BMI China Metals Report Q2 2014

Q2 2014www.businessmonitor.com

CHINAMETALS REPORTINCLUDES 5-YEAR FORECASTS TO 2018

ISSN 2040-6762Published by:Business Monitor International

China Metals Report Q2 2014INCLUDES 5-YEAR FORECASTS TO 2018

Part of BMI’s Industry Report & Forecasts Series

Published by: Business Monitor International

Copy deadline: February 2014

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CONTENTS

BMI Industry View ............................................................................................................... 7

SWOT .................................................................................................................................. 10Metals SWOT .......................................................................................................................................... 10

Industry Forecast .............................................................................................................. 12Aluminium: Expanding & Shifting West ....................................................................................................... 12

Table: China - Aluminium Production, Consumption & Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Copper: Slowdown In Place ...................................................................................................................... 19

Economic Slowdown To Hit Consumption Growth ........................................................................................ 20

Falling Margins To Curb Output Growth .................................................................................................... 21Table: China - Refined Copper Production, Consumption & Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Lead: Autos Sector To Lend Support ........................................................................................................... 23Table: China - Refined Lead Production, Consumption & Balance (kt, unless stated otherwise) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Nickel: Growth To Slow As Economy Rebalances .......................................................................................... 26Table: China - Refined Nickel Production, Consumption & Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Steel: Bloated Sector Running Out Of Luck ................................................................................................... 29

Demand: Weakness Ahead, Longs To Underperform ..................................................................................... 30

Production: Boom Years Are Over ............................................................................................................ 33

No Sustainable Lifeline From Exports ........................................................................................................ 34

Limited Support From Stimulus Measures ................................................................................................... 35

Large Players To Dominate ..................................................................................................................... 36

Production To Shift Westwards ................................................................................................................. 37Table: China - Steel Production & Consumption Forecasts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

Table: China's Steel Industry, 2005-2012 (kt) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

Tin: Demand Growth To Prove More Resilient .............................................................................................. 38Table: China - Refined Tin Production, Consumption & Balance (kt, Unless Stated Otherwise) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

Zinc: Hit By Faltering Steel Sector .............................................................................................................. 43Table: China - Refined Zinc Production, Consumption & Balance (kt, Unless Stated Otherwise) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

Regulatory Development .................................................................................................. 48Table: Political Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Commodities Forecast ..................................................................................................... 52Commodity Strategy ................................................................................................................................. 52

Aluminium: Continued Short-Term Weakness .............................................................................................. 55

Copper: Recent Strength Doesn't Change Our View ...................................................................................... 55

Nickel: Recent Strength To Subside ........................................................................................................... 57

Zinc: Price Momentum To Continue .......................................................................................................... 59Table: Select Commodities - Performance & BMI Forecasts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

Commodities Forecast .............................................................................................................................. 61Table: BMI Steel Forecast . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

China Metals Report Q2 2014

© Business Monitor International Page 4

Short-Term Outlook ................................................................................................................................ 62

Core View ............................................................................................................................................. 62

Global Steel Glut To Persist ..................................................................................................................... 62

Production: Rationalisation In The Long Term ............................................................................................ 63

Consumption: Growth Decelerating ........................................................................................................... 65

Excessive Chinese Exports ....................................................................................................................... 66

Growing Arbitrage Between East & West ................................................................................................... 67

Risks To Price Outlook ............................................................................................................................ 67Table: Steel Data & Forecasts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

Table: Global Steel Prices By Region & Product, US$/tonne (ave) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

Competitive Landscape .................................................................................................... 70Table: China - Largest Listed Metal Producers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72

Company Profile ................................................................................................................ 74Aluminum Corporation of China (Chalco) .................................................................................................... 74

Company Overview ................................................................................................................................ 75

Latest Financial Results .......................................................................................................................... 75Table: Chalco - Key Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

Baoshan Iron & Steel ............................................................................................................................... 78Table: Baoshan Iron & Steel - Key Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

Angang Steel .......................................................................................................................................... 82Table: Angang Steel - Key Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

Methodology ...................................................................................................................... 86Cross Checks ........................................................................................................................................ 86



BMI Industry View

BMI View: China's metals industry is set to face a protracted period of slowing growth as the country's

rebalancing process begins in earnest. Companies operating in sectors that are tied heavily to the

construction industry will take the brunt of weakness from the sharp slowdown in fixed asset investment.

With the Chinese economy on course for a continued slowdown over the coming years, we expect China's

metals industry to come under greater pressure. The rebalancing of the Chinese economy away from fixed-

asset investment and towards private consumption will significantly dampen appetite for construction-

related materials. In particular, metals such as steel and refined nickel will be adversely affected due to their

heavy usage in the construction sector.

Slowdown Underway

China - Real GDP (% chg y-o-y)

2007

2008

2009

2010

2011

2012

2013

f

2014

f

2015

f

2016

f

2017

f

0

2

4

6

8

10

12

14

16

f = BMI forecast. Source: BMI, National Bureau of Statistics

We forecast China's real GDP growth to average 6.1% between 2013 and 2023, compared with an

impressive average growth rate of 10.3% per annum over the past decade. In our view, attempts by the

Chinese government to arrest the structural slowdown in the country's economy will only cushion the



impact of an economic slowdown, rather than revive a growth upturn. That said, we note that China will

retain a structural deficit for key metals such as iron ore, copper and nickel despite slowing consumption

growth.

Demand Slowing...

China - Consumption Of Select Commodities (% of Global Total)

f = BMI forecast. Source: BMI, WBMS, EIA

Government plans to significantly consolidate the metals and mining industry will continue to gain traction

in the coming months, particularly with growing environmental concerns and increasing scrutiny on local

government debt. Consolidation of the metals' industry will be driven by slumping profit margins, falling

prices and the reorientation of China's economy away from fixed asset investment and towards private

consumption. Indeed, state-owned companies, which already enjoyed a dominant role in the mining and

metals industry, will emerge to be even more prominent after the consolidation.



...But Still Retaining Appetite For Some

China - % Of Global Production & Consumption (2012)

Source: BMI, WBMS

However, we are aware that efforts aimed at consolidating the Chinese steel industry are susceptible to

several roadblocks. First, anecdotal evidence suggests that local governments, reliant on steel revenues,

often idle furnaces only for a period of time long enough to escape the central government's attention.

Second, some of the furnaces that were torn down in Hebei had in fact been sitting idle for some time.

Third, it is estimated that the potential job losses stemming from all state-required capacity cuts could reach

as high as 200,000, a figure that could trigger widespread social unrest amidst the slowdown of the Chinese

economy.

While injunctions from the new leaders to rationalise and consolidate the bloated steel industry have been

forthcoming in recent months, we continue to harbour doubts over the effectiveness of the policies initiated.

For instance, China's edict to more than 1,900 companies to shut excess production capacity across many

different sectors in 2013 is unlikely to have much impact on the metals industry. According to the China

Steel Association, the edict will result in just 7mn tonnes (mnt) of steel output being idled in a sector that

has more than 300mnt of surplus capacity. Similarly, China has ordered about 286 thousand tonnes (kt) of

excess aluminium output to be shut when smelting capacity is 30mnt and demand is about 23mnt.



SWOT

Metals SWOT

SWOT Analysis

Strengths ■ Resilient growth in the automobile sector will provide a silver lining for lead, and to a

lesser extent, aluminium producers.

Weaknesses ■ Metals consumption growth will experience a marked slowdown over the coming

years as China's rebalancing process begins in earnest. Steel will be the hardest hit

due to its heavy usage in the construction sector.

■ Remains heavily dependent on higher-grade iron ore (62% content) from Australia

and Brazil.

■ Stimulus measures will provide only limited respite to the metals industry. Indeed,

China's economy appears to be finally buckling under the weight of its credit binge

and we believe that a recession is at hand.

