50% in the next years are contributing more to annual steel demand growth than new floor space additions alone. Exhibit 17: Replacement of low-grade housing is a key driver of steel demand growth; high-rise units are raising steel intensity Shanghai housing clearance many more dwellings to come Exhibit 18: China s infrastructure roll-out is far from complete including enhancement and improvement of existing networks and utilities The Three Gorges Dam much more power infrastructure to come Source: Credit Suisse Source: Credit Suisse Driver 3: Increase in the fleet of capital goods. The absolute size of China s industrial economy and indeed its emerging services will continue to grow, stimulating continued growth in the fleet of equipment and machinery to service this growth. Growth in steel demand in this sector has outpaced all other applications in the past decade, but from a low base. Compound annual growth averaged 16% in , and we expect rates of growth to continue to match or slightly outpace GDP growth at around 9% in A number of trends are apparent here: Natural growth has, and should continue to be, an important driver. However, import substitution has also been responsible for a high pace of growth in steel use in this sector, especially as, to date, the most rapid growth has taken place in more basic, large volume products. Rates of growth relative to sector GDP expansion will moderate, reflecting a gradual shift towards producing higher-value added equipment; however, this evolution will take time (China still relies on imports of the most sophisticated machinery and equipment, though there are many examples where manufacturers are making inroads). Manufacturers are primarily servicing domestic markets, but are also positioning for export business, especially into other emerging markets. Have We Reached Peak Steel Demand in China? We Think Not 11

12 Steel s smaller uses are growing rapidly and are far from a point of market saturation Driver 4: Increase in transport sector steel use. China s vehicle and transport fleets are rising rapidly, but are far from maturity. Natural growth in these markets should also continue to match the general rate of GDP growth reflecting: Increases in vehicle fleet population and density to match comparable Asian regions China s vehicle production and ownership is rising rapidly, but the country has less than 60 autos per 1,000 people, compared to more than 160 in East Asia as a whole and almost 600 in Western Europe. Continued growth in truck and passenger transport fleets, mitigated by modal shifts to greater use of rail; however, expansion of China s export markets in this sector is also an influence. Driver 5: Shifting emphasis on critical infrastructure. China s focus on infrastructure development will persist, with an extra emphasis on energy, pollution control and raising efficiency, health and safety. It is possible that we are under-estimating the direct uses of steel in infrastructure. All things being equal though, a constant rate of installing, for example, road and rail line-kilometers should entail a constant rate of steel use; in the case of infrastructure the flow will be most heavily influenced by cyclical changes in the pace of investment in the sector, shifts between infrastructure sectors (with different steel intensities) and replacement rates of existing infrastructure (e.g., highway repairs). Tracking these changes in terms of their relative importance to steel and other commodities is a challenge, but is worthy of close monitoring; for example, a stronger emphasis on improving the power grid is clearly beneficial for aluminium and copper use. An important element of expanding the stock of infrastructure is the opening up of other activities through increases in productivity. The development of construction and industry along important road and rail corridors and in satellite cities is clearly a major factor in the annual increases of floor space over the past decade. Further, steel demand growth will likely be strongest in those activities, such as energy infrastructure, which are central to the current 5-Year Plan objectives. Growth in a myriad of other applications is likely to persist at relatively high rates in percentage terms, but volumetrically is subordinate to the influences outlined above. Are we being too bullish or bearish? On balance, we believe that we have constructed a view of future steel demand in China that reflects both the aspirations of the government to effect a change in economic direction, and to meet the need to extend and deepen China s capital stock of buildings, infrastructure and goods supporting both its industrial growth and evolution: Our forecasts are consistent with the emergence of a stronger services-based and higher value-added industrial economy. We consider that there is an upside risk to these forecasts should this year s cyclical concerns give way to a period of satisfying pent-up demand through higher investment rates than we have incorporated in our forecasts over We have highlighted that the period from 2001 to 2007 proved to be an anomalous one for steel demand growth. However, to believe that annual steel demand has now reached a level plateau, and that it may even fall into decline, is to assume that China s goals of improving urban (and indeed, rural) living standards are to be thwarted. A belief in peak steel implicitly comes with a core view of a sharper fall-off in investment activity and levels than is the case in our forecasts. We feel this peaking would have to be associated with headline GDP growth well below the 7-8% we expect in Have We Reached Peak Steel Demand in China? We Think Not 12

13 In short, peak steel would mean a capping out of the rate of creating housing supply, road, rail and utility infrastructure a lower quality outcome. The consequences of this result would emerge soon in the form of stagnating and deteriorating urban living conditions rising congestion, decaying utility infrastructure, inadequate shelter, especially for lower income groups, and disappointed aspirations. This would be a gloomy prognosis that could precipitate a big sell-off across basic materials plays and could also have knock-on effects into the broader global economy. Our own central forecasts point to future challenges for steelmakers and raw materials suppliers. While collectively these suppliers have consistently under-estimated the scale of China s demand, increased flow in supply a long-lagged response to higher prices and more intensive competition are sowing the seeds for further changes in the game in the next decade. Have We Reached Peak Steel Demand in China? We Think Not 13

14 GLOBAL COMMODITIES RESEARCH Ric Deverell, Managing Director Global Head of Commodities Research Eric Miller, Managing Director Global Head of Fixed Income and Economic Research LONDON One Cabot Square, London E14 4QJ, United Kingdom Tom Kendall, Director Head of Precious Metals Research Marcus Garvey, Analyst Martin Yu, Analyst TECHNICAL ANALYSIS Cilline Bain, Associate NEW YORK 11 Madison Avenue, New York, NY Jan Stuart, Managing Director Head of Energy Research Joachim Azria, Associate Stefan Revielle, Associate SINGAPORE One Raffles Link, Singapore Andrew Shaw, Director Head of Base Metals & Bulks Research Ivan Szpakowski, Associate

15 Disclosure Appendix Analyst Certification Ric Deverell, Andrew Shaw, Ivan Szpakowski, Martin Yu and Marcus Garvey each certify, with respect to the companies or securities that he or she analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. Important Disclosures Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail, please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: Credit Suisse s policy is to publish research reports as it deems appropriate, based on developments with the subject issuer, the sector or the market that may have a material impact on the research views or opinions stated herein. The analyst(s) involved in the preparation of this research report received compensation that is based upon various factors, including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's Investment Banking and Fixed Income Divisions. Credit Suisse may trade as principal in the securities or derivatives of the issuers that are the subject of this report. At any point in time, Credit Suisse is likely to have significant holdings in the securities mentioned in this report. As at the date of this report, Credit Suisse acts as a market maker or liquidity provider in the debt securities of the subject issuer(s) mentioned in this report. For important disclosure information on securities recommended in this report, please visit the website at or call For the history of any relative value trade ideas suggested by the Fixed Income research department as well as fundamental recommendations provided by the Emerging Markets Sovereign Strategy Group over the previous 12 months, please view the document at Credit Suisse clients with access to the Locus website may refer to For the history of recommendations provided by Technical Analysis, please visit the website at Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties. Emerging Markets Bond Recommendation Definitions Buy: Indicates a recommended buy on our expectation that the issue will deliver a return higher than the risk-free rate. Sell: Indicates a recommended sell on our expectation that the issue will deliver a return lower than the risk-free rate. Corporate Bond Fundamental Recommendation Definitions Buy: Indicates a recommended buy on our expectation that the issue will be a top performer in its sector. Outperform: Indicates an above-average total return performer within its sector. Bonds in this category have stable or improving credit profiles and are undervalued, or they may be weaker credits that, we believe, are cheap relative to the sector and are expected to outperform on a total-return basis. These bonds may possess price risk in a volatile environment. Market Perform: Indicates a bond that is expected to return average performance in its sector. Underperform: Indicates a below-average total-return performer within its sector. Bonds in this category have weak or worsening credit trends, or they may be stable credits that, we believe, are overvalued or rich relative to the sector. Sell: Indicates a recommended sell on the expectation that the issue will be among the poor performers in its sector. Restricted: In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated: Credit Suisse Global Credit Research or Global Leveraged Finance Research covers the issuer but currently does not offer an investment view on the subject issue. Not Covered: Neither Credit Suisse Global Credit Research nor Global Leveraged Finance Research covers the issuer or offers an investment view on the issuer or any securities related to it. Any communication from Research on securities or companies that Credit Suisse does not cover is factual or a reasonable, non-material deduction based on an analysis of publicly available information. Corporate Bond Risk Category Definitions In addition to the recommendation, each issue may have a risk category indicating that it is an appropriate holding for an "average" high yield investor, designated as Market, or that it has a higher or lower risk profile, designated as Speculative and Conservative, respectively. Credit Suisse Credit Rating Definitions Credit Suisse may assign rating opinions to investment-grade and crossover issuers. Ratings are based on our assessment of a company's creditworthiness and are not recommendations to buy or sell a security. The ratings scale (AAA, AA, A, BBB, BB, B) is dependent on our assessment of an issuer's ability to meet its financial commitments in a timely manner. Within each category, creditworthiness is further detailed with a scale of High, Mid, or Low with High being the strongest sub-category rating: High AAA, Mid AAA, Low AAA obligor's capacity to meet its financial commitments is extremely strong; High AA, Mid AA, Low AA obligor's capacity to meet its financial commitments is very strong; High A, Mid A, Low A obligor's capacity to meet its financial commitments is strong; High BBB, Mid BBB, Low BBB obligor's capacity to meet its financial commitments is adequate, but adverse economic/operating/financial circumstances are more likely to lead to a weakened capacity to meet its obligations; High BB, Mid BB, Low BB obligations have speculative characteristics and are subject to substantial credit risk; High B, Mid B, Low B obligor's capacity to meet its financial commitments is very weak and highly vulnerable to adverse economic, operating, and financial circumstances; High CCC, Mid CCC, Low CCC obligor's capacity to meet its financial commitments is extremely weak and is dependent on favorable economic, operating, and financial circumstances. Credit Suisse's rating opinions do not necessarily correlate with those of the rating agencies.