Opportunities ■ Continual restructuring of China's metal and mining industry, as part of the 12th Five-

Year Plan (2011-2015), creates opportunities for larger players to gain market share.

■ Closure of smaller, less efficient mines will give way to further productivity gains down

the road.



SWOT Analysis - Continued

Threats ■ Imports of raw materials such as bauxite and nickel ore are threatened by resource

nationalism and debilitating regulations in countries such as Indonesia.

■ Profit margins for the Chinese steel sector are as low as 0.4%, as of December

2013.

■ Recent clampdown in bank lending to the steel sector will see more producers going

out of business.

■ Efforts to curb environmental pollution could lead to tighter regulations on the metals

industry over the coming quarters.



Industry Forecast

Aluminium: Expanding & Shifting West

BMI View: The entrenched problem of overcapacity in the aluminium industry is unlikely to fade away

anytime soon. China will continue to drive the supply glut in the global market with the migration of its

smelter capacity west, where rich deposits of thermal coal that will help to substantially lower the costs of

production are located. Indeed, private consumption of durable goods and continued growth in the autos

sector will fail to absorb excess supply in the Chinese market, and this could translate into greater volumes

of cheap aluminium shipments from China over the coming quarters.

We expect China to remain the key growth driver in global aluminium production over the coming years, a

consistent trend over the past decades. According to the London Metal Exchange, China accounted for 119

of the 133 aluminium smelters built globally between 1985 and 2005. Admittedly, the Chinese

government's gradual embrace of free market economics should put an end to the years of artificial support

enjoyed by many domestic producers. However, we believe the global aluminium market will remain

suppressed by the weight of supply pressure from China over the coming years.



China In Driving Seat

Global Aluminium Production (As % Share of Total Output)

e/f = BMI estimate/forecast. Source: WBMS, BMI

Despite production cutbacks by international producers in recent quarters, the entrenched problem of

overcapacity in the aluminium sector is unlikely to fade away anytime soon. Major producers such as Alcoa

and Rusal will continue to suffer the pain of supply glut emanating from China in the medium term, while

the looming LME warehouse reforms could unleash a flood of metal onto the market (see 'LME Changes To

Be Felt In Aluminium Market', November 11, 2013).



Persistent Overcapacity

Aluminium - Global Production Balance (LHS) & Stocks-To-Use Ratio (RHS)


We forecast Chinese aluminium output to increase at an average clip of 5.1% between 2014 and 2017, with

the country's share of global output rising from 46.8% to 49.1% over the same period. In a bid to improve

its sitting on the global cost curve, China has been pushing its aluminium industry to 'go west' since 2012.

According to market estimates, production capacity at the far north-western province of Xinjiang will

increase from 1.5mn tonnes per annum (mntpa) in 2012 to 8-12mntpa in 2015, 15-20mntpa by 2020, and

eventually, up to 30mntpa.



Going West...

China - Aluminium Production - By Province (mnt, 2013) & As % Share of Total (LHS)

Source: Antaike Information Development, BMI

Crucially, Chinese aluminium producers are leveraging on the rich deposits of thermal coal in Xinjiang to

lower their costs of production. With around 1.1tn tonnes of thermal coal on offer, the costs of mining coal

in the province range between US$9/tonne for open-cut mines to US$23/tonne for underground operations.

As a result, power costs in Xinjiang are as low as one-sixth of those in eastern China. Given that the price of

energy accounts for as much as 40% of aluminium production costs, the availability of cheap electricity in

Xinjiang should insulate smelting operations from weakness in aluminium prices to a certain extent. To be

sure, total production costs in Xinjiang are estimated to be US$450-700/tonne lower than the country's

existing capacity, despite incurring higher freight, labour and capital costs.



...For Power Savings

Aluminium Production Cost By Category (As % Share of Total Cost)

Source: AME, CBA, BMI. Note: Data last dated 2011.

Additionally, we note that advances in smelter potline technology have substantially improved power

efficiency in China's aluminium sector over the years. At present, power consumption for every unit of

aluminium output in China is approximately 13.4kwh/kg, compared with the global average of 14.0kwh/kg.

While the mineral export ban in Indonesia will stem bauxite supply to the seaborne market (see 'Mineral

Export Ban Watered Down On Cue', January 15, 2014), this is unlikely to have a significant impact on

Chinese aluminium production in the coming years. First, we continue to believe that Indonesia's export

ban on unprocessed ores will eventually be moderated over the coming quarters. Second, Chinese alumina

refiners have accumulated substantial stockpiles of bauxite, estimated at 18 months of import cover, ahead

of the ban. Third, the Chinese government has been pressing for lower dependency on imports by

encouraging the development of domestic supplies. China's Ministry of Industry and Information

Technology has mandated that all new alumina projects in the country must be vertically integrated with

nearby bauxite mines and equipped with an output capacity of at least 800 thousand tonnes per annum

(ktpa). Lastly, supply from other major bauxite producers such as Australia and Brazil should buffer the

impact of a supply halt in Indonesia.



Seeking Supply Security

China - Bauxite Production

Bauxite Production, mnt (LHS)% chg y-o-y (RHS)

2005

2006

2007

2008

2009

2010

2011

2012

2013

e

2014

f

2015

f

2016

f

2017

f

0

10

20

30

40

50

60

70

80

0

10

20

30

40

e/f = BMI estimate/forecast. Source: USGS, BMI

In our view, the migration of Chinese smelter capacity towards the west will cause a major downside risk to

aluminium prices over the medium term. The push to lower cash costs by capturing better power economics

in Xinjiang could exacerbate the oversupply problem in the aluminium industry more than we currently

anticipate. A swelling domestic surplus could result in greater volumes of cheap Chinese aluminium seeping

into the global market. We forecast aluminium prices to remain subdued over the coming years, increasing

from an average of US$1,887/tonne in 2013 to US$2,050/tonne in 2017 (see 'Aluminium Prices To Average

US$1,850/tonne In 2014', January 16, 2014).



Struggling To Head Higher

Three-Month LME Aluminium (US$/tonne)

2007

2008

2009

2010

2011

2012

2013

2014

f

2015

f

2016

f

2017

f

0

500

1,000

1,500

2,000

2,500

3,000

f = BMI forecast. Source: Bloomberg, BMI

We expect China to post a growing surplus of aluminium production in the coming years. While private

consumption of durable goods and continued growth in the autos sector will bolster demand growth for the

metal, this will fail to absorb excess supply in the domestic market. The structural shift of the Chinese

aluminium industry to the west will force the exit of marginal producers in the eastern and central provinces

(particularly Henan, Sichuan, Gansu and Yunnan) over the coming quarters. Nonetheless, aluminium

production in China will continue to grow in absolute terms as the industry heads towards a lower-cost

model.



Table: China - Aluminium Production, Consumption & Balance

2009 2010 2011 2012 2013e 2014f 2015f 2016f 2017f

Primary Aluminium(000 tonnes)

Consumption 14,300 15,854 17,629 20,275 21,978 23,186 24,230 25,369 26,434

% Change y-o-y 15.2 10.9 11.2 15.0 8.4 5.5 4.5 4.7 4.2

Production 12,890 16,244 18,062 20,268 22,092 23,417 24,705 25,841 26,953

% Change y-o-y -2.2 26.0 11.2 12.2 9.0 6.0 5.5 4.6 4.3

Balance -1,410 390 433 -7 114 231 475 473 519


Copper: Slowdown In Place

China will retain its dominance in the global copper sector despite our expectation for a continued

slowdown in the country's economy. China is the world's largest producer and consumer of refined copper,

accounting for 28.5% and 43.2% of global total in 2012, respectively. With a persistent shortfall in copper

production, the country has accounted for an increasing proportion of global refined imports over the last

decade to 41.8% in 2012.