16 References in this report to Credit Suisse include all of the subsidiaries and affiliates of Credit Suisse AG operating under its investment banking division. For more information on our structure, please use the following link: This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject Credit Suisse AG or its affiliates ( CS ) to any registration or licensing requirement within such jurisdiction. All material presented in this report, unless specifically indicated otherwise, is under copyright to CS. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, without the prior express written permission of CS. All trademarks, service marks and logos used in this report are trademarks or service marks or registered trademarks or service marks of CS or its affiliates. The information, tools and material presented in this report are provided to you for information purposes only and are not to be used or considered as an offer or the solicitation of an offer to sell or to buy or subscribe for securities or other financial instruments. CS may not have taken any steps to ensure that the securities referred to in this report are suitable for any particular investor. CS will not treat recipients of this report as its customers by virtue of their receiving this report. The investments and services contained or referred to in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about such investments or investment services. Nothing in this report constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to your individual circumstances, or otherwise constitutes a personal recommendation to you. CS does not advise on the tax consequences of investments and you are advised to contact an independent tax adviser. Please note in particular that the bases and levels of taxation may change. Information and opinions presented in this report have been obtained or derived from sources believed by CS to be reliable, but CS makes no representation as to their accuracy or completeness. CS accepts no liability for loss arising from the use of the material presented in this report, except that this exclusion of liability does not apply to the extent that such liability arises under specific statutes or regulations applicable to CS. This report is not to be relied upon in substitution for the exercise of independent judgment. CS may have issued, and may in the future issue, other reports that are inconsistent with, and reach different conclusions from, the information presented in this report. Those reports reflect the different assumptions, views and analytical methods of the analysts who prepared them and CS is under no obligation to ensure that such other reports are brought to the attention of any recipient of this report. CS may, to the extent permitted by law, participate or invest in financing transactions with the issuer(s) of the securities referred to in this report, perform services for or solicit business from such issuers, and/or have a position or holding, or other material interest, or effect transactions, in such securities or options thereon, or other investments related thereto. In addition, it may make markets in the securities mentioned in the material presented in this report. CS may have, within the last three years, served as manager or co-manager of a public offering of securities for, or currently may make a primary market in issues of, any or all of the entities mentioned in this report or may be providing, or have provided within the previous 12 months, significant advice or investment services in relation to the investment concerned or a related investment. Additional information is, subject to duties of confidentiality, available on request. Some investments referred to in this report will be offered solely by a single entity and in the case of some investments solely by CS, or an associate of CS or CS may be the only market maker in such investments. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Information, opinions and estimates contained in this report reflect a judgement at its original date of publication by CS and are subject to change without notice. The price, value of and income from any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of securities and financial instruments is subject to exchange rate fluctuation that may have a positive or adverse effect on the price or income of such securities or financial instruments. Investors in securities such as ADR s, the values of which are influenced by currency volatility, effectively assume this risk. Structured securities are complex instruments, typically involve a high degree of risk and are intended for sale only to sophisticated investors who are capable of understanding and assuming the risks involved. The market value of any structured security may be affected by changes in economic, financial and political factors (including, but not limited to, spot and forward interest and exchange rates), time to maturity, market conditions and volatility, and the credit quality of any issuer or reference issuer. Any investor interested in purchasing a structured product should conduct their own investigation and analysis of the product and consult with their own professional advisers as to the risks involved in making such a purchase. Some investments discussed in this report may have a high level of volatility. High volatility investments may experience sudden and large falls in their value causing losses when that investment is realised. Those losses may equal your original investment. Indeed, in the case of some investments the potential losses may exceed the amount of initial investment and, in such circumstances, you may be required to pay more money to support those losses. Income yields from investments may fluctuate and, in consequence, initial capital paid to make the investment may be used as part of that income yield. Some investments may not be readily realisable and it may be difficult to sell or realise those investments, similarly