Import Growth To Slow

China - Copper Production, Consumption & Balance (kt)


Economic Slowdown To Hit Consumption Growth

We believe growth in refined copper consumption will weaken in the coming quarters on our expectation

that the economic slowdown in China will come back into focus in H114 (see 'Banking Instability To Weigh

On Growth Prospects In 2014', January 20). Weakness in the economy will be centred on the heavy

industry and construction sectors, which have been key drivers of copper demand over recent years.

However, we expect demand for copper to hold up better compared with other industrial metals such as

steel and nickel which are more reliant on fixed capital investment as a source of demand.



Growth To Cool

China - Copper Production & Consumption (% chg y-o-y)

Source: WBMS

We forecast a slowdown in copper consumption growth to 4.7% between 2014 and 2017. This compares

with an average growth rate of 12.8% over the past decade, during which a boom in residential and

infrastructure construction and the development of export-led manufacturing underpinned a surge in copper

usage.

Falling Margins To Curb Output Growth

Chinese refined copper production is relatively consolidated in the hands of a few large players, with

Jiangxi Copper being the largest producer, at around 18% of the country's total output in 2011. Jiangxi

Copper will be a key growth driver in copper output over our forecast period, although production targets

are likely to be scaled back due to falling profitability. We believe profit margins for copper smelters will

remain under pressure over the coming quarters given our expectation for copper prices to remain subdued

against the backdrop of slowing economic growth in China. We forecast Chinese copper production to grow

at an average clip of 7.1% per annum in the coming years.



State-Run Companies To Maintain Dominance

China - Refined Copper Production By Company (2011)

Source: Reuters

Import Growth To Weaken Eventually

China's refined copper imports fell 5.6% year-on-year (y-o-y) to reach 3.2mn tonnes (mnt) in 2013, down

from a record 3.4mnt in 2012. While imports for December expanded by 30.8% y-o-y, we believe the

Chinese government's clampdown on the copper-collateral trade will eventually lay bare a weaker trade

picture. Beijing implemented a set of new rules in May 2013 in order to crack down on trade financing

based on fabricated trades, causing more banks to limit funding for smaller copper importers.



Table: China - Refined Copper Production, Consumption & Balance

2009 2010 2011 2012 2013e 2014f 2015f 2016f 2017f

Refined Copper ('000 tonnes)

Consumption 7,086 7,385 7,915 8,840 9,768 10,393 10,913 11,404 11,746

% Change y-o-y 37.6 4.2 7.2 11.7 10.5 6.4 5.0 4.5 3.0

Production 4,051 4,540 5,197 5,824 6,901 7,522 8,086 8,636 9,068

% Change y-o-y 6.8 12.1 14.5 12.1 18.5 9.0 7.5 6.8 5.0

Balance -3,035 -2,845 -2,718 -3,017 -2,867 -2,871 -2,827 -2,768 -2,679


Lead: Autos Sector To Lend Support

BMI View: We forecast Chinese refined lead production to increase at an average rate of 3.3% between

2014 and 2017. The industry-wide clampdown on small lead plants over the past quarters is unlikely

to reduce output considerably as a large number of firms are choosing to expand capacity by building even

bigger plants. Imports for refined lead should hold up over the long term as lead consumption proves more

resilient than construction-related metals such as steel and nickel, while production for the metal remains

constrained by the country's consolidation plan.

We expect China to remain a dominant player in the global industry for both refined lead production and

consumption, having accounted for just under half of both in 2012. The country is almost self-sufficient in

lead supply and runs a negligible domestic deficit. As a result, China accounted for 1.7% of global refined

lead imports in 2012.

Consumption: Not As Exposed To Construction Slowdown

Despite our downbeat macro view on China, we believe demand for lead will be less affected than other

industrial metals due to its primary usage in the autos sector. Lead-acid battery production is also quite

inelastic given that 60-70% of production is for replacement batteries. We forecast growth in Chinese

refined lead consumption to improve over the coming quarters, following a slowdown in 2013. We expect

consumption growth to average 4.1% per annum between 2014 and 2017.



Locked In Structural Deficit

China - Refined Lead Production, Consumption & Balance (kt)

e/f = BMI estimate forecast. Source: BMI, WBMS

Production: Modest Growth Ahead

We forecast refined lead production in China to average 3.3% between 2014 and 2017, compared with an

annual growth rate of 11.8% over the past decade. With China accounting for 44% of global lead

production, a slowdown in Chinese lead output growth will have a major impact on global lead production

levels. China was the main driver of global growth between 2008 and 2012, with production growing at an

annual average rate of 11.0% compared with the average growth rate of 4.7% globally.

Refined lead production growth over our forecast period will be well-below historical averages given the

Chinese government's plan to curb non-ferrous metal production growth, as part of China's 12th Five-Year

Non-ferrous Industry Plan (2011-2015). The Chinese government plans to consolidate the lead industry by

ensuring that the top 10 smelters in the country will eventually account for 60% of total lead production by

2015. Crucially, lead will be a particular focus of the government given its poisonous properties which have

resulted in a steady flow of lead-poisoning events across the country. China plans to contain output growth

of the top 10 major non-ferrous metals to an average annual rate of 8% between 2011 and 2015 compared

with 13.7% between 2006 and 2010.



Recovery Ahead

China - Refined Lead Production & Consumption (% chg y-o-y)

Source: BMI, WBMS

In 2013, China ordered small lead plants with an annual capacity of 30 thousand tonnes per annum (ktpa) to

either shut down operations by year-end or upgrade their facilities to reach a minimum annual capacity of

50ktpa. However, this is unlikely to adversely affect output growth significantly over our forecast period.

Anecdotal evidence suggests that a large number of firms are choosing to expand their capacity by building

even bigger plants. Indeed, the industry-wide clampdown over the past quarters would not be enough to

offset the entry of a new generation of modern, high-tech facilities that will be entering the supply chain

soon.

Secondary Production To Suffer

We believe secondary production growth will not grow at double-digit rates again in the near term as the

government focuses on closing down secondary production first. Recyclers are more prone to causing

environmental damage due to the production process. Secondary production growth declined sharply to

3.8% in 2012 compared with an average of 16.9% for the previous three years.



China To Remain A Marginal Importer

China will be a net importer of refined lead in the coming years as the domestic market remains locked in

deficit over our forecast period. Although Australia is the world's largest exporter of refined lead, Chinese

imports from the country have dwindled in recent years as shipments from secondary producers have

increased. According to the WBMS, Australia only exported 838 tonnes of refined lead to China in 2012,

compared with 10.3kt in 2010.

Table: China - Refined Lead Production, Consumption & Balance (kt, unless stated otherwise)

2008 2009 2010 2011 2012 2013e 2014f 2015f 2016f 2017f

Refined Lead ('000 tonnes)

Consumption 3,456 3,925 4,212 4,662 4,673 4,589 4,754 4,944 5,152 5,389

% Change y-o-y 34.3 13.6 7.3 10.7 0.2 -1.8 3.6 4.0 4.2 4.6

Production 3,452 3,773 4,199 4,648 4,646 4,604 4,696 4,837 5,006 5,231

% Change y-o-y 23.8 9.3 11.3 10.7 0.0 -0.9 2.0 3.0 3.5 4.5

Balance -5 -152 -13 -15 -27 15 -58 -107 -145 -157

e/f = BMI estimate/forecast. Source: BMI, WBMS

Nickel: Growth To Slow As Economy Rebalances

BMI View: A rebalancing of the Chinese economy towards private consumption rather than fixed-asset

investment will impose downward pressure on the refined nickel industry and we forecast significantly

slower production and consumption growth than over the previous decade. We expect refined nickel

production to grow at an annual average rate of 5.0% to reach 576kt by 2017, while consumption will

increase by 6.5% per annum over the same period to reach 1.02mnt.

China is by far the world's largest refined nickel producer and consumer, accounting for 33% and 47% of

global output and consumption in 2012, respectively. The country, however, has been experiencing a

structural deficit in refined nickel production over the past decade and we believe this trend will persist to

reach a deficit of 300 thousand tonnes (kt) by 2017. With imports at around 25% of the global total, China

is also the largest refined nickel importer in the world.



Persisting Reliance On Imports

China - Refined Nickel Production, Consumption & Balance (kt)


We expect Chinese nickel consumption growth to slow over our forecast period as demand from the bloated

steel sector falters (see 'Writing On The Wall For Chinese Steel', July 31, 2013). Indeed, stainless steel

represents the largest industrial use for refined nickel as a common component in the construction,

automotive and engineering sectors.

The key factor underpinning our downbeat view on China's steel industry is our expectation for a continued

slowdown in fixed-asset investment as private consumption becomes an increasingly important driver of

growth in the Chinese economy. As such, we believe construction activity in China will moderate

significantly over the coming quarters and this will have a notable impact on growth in refined nickel

consumption given the steel-intensive nature of the industry. We forecast refined nickel consumption to

grow at an average rate of 6.5% per annum between 2014 and 2017, compared with an average annual

growth rate of 23.5% over the past decade.

Our forecast for refined nickel production growth in China is largely driven by the output expansion of the

country's largest refiner, Jinchuan Non-Ferrous Metals. The company plans to expand production



capacity from 90ktpa to 300ktpa by 2014. Nonetheless, we expect nickel production growth to slow over

our forecast period in line with our downbeat macro view on China. We expect to see China's economic

growth slow from 7.7% in 2013 to 7.1% in 2014 as reform efforts undermine traditional areas of investment

growth.

Indonesia's Pullback No Major Threat

China - Nickel Ore Imports By Country (2012)

Source: BMI, WBMS

With the mineral export ban in Indonesia firmly in place (see 'Mineral Export Ban Watered Down On Cue',

January 15, 2014), we expect the Chinese nickel market to undergo shifting trade dynamics over the

coming quarters. The Indonesian government's decision to press ahead with the export ban on nickel ore

could see China turning to the Philippines to fill the supply gap once its domestic inventories are being

depleted. However, we are aware that low-grade ore from the Philippines may considerably undermine the

economics of Chinese NPI production and prompt China to step up its purchases of refined nickel

altogether. Nevertheless, our core view remains that the export ban on nickel ore will eventually be

moderated and replace with further hike in export tax over the coming quarters.



Table: China - Refined Nickel Production, Consumption & Balance

2009 2010 2011 2012 2013e 2014f 2015f 2016f 2017f

Refined Nickel ('000 tonnes)

Consumption 490 446 610 724 841 894 939 983 1029

% Change y-o-y 53.3 -9.0 36.9 18.7 16.1 6.4 5.0 4.7 4.6

Production 273 318 354 390 461 490 518 547 576

% Change y-o-y 31.3 16.5 11.3 10.2 18.1 6.3 5.8 5.5 5.3

Balance -217 -128 -256 -334 -380 -405 -421 -437 -453


Steel: Bloated Sector Running Out Of Luck

BMI View: China's bloated steel sector is set to come under increasing pressure over the coming quarters

as a result of contracting growth in fixed asset investment. Weak end-user demand and low prices will

maintain pressure on producer margins and we forecast significantly slower production and consumption

growth compared with the previous decade. While rising steel exports from China have been an outlet to

relieve domestic overcapacity, this is unlikely to be a sustainable trend due to the proliferation of anti-

dumping investigations by other countries in recent quarters.

As spotlighted by the demise of Suntech Power Holdings, the world's largest solar manufacturer, in 2013,

we are starting to see signs of a broader realisation on the part of Beijing that the previous government's

state investment-led policies were inherently unsustainable. With a raft of precarious fundamentals

weighing heavily on the Chinese steel industry, we believe the decades of blind expansion and artificial

government-led support are fast catching up with the sector. According to the China Iron and Steel

Association (CISA), the average profit margin for 80 major Chinese steel producers reached 0.13% in

H113, the lowest among all industries in the country.

We forecast Chinese steel production to grow by an annual clip of 4.3% between 2014 and 2017, while

consumption growth will increase by an average of 5.0% per annum over the same period. This will mark a

dramatic slowdown from the previous decade, during which annual production and consumption growth

averaged 13.7% and 11.4%, respectively.



Consolidation A Slow Process

China - Steel Production, Consumption And Balance (mnt)


China is by far the world's largest steel producer and consumer, accounting for 45.3% and 44.5% of global

output and consumption in 2011, respectively. It runs a domestic steel surplus, but is only a modest

exporter.

Demand: Weakness Ahead, Longs To Underperform

The key factor underpinning our downbeat view on China's steel industry is our expectation of a sharp

slowdown in Chinese fixed-asset investment, which will see further softening in demand growth for steel.

We expect construction activity in China to moderate significantly, which will have a notable impact on

demand given the steel-intensive nature of the industry.



Waning Support For Steelmakers

China - Select Indicators (% chg y-o-y)

Fixed Capital FormationConstruction Industry Value Real GDP

2007

2008

2009

2010

2011

2012

2013

2014

f

2015

f

2016

f

2017

f

0

4

8

12

16

20

24

f = BMI forecast. Source: National Bureau of Statistics, China Statistical Yearbook, BMI.

We expect growth in Chinese construction activity to moderate significantly, and forecast construction

sector value growth of 5.1% in 2014, compared with 6.4% in 2013. At the heart of this slowdown will be a

rebalancing of the economy away from fixed asset investment. This trend will be exacerbated in the short

term by a sharp contraction in residential construction. Our core view remains that the property tightening

measures enacted in 2013 are unlikely to be rolled back in the face of continued rising prices. As a result,

we forecast growth in apparent steel use to slow to 3.5% in 2014 from an estimated 6.1% in 2013.



Demand Slowing As China Shifts Gear

China's Steel Consumption By Sector (2011)

Source: CISA, Bloomberg Industries

Due to the nature of China's economic slowdown, we expect the flats segment to experience more resilient

demand than the longs segment. The longs segment will be weighed down by an end to the boom years for

construction, while flats will be supported by a more resilient outlook for domestic manufacturing and

consumption.



Creeping Up

China - Total Steel inventories

Source: Shanghai Steelhome Information, BMI

Production: Boom Years Are Over

We believe consolidation of the behemoth Chinese steel sector will be primarily driven by the deterioration

in margins that has made production unprofitable at many smaller, inefficient mills. While abundant finance

has previously allowed such mills to shore up operations in recent years, a clampdown on bank lending to

the steel sector will bring to the fore the cost rationalisation of production.



Production Growth To Slow

China - Crude Steel Production

Source: WSA, BMI

However, we are aware that efforts aimed at consolidating the Chinese steel industry are susceptible to

several roadblocks. Anecdotal evidence suggests that local governments, reliant on steel revenues, often idle

furnaces only for a period of time long enough to escape the central government's attention. Additionally,

some of the furnaces that were torn down in Hebei had in fact been sitting idle for some time. Most

importantly, it is estimated that the potential job losses stemming from all state-required capacity cuts could

reach as high as 200,000, a figure that could trigger widespread social unrest amidst the slowdown of the

Chinese economy.

No Sustainable Lifeline From Exports

As domestic overcapacity continues to bite, we expect greater volumes of steel to be channeled into the

seaborne market. While rising steel exports from China have been an outlet to relieve domestic

overcapacity, we do not see this trend as sustainable. The proliferation of anti-dumping investigations by

countries from the US to Indonesia in recent quarters should stem the recent surge in Chinese steel exports.



Imports could also be discouraged, aided by government policy intended to support embattled domestic

producers. CISA has appealed to central government to alter tax incentives to encourage the purchase of

high-end steel products from domestic producers by plants that usually rely on overseas suppliers.

Exports To Offer Limited Respite

China - Steel Exports

Source: WSA

Limited Support From Stimulus Measures

Incorporated into our forecasts is an expectation that central government economic stimulus measures will

have only a limited impact on turning the ailing steel sector around. First, we do not expect stimulus

measures to compare with 2009-2010 in terms of scale or composition. We expect stimulus measures to be

more weighted towards supporting private consumption than the 2009-2010 stimulus, which was extremely

fixed investment intensive.

Second, Beijing's new leaders are adopting a more cautious stance towards the country's urbanisation drive,

fearing another spending binge could push up local debt levels and inflate a property bubble. Local and

provincial governments are the primary purchasers of domestic steel, and this section of the economy faces

mounting debt levels and central government pressure to curb industrial inefficiency.



Furthermore, as highlighted by the bankruptcy of Jiangxi Pingte Iron & Steel Co Ltd in 2013 (a relatively

small producer with an annual output capacity of 800kt), the Chinese government is adopting an increasing

hardline stance by starting to refrain from further corporate bailouts in the steel sector. This will almost

certainly pave the way for industry consolidation once many of the steel mills currently operating on razor-

thin profit margins are allowed to go bust.

Profit Crunch

Price Ratio: China Steel Rebar/Iron Ore Import Price

Source: Bloomberg

Large Players To Dominate

The dominance of large state-owned steel mills will increase as weak margins at inefficient small mills

force some consolidation. While margins at larger mills will also remain weak, state entities will benefit

from greater government support. According to CISA, China's 10 largest crude steel makers produced 46%

of the country's total crude steel output in 2012. China aims to concentrate 60% of the country's total steel

capacity in the hands of its top 10 firms by the end of 2015, according to its latest five-year plan for the

industry.



Production To Shift Westwards

Over the long term we expect the focus of China's steel sector to move from the east of the country, as the

government announced plans to encourage iron ore mining and steel manufacturing in the west, in

provinces such as Xinjiang and Gansu. Land, labour and electricity tend to be cheaper in the west of the

country, and thus at a time of narrowing margins, companies are looking to lower costs. Approximately

60% of China's steel production is concentrated in six provinces, with Hebei, at 27% of the total output,

accounting for the single largest share of production.

Table: China - Steel Production & Consumption Forecasts

2009 2010 2011 2012 2013e 2014f 2015f 2016f 2017f

Crude SteelProduction ('000t) 577,070 638,743 683,883 705,083 762,195 787,348 805,457 821,566 837,175

% Change y-o-y 12.6 10.7 7.1 3.1 8.1 3.3 2.3 2.0 1.9

Apparent crude steeluse ('000t) 574,420 612,060 649,850 676,494 717,760 742,882 765,911 788,122 809,402

% Change y-o-y 23.4 6.6 6.2 4.1 6.1 3.5 3.1 2.9 2.7

e/f = BMI estimate/forecast. Source: WSA, BMI

Table: China's Steel Industry, 2005-2012 (kt)

2005 2006 2007 2008 2009 2010 2011 2012

Steel

Crude SteelProduction 355,790 421,024 489,712 512,339 577,070 638,743 701,968 716,542

Ingots 9,926 12,346 10,448 9,099 7,735 10,851 10,573 10,800

CCS 345,030 408,048 474,303 483,716 568,532 626,716 690,472 704,742

Liquid forcasting 833 630 854 354 804 1,176 924 1,000

Hot rolledproducts 381,510 470,840 566,074 613,795 693,405 802,014 885,195 951,860

Hot rolledlongs 190,916 232,970 271,348 276,115 335,361 368,365 407,522 449,142

Hot rolled flats 172,780 214,761 243,897 275,508 297,167 364,347 447,592 284,639

Other 7,474 19,123 18,179 18,179 18,179 18,179 18,179 37,579

Heavy sections 7,113 9,182 10,354 10,255 9,643 9,771 11,038 11,328

Light sections 19,241 25,623 29,270 29,455 36,965 39,661 45,734 47,020



China's Steel Industry, 2005-2012 (kt) - Continued

2005 2006 2007 2008 2009 2010 2011 2012

Concretereinforcingbars 71,232 86,786 103,909 100,927 130,741 141,378 154,056 175,377

Hot rolled bars(excluding crb) 29,779 37,392 45,435 48,089 53,101 65,705 69,401 74,102

Wire rod 60,464 70,638 79,210 82,708 98,907 106,206 122,591 136,161

Tube and tubefittings 28,906 36,614 41,385 50,894 53,214 56,729 66,977 75,951

Exports

Exports 27,414 51,706 66,357 56,304 23,969 41,646 47,899 54,793

Imports

Imports 27,312 19,105 17,185 15,622 22,350 17,181 16,349 14,154

Imports ofscrap 10,136 5,385 3,395 3,590 13,692 5,848 6,767 4,974

Source: WSA

Tin: Demand Growth To Prove More Resilient

BMI View: We expect refined tin production in China to increase at a modest growth clip of 1.0% between

2014 and 2017. Low tin prices by historical standards, the pullback of tin ore supply from Indonesia and

the Chinese government's plans to curb metal output growth will remain major hurdles to production.

Refined tin consumption will also grow at a slower rate than in recent years, although a gradual

reorientation in China's economy towards private consumption will sustain the long-term expansionary

trend.

We believe China will continue to dominate the global refined tin market over the coming years. The

country accounted for 41% and 49% of global production and consumption in 2012, respectively. China has

run an increasingly large domestic deficit in recent years and thus has been forced to ramp up on imports. It

was the second-largest importer of refined tin in 2012, accounting for 11% of global imports.



Domestic Deficit Here To Stay

China - Refined Tin Production, Consumption & Balance (kt)


Production Growth To Slow

Government consolidation plans and disrupted ore supply from Indonesia should constrain refined tin

output growth in China. In a bid to move up the value chain, Indonesia, the world's top exporter of refined

tin, prohibit the exports of tin ingots with purity levels of less than 99.9% from July 1, 2013. This ruling is

bound to take its toll on Chinese refiners who imported around 50% of the metal ore from Indonesia for the

production of high-grade tin in 2012. Although China may shift its attention towards Malaysia for supplies

of low-grade tin, shipments from the latter are unlikely to be forthcoming since Malaysia also relies on

imports from Indonesia.

Additionally, there is a lack of domestic expansion plans from major tin companies including Yunnan Tin,

Yunnan Chengfeng, Guangxi China Tin and Gejiu Zi-Li. Overall, we forecast China's refined tin

production to increase from 172 thousand tonnes (kt) in 2014 to reach 188kt by 2017, marking an average

growth rate of 1.0% per annum.



Taking The Strain

China - Refined Tin Production & Consumption (% chg y-o-y)

Source: BMI, WBMS

With regard to prices, while we forecast global tin prices to outperform the wider base metal complex,

prices will not return to 2011 highs. Tin prices will trend modestly higher over the medium term and we

forecast prices to average US$22,500/tonne in 2014. In 2012, China imposed a mining tax on tin ore which

now stands at CNY12-20/tonne, a sharp increase from the previous range of CNY0.6-1.0/tonne. In a bid to

conserve resources and curb metal production growth, the country has in recent years slowly been

implementing a series of natural resource extraction taxes. Top tin producer Yunnan Tin estimates that the

new law would be likely to increase costs at the company by an additional CNY50mn (US$7.9mn).

Demand To Outpace Supply

We expect refined tin consumption in the country to reach 210kt by 2017, marking an average growth rate

of 5.7% per annum. Despite our downbeat macro view on China, demand for consumer electronics should

continue to improve as private consumption becomes an increasingly important driver of the Chinese

economy.



Yunnan Tin Dominates

China - Refined Tin Output By Company (2011)

Source: BMI, ITRI, WBMS

Persisting Reliance On Imports

We believe China will remain a net importer of tin, but sourcing imports will become increasingly

difficult. This is mainly due to the beneficiation push in Indonesia, as well as the fact that production base in

major tin-producing countries is likely to remain stagnant over the medium term. Indeed, we expect the

global tin market to remain undersupplied in the years ahead. According to the International Tin Research

Institute (ITRI), no new tin mines will enter into production this year, while the bulk of new projects are

still a decade or more from reaching production. Moreover, a limited appetite for mine financing amidst the

current mining downturn could place a greater number of mining projects on the backburner.



Supply Remains Hostage To Indonesia's Policy

Global Refined Tin Exports By Origin (2012)

Source: BMI, WBMS

Table: China - Refined Tin Production, Consumption & Balance (kt, Unless Stated Otherwise)

2009 2010 2011 2012 2013e 2014f 2015f 2016f 2017f

Refined Tin ('000 tonnes)

Consumption 152 168 178 186 190 199 210 221 232

% Change y-o-y 12.6 10.4 6.3 4.3 2.1 4.7 5.3 5.4 5.0

Production 140 150 156 162 169 172 177 183 188

% Change y-o-y 0.0 7.1 4.0 4.0 3.9 2.1 3.1 2.9 3.1

Balance -12.0 -17.8 -22.5 -23.9 -21.5 -26.9 -32.1 -38.3 -43.6




Zinc: Hit By Faltering Steel Sector

BMI View: Waning appetite from China's bloated steel sector will restrict zinc consumption growth and

production will all but stagnate. With the global market significantly oversupplied, and prices set to stay

stubbornly low, we expect output growth to falter as refiners and miners seek to support prices by

maintaining steady capacity rather than investing in new output. A structural deficit means that China will

remain a net importer of refined zinc, but import growth will slow in the coming years.

China dominates the global refined zinc sector, accounting for 38% and 44% of total production and

consumption in 2012, respectively. The country runs a domestic deficit of the metal and as a result was the

world's second-largest importer of refined zinc in 2012, accounting for 13% of total shipments.

Embattled Steel Sector To Drag On Zinc Consumption

Zinc relies on the steel sector for the vast majority of overall demand. The metal is fundamental in the

manufacturing of galvanised steel, an important input for the construction and manufacturing sectors.

Underpinned by our downbeat macro view on China, we believe demand growth for zinc will disappoint

over the medium term as the downshift in the Chinese economy forces a cut in steel production rates. Our

bearish outlook on the Chinese real estate sector will have significant implications for steel and zinc, as

demand for both metals will come in below market expectations.

We expect growth in Chinese construction activity to moderate significantly in the coming quarters, and

forecast construction sector value growth of 5.1% in 2014. This compares with an average growth rate of

12.0% per annum over the past decade. Similar to steel, zinc will be one of the metals most affected by a

slowdown in China. We see no return to the boom years of Chinese galvanised steel production. For overall

crude steel production, we forecast average growth of 4.3% between 2014 and 2017. This is in stark

contrast to the average production growth of 13.7% over the preceding 10-year period.



Persistent Deficit

China - Refined Zinc Production, Consumption & Balance (kt)

f = BMI forecast. Source: BMI, WBMS

Zinc consumption will take a hit from a slowdown in demand from the steel sector and we forecast only

modest expansion in overall usage in the coming years. Due to the nature of the economic slowdown in

China over the coming quarters, demand from the longs segment of the steel sector will be particularly

weak. Indeed, we expect fixed asset investment to be at the heart of the economic slowdown, while private

consumption will remain relatively resilient. As a result zinc demand from the steel flats segment, used

primarily for durable goods such as autos, will be the key source of growth for zinc consumption.



China Dominates

Global - Refined Zinc Production (2012)

Source: BMI, WBMS

We believe economic stimulus measures in 2013 will only stem the trend of slowing demand from the steel

sector, rather than reverse it. We do not expect stimulus from the government to match the 2008-2009

stimulus either in terms of scale or composition. For instance, stimulus measures will be more focused on

cushioning private consumption rather than enacting mass fixed investment programmes.

Production Stagnation

Continued global oversupply of zinc and slackening domestic demand will keep domestic prices subdued

and should give producers less financial incentive to increase output. We forecast prices to average US

$1,950/tonne in 2014, placing us below Bloomberg consensus of US$2,039/tonne. The weakness in zinc

prices will discourage investment into new zinc refining capacity and we therefore forecast declining

production growth out to 2017. Overall, we expect output in China to reach 6.9mn tonnes (mnt) by 2017,

growing at an average rate of 5.0% per annum. In contrast, China's zinc consumption will continue to

outpace production, and we expect consumption to increase at an annual average rate of 4.4% over the same

period, to reach 7.7mnt by 2017.



Losing Strength

China - Refined Zinc Production & Consumption Growth (% chg y-o-y)

Source: BMI, WBMS

The weak outlook for zinc prices will see smelters facing further financial tightness in 2014, amid concerns

of a further credit crunch in China. Because Chinese smelters are relatively inefficient and high-cost

producers, we expect to see further weakness in output as prices decline over the coming quarters. The

country's largest zinc smelter Zhuzhou Smelter Group posted an EBITDA of -28.9% in 2012 due to these

dynamics. We therefore anticipate that few smelters will add to their refining capacity in the coming years,

with output growth reliant on zinc prices and demand.

Imports To Remain Steady

Our expectation for a concurrent contraction in both production and consumption growth will see that

China's dependence on zinc imports will persist over the coming years. Despite being the world's largest

zinc producer, China is unable to meet domestic consumption requirements with domestic supply. Imports

therefore are a key indicator of domestic demand.



Table: China - Refined Zinc Production, Consumption & Balance (kt, Unless Stated Otherwise)

2009 2010 2011 2012 2013e 2014f 2015f 2016f 2017f

Refined Zinc ('000tonnes)

Consumption 5,054 5,595 5,670 5,982 6,568 6,864 7,159 7,417 7,676

%Changey-o-y 18.6 10.7 1.3 5.5 9.8 4.5 4.3 3.6 3.5

Production 4,280 5,160 5,220 5,486 5,964 6,214 6,456 6,669 6,883

%Changey-o-y 7.0 20.6 1.2 5.1 8.7 4.2 3.9 3.3 3.2

Balance -774 -435 -450 -496 -605 -650 -703 -747 -793




Regulatory Development

BMI View: China's metals industry is set to grapple with a string of tighter environmental regulations over

the coming quarters. A series of new regulations aimed at slimming down the bloated industry will continue

to gather momentum as domestic companies are forced to shut excess production capacity.

We expect China's metals sector to face tighter environmental regulations over the coming quarters. As

evidenced by the recent wave of 'greener initiatives' being introduced in the metals industry, there is a

growing emphasis on the negative environmental impact of industrial production in China. Indeed, China's

rapid economic growth has come at the cost of environmental degradation. In 2005, Chinese officials

acknowledged that more than 70% of the country's rivers and lakes were polluted. In July 2010, the

Ministry of Environmental Protection stated that 24% of China's surface water was unfit for any purpose,

including industrial use.

Recent Developments

■ The provincial government of Hebei has orchestrated a string of furnace shutdowns in recent months dueto heavy pollution in the region.

■ Tighter environmental regulations will be imposed on the metals industry in a bid to addressenvironmental pollution.

■ More than 1,900 companies across the heavy industries are forced to slash excess production capacity in2013.

Companies Held To Higher Environmental Standards

Chinese steelmakers will be forced to increasingly rationalise production over the coming quarters as the

Chinese government steps up its fight against air pollution. The provincial government of Hebei has

orchestrated a string of furnace shutdowns in recent months due to heavy pollution in the region. Hebei has

been ordered to retire 60mn tonnes (mnt) of capacity, or a quarter of the province's steel capacity and 75%

of the nationwide target, over the next five years. According to the Ministry of Environmental Protection,

seven of China's 10 most polluted cities are located in Hebei, where visibility levels in the southern areas

are the worst nationwide.

In 2012, China announced a series of new regulations to fine-tune its iron and steel industry in an effort to

spur energy efficiency and make it more environmentally friendly. According to the Ministry of Industry

and Information Technology, iron and steel companies are prohibited to produce a list of obsolete products

including hot rolled silicon steel and twisted steel of primary level. Furthermore, powder dust emissions,



sulphur dioxide emissions and water consumption for producing each ton of steel should not exceed 1.19kg,

1.63kg and 4.1m3, respectively. For equipment capacity requirements, shaft furnaces should be more than

400m3, converter or electric furnaces should be above 30 tonnes, while high-alloy steel furnaces should be

over 10 tonnes.

Efforts To Slim Bloated Industries Continue

Apart from tighter regulations aimed at curbing environmental pollution, Beijing's new leaders have also

announced a string of measures aimed at slimming down the bloated industries across many sectors. In

2013, the Chinese government ordered more than 1,900 companies operating in sectors such as steel,

aluminium and cement, to shut excess production capacity. Chinese Premier Li Keqiang has pledged to

tackle the persisting problem of overcapacity as China rebalances its growth model away from fixed-asset

investment and towards private consumption. Under the edict, more than seven million tonnes (mnt) of

excess steel output and 260 thousand tonnes (kt) of excess aluminium output will be slashed.

Amongst other initiatives, the aluminium sector will be slapped with a set of revised regulations. These

include a ban on the construction of new smelting plants in environmentally sensitive zones and the

introduction of stricter limits on power consumption and emissions. New and upgraded aluminium smelting

capacity will be required to have electricity consumption of 12,750-13,200 kwh per tonne, compared with

the current capacity of 13,350-13,800 kwh per tonne.

Tax Regime

China is pushing ahead with reform, with the emphasis on reducing taxes and unifying income tax rates for

domestic and foreign companies.

Corporate Tax: The standard rate is 33%, comprising a 30% national tax and a 3% local tax. Foreign

investment enterprises (FIEs) generally pay tax at concessional rates depending on the location and type of

business. The state tax rate of 30% may be reduced to 15% or 24% if the FIE is located in one of the

specially designated zones. Qualified FIEs are entitled to a tax exemption or reduction during a tax holiday

period. The local tax of 3% may be waived or reduced by the local government. A unified tax for Chinese

and foreign enterprises, involving the removal of concessional rates and exemptions, is anticipated.

Income Tax: Income tax is levied on Chinese and foreign individuals at progressive rates ranging up to a

45% limit. Non-residents who are resident for less than a year are subject to personal tax only on income

sourced in China.



Indirect Tax: China is obliged by WTO rules to offer identical tax treatment for domestic and imported

products. VAT is levied at two rates: a standard 17% rate and a lower 13% rate. A 6% VAT rate applies to

small enterprises.

Withholding Tax: There is no withholding tax on dividends, but a 10% rate is applied to interest and 10%

on royalties.

Corruption To Remain Key Concern

Corruption is prevalent, and anti-corruption efforts are obstructed by weak or non-existent monitoring

mechanisms. Embezzlement and financial mismanagement have been identified by numerous audit reports.

The use of guanxi is widespread in the upper echelons of business. Many of those who come under

investigation are able to deploy their connections to avoid prosecution.

Red tape is a major issue for investors. Given that many laws are defined in very general terms, it is often

left to the bureaucracy to make decisions. With a lack of accountability, this process provides opportunities

for corruption, while numerous bureaucratic obstacles stymie the easy acquisition of licences. According to

World Bank data, 20 separate procedures are required to enforce a contract, which take an average of 180

days.

Table: Political Overview

System of Government Single-party socialist republic

Head of State President Xi Jinping (serving first of a maximum two five-year terms)

Head of Government Prime Minister Li Keqiang (serving first of a maximum two five-year terms)

Last Election Presidential and parliamentary - March 2013

CPC congress - November 2012

Composition of CurrentGovernment Communist Party of China

Key Figures

The Politburo Standing Committee acts as the de facto highest decision-making body inChina and comprises the top leadership of the ruling party. Its members, in order of protocol,are: Xi Jinping (concurrently general secretary of the Communist Party), Li Keqiang, ZhangDejiang, Yu Zhengsheng, Liu Yunshan, Wang Qishan, Zhang Gaoli.

Other Key Posts

Finance Minister - Lou Jiwei; Foreign Minister - Wang Yi; Defence Minister - ChangWanquan; Minister of Public Security - Guo Shengkun; Central Bank Governor - ZhouXiaochuan.

Main Political Parties(number of seats inparliament)

Communist Party of China (CPC): The founding and ruling political party of the People'sRepublic of China, whose paramount position as the supreme political authority isguaranteed by China's constitution and realised through control of all state apparatus. TheCPC was founded in 1921 and came to rule all of mainland China after defeating its rival, theKuomintang (KMT), in the Chinese Civil War.



Political Overview - Continued

System of Government Single-party socialist republic

Next Election Presidential and parliamentary - March 2018

CPC congress - Autumn 2017

Ongoing Disputes

Ongoing dispute over Taiwanese sovereignty and Tibetan autonomy; some minor territorydisputes with Asian neighbours, including with Japan over the Senkaku Islands in the EastChina Sea and with Taiwan, Malaysia, the Philippines and Vietnam over the Spratly Islands inthe South China Sea.

Key Relations/ TreatiesClose Link With ASEAN, WTO member, permanent seat on the UN Security Council,founding member of the Shanghai Cooperation Organisation (SCO).

BMI Short-Term PoliticalRisk Rating 77.3

BMI Structural PoliticalRisk Rating 62.9

Source: BMI



Commodities Forecast

Commodity Strategy

■ The first contractionary Chinese manufacturing PMI since July 2013 (HSBC flash PMI of 49.6 forJanuary) bolsters our view that metals demand growth in China will cool in 2014. Combined with apositive supply outlook for many metals, this will cap recent price strength.

■ Our 2014 price forecasts remain generally below Bloomberg consensus, particularly for copper and ironore.

■ We retain a bearish iron ore view in our strategy table (currently up by 4.16%). Faltering demand growthfrom China's steel sector and robust mine supply growth should see iron ore prices significantlyunderperform in comparison to other metals in 2014.

■ Temporary upside risks linger for copper due to the potential for greater Chinese demand for collateralpurposes in the coming months. A break above US$7,400/tonne would be a positive short-term signal forprices.

■ Tin, lead and zinc prices will outperform other metals over the coming quarters due to a combination ofsupply disruption and resilient demand.

Post-Commodities Boom Era

S&P GSCI Industrial Metals Index (monthly chart)

Source: BMI, Bloomberg



Iron Ore: Further Weakness Ahead

We expect the recent slump in iron ore prices to gain traction over the coming months as the economic

slowdown in China increases. In a sign of the stalling momentum of the country's economy, factory output

growth in China fell to a five-month low of 9.7% year-on-year (y-o-y) in December 2013. The resilience of

China's steel sector over the past year is starting to fade, emphasised by the 10.3% fall in iron ore prices

since December 2013. Chinese crude steel production expanded by 5.9% y-o-y in November 2013,

compared with 10.1% y-o-y from the previous month.

Waning Support From Chinese Steel Sector

China - Iron Ore Import Price (US$/tonne, LHS) & Steel Production and Iron Ore Imports (% chg y-o-y, RHS)

Note: China iron ore import price, 62% grade (US$/dry metric tonne, CFR). Source: BMI, Bloomberg, China Customs General

Administration

Apart from weakening import growth in China, we believe the ramp up of supply in the seaborne market

will remain a drag on prices over the medium term. Major miners in Australia and Brazil are forging ahead

with a series of output expansion plans in a bid to further lower their costs of production. We forecast iron

ore prices to average US$115/tonne in 2014, compared with an average of US$135/tonne last year. Our

bearish conviction on iron ore is reflected in our Commodities Strategy Table, currently up 4.1% since

initiation (see 'Views Update: Bearish Iron Ore', January 09, 2014).



Steel: Limited Scope For Higher Prices

Despite improving global steel demand and an uptick in the MEPS Carbon Steel Index over H213, we retain

a subdued outlook on steel prices. Over 2013, steel production grew on average 4.2% y-o-y, while steel

prices averaged US$708/tonne, lower than their 2012 average of US$757/tonne. We forecast further

weakness in steel prices for 2014, anticipating prices to average US$695/tonne. This forecast is based on

our expectation of continued overcapacity, particularly in China's bloated steel sector. Despite the removal

of some older steelmaking capacity in 2013, steelmaker margins in many countries will stay wafer-thin as

sales remain pressurised by sluggish demand growth in domestic consumption and cheap Chinese supply in

the seaborne market. While we do expect a slowdown in Chinese steel production growth over 2014 as the

government's efforts to reform the sector take hold and producers respond to weak profit margins, the

restructuring of the Chinese steel industry will be a protracted process.

Price Weakness To Stunt Growth

Global Steel Production % Growth y-o-y & MEPS Carbon Steel Index (US$/tonne)




Aluminium: Continued Short-Term Weakness

We forecast continued weakness in LME aluminium prices as global production overcapacity and

inventories remain at all-time highs. We recently revised our 2014 price forecast downward to US$1,850/

tonne, from US$1,900/tonne previously, to reflect price weakness at the year's outset. LME reforms and a

decline in aluminium financing on the back of interest rate normalisation should free up more metal locked

up in such trades for end users and put downward pressure on prices. High aluminium premiums will

incentivize metal production, adding to global supplies. We also forecast continued market surpluses

through 2017, capping price growth over our forecast period.

Underperformance To Persist

Three-Month LME Aluminium (US$/tonne), Weekly


Copper: Recent Strength Doesn't Change Our View

We forecast copper prices are likely to continue trading within the US$7,200-7,400 range over the coming

weeks, but maintain our forecast that prices will average US$6,800/tonne for the year. Recent strength can

be attributed to copper remaining in backwardation, indicating short-term market tightness on the back of

recent strength in Chinese imports. However, we maintain our view that China's underlying macroeconomic

fundamentals will weaken through the year as the economy becomes less reliant on fixed asset investment,



leading to slowing copper demand across the economy. A wider crackdown on collateral financing, which is

currently pushing up copper demand and which is not tied to specific industrial or commercial use, should

also lead to slowing import growth. Strong mine supply growth in various producing countries should cap

upward price movement as more metal comes onto the market and underlies our forecast for continued

market surpluses through our forecast period.

Falling Back From Resistance

Three-Month LME Copper (US$/tonne), Weekly


Lead: Modest Price Gains Ahead

We expect lead prices to outperform other industrial metals including aluminium, copper and nickel over

coming quarters as lead will be relatively insulated from a fixed asset investment slowdown occurring in

China. Lead's primary usage in batteries for the autos sector will provide upside for prices as we remain

positive on the outlook for global vehicle production over coming years. We forecast lead prices to head

higher from the current price of US$2,194/tonne, to average US$2,250/tonne over 2014.



Solid Autos Growth To Bolster Lead Demand

Select Countries: Vehicle Production Growth (% y-o-y)

United States Germany China

2011

2012

2013

2014

f

2015

f

2016

f

2017

f

2018

f

-10

0

10

20

f=BMI forecast. Source: OICA, VDA, CAAM, BMI

Our outlook for lead also applies to the supply side. We forecast the global stocks-to-use ratio for refined

lead to decrease from an estimated 6.4% in 2013 to 0.5% in 2017. According to our estimates, the refined

lead market will slip into a deficit of 79.5kt in 2014, largely as a result of a collapse in production growth in

China.

Nickel: Recent Strength To Subside

After persistent declines, we believe nickel prices have bottomed out and should respect 2013 lows over the

coming months, leading us to forecast prices will average US$14,750/tonne through the year. Recently

imposed restrictions by the Indonesian government on nickel ore exports have pushed up LME prices above

long-term resistance, but it remains a core view of BMI that the Indonesian government is likely to

moderate its mining policy in the coming months, with higher export tariffs imposed in place of a complete

ban on nickel ore. This should still provide some nickel price support, but we expect high global inventories

and still subdued global steel capacity utilization below 80% to cap gains. Thus, our forecast for 2014

remains below Bloomberg consensus. Still, our forecast for global surpluses to decline through 2016, and

for a deficit to emerge in 2017, lead us to predict rising LME prices through our forecast period.



Modest Turnaround In Sight

Three-Month LME Nickel (US$/tonne), Weekly


Tin: In A Sweet Spot

In line with our expectation, tin prices are slowly improving after a four-month low of US$21,598/tonne in

January 09, 2014 (see 'Tin To Average US$22,500/tonne In 2014', January 08, 2014). We expect tin to

outperform the industrial metals complex over the coming quarters, and expect the uptrend in the ratio

between tin and the S&P GSCI Industrial Metals Index to stay intact. In contrast to construction-heavy

metals such as steel and nickel, the sharp slowdown in Chinese fixed asset investment growth will deal a

much softer blow to demand growth for refined tin. Moreover, we believe any significant fall in tin prices

would invite price-supportive action from the Indonesian government.



Tin Outperformance To Resume

Three-Month LME Tin (US$/tonne, LHS) & Price Ratio: Tin / S&P GSCI Industrial Metals Index (RHS)


Zinc: Price Momentum To Continue

We expect zinc prices, alongside lead, will continue to outperform the base metals complex and may test

resistance around US$2,200/tonne. Market fundamentals should remain supportive of zinc prices as has

been the case in recent months. Indeed, September through November 2013 saw monthly zinc deficits

emerge, and global LME inventories continue to move downward. With continued inventory draw downs

leaving global stockpiles at their lowest levels since September 2012, we believe consumption demand

remains strong and will continue to outpace production. Still, we maintain our forecast that zinc prices will

average US$1,950/tonne in 2014, due to steady mine supply growth and global steel capacity utilization

remaining below 80%. Given zinc's use in the galvanization of steel, the latter will continue to weigh on

prices. Given our forecast for zinc deficits to emerge in 2015 and persist through 2017, we believe risks lie

to the upside over the medium-term.



Potential Test Of Resistance

Three-Month LME Zinc (US$/tonne), Weekly




Table: Select Commodities - Performance & BMI Forecasts

Commodity Unit Spot PriceYTD

(% Chg)1 Year

(% Chg) 2013 AvgYTD (ave)

2014 (BMI ave)

2015 (BMI ave)

Aluminium US$/tonne 1,773 -1.5 -14.6 1,887 1,784 1,850 1,950

Copper US$/tonne 7,264 -1.3 -10.4 7,349 7,317 6,800 6,750

Gold US$/oz 1,245 3.6 -26.1 1,409 1,239 1,150 1,100

Iron Ore US$/tonne 124 -8.0 -15.4 135 130 115 105

Lead US$/tonne 2,175 -2.0 -8.2 2,155 2,177 2,250 2,300

Nickel US$/tonne 14,670 5.5 -16.4 15,081 14,184 14,750 15,500

Palladium US$/oz 746 3.8 2.7 726 741 650 650

Platinum US$/oz 1,461 6.5 -14.0 1,486 1,429 1,500 1,500

Silver US$/oz 20 3.6 -38.2 23 20 32.00 32.00

Steel US$/tonne 716 -0.7 -0.7 708 716 695 690

Tin US$/tonne 22,150 -0.9 -9.5 22,298 22,058 22,500 23,000

Zinc US$/tonne 2,063 0.4 -1.1 1,939 2,058 1,950 2,050


Commodities Forecast

Table: BMI Steel Forecast

Spot Short-Term 2014 2015 2016 2017

US$/tonne, average 716 720 695 690 685 690




Short-Term Outlook

The uptick in the MEPS Carbon Steel World Price

seen since mid-2013 is likely to endure in the short

term as prices are bolstered by