it may prove difficult for you to obtain reliable information about the value, or risks, to which such an investment is exposed. This report may provide the addresses of, or contain hyperlinks to, websites. Except to the extent to which the report refers to website material of CS, CS has not reviewed any such site and takes no responsibility for the content contained therein. Such address or hyperlink (including addresses or hyperlinks to CS s own website material) is provided solely for your convenience and information and the content of any such website does not in any way form part of this document. Accessing such website or following such link through this report or CS s website shall be at your own risk. This report is issued and distributed in Europe (except Switzerland) by Credit Suisse Securities (Europe) Limited, One Cabot Square, London E14 4QJ, England, which is regulated in the United Kingdom by The Financial Services Authority ( FSA ). This report is being distributed in Germany by Credit Suisse Securities (Europe) Limited Niederlassung Frankfurt am Main regulated by the Bundesanstalt fuer Finanzdienstleistungsaufsicht ("BaFin"). This report is being distributed in the United States and Canada by Credit Suisse Securities (USA) LLC; in Switzerland by Credit Suisse AG; in Brazil by Banco de Investimentos Credit Suisse (Brasil) S.A; in Mexico by Banco Credit Suisse (México), S.A. (transactions related to the securities mentioned in this report will only be effected in compliance with applicable regulation); in Japan by Credit Suisse Securities (Japan) Limited, Financial Instruments Firm, Director-General of Kanto Local Finance Bureau (Kinsho) No. 66, a member of Japan Securities Dealers Association, The Financial Futures Association of Japan, Japan Securities Investment Advisers Association, Type II Financial Instruments Firms Association; elsewhere in Asia/ Pacific by whichever of the following is the appropriately authorised entity in the relevant jurisdiction: Credit Suisse (Hong Kong) Limited, Credit Suisse Equities (Australia) Limited, Credit Suisse Securities (Thailand) Limited, Credit Suisse Securities (Malaysia) Sdn Bhd, Credit Suisse AG, Singapore Branch, and elsewhere in the world by the relevant authorised affiliate of the above. Research on Taiwanese securities produced by Credit Suisse AG, Taipei Branch has been prepared by a registered Senior Business Person. Research provided to residents of Malaysia is authorised by the Head of Research for Credit Suisse Securities (Malaysia) Sdn Bhd, to whom they should direct any queries on This research may not conform to Canadian disclosure requirements. In jurisdictions where CS is not already registered or licensed to trade in securities, transactions will only be effected in accordance with applicable securities legislation, which will vary from jurisdiction to jurisdiction and may require that the trade be made in accordance with applicable exemptions from registration or licensing requirements. Non-U.S. customers wishing to effect a transaction should contact a CS entity in their local jurisdiction unless governing law permits otherwise. U.S. customers wishing to effect a transaction should do so only by contacting a representative at Credit Suisse Securities (USA) LLC in the U.S. This material is not for distribution to retail clients and is directed exclusively at Credit Suisse's market professional and institutional clients. Recipients who are not market professional or institutional investor clients of CS should seek the advice of their independent financial advisor prior to taking any investment decision based on this report or for any necessary explanation of its contents. This research may relate to investments or services of a person outside of the UK or to other matters which are not regulated by the FSA or in respect of which the protections of the FSA for private customers and/or the UK compensation scheme may not be available, and further details as to where this may be the case are available upon request in respect of this report. CS may provide various services to US municipal entities or obligated persons ("municipalities"), including suggesting individual transactions or trades and entering into such transactions. Any services CS provides to municipalities are not viewed as advice within the meaning of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. CS is providing any such services and related information solely on an arm s length basis and not as an advisor or fiduciary to the municipality. In connection with the provision of the any such services, there is no agreement, direct or indirect, between any municipality (including the officials, management, employees or agents thereof) and CS for CS to provide advice to the municipality. Municipalities should consult with their financial, accounting and legal advisors regarding any such services provided by CS. In addition, CS is not acting for direct or indirect compensation to solicit the municipality on behalf of an unaffiliated broker, dealer, municipal securities dealer, municipal advisor, or investment adviser for the purpose of obtaining or retaining an engagement by the municipality for or in connection with Municipal Financial Products, the issuance of municipal securities, or of an investment adviser to provide investment advisory services to or on behalf of the municipality. Copyright 2012 CREDIT SUISSE GROUP AG and/or its affiliates. All rights reserved. Investment principal on bonds can be eroded depending on sale price or market price. In addition, there are bonds on which investment principal can be eroded due to changes in redemption amounts. Care is required when investing in such instruments. When you purchase non-listed Japanese fixed income securities (Japanese government bonds, Japanese municipal bonds, Japanese government guaranteed bonds, Japanese corporate bonds) from CS as a seller, you will be requested to pay purchase price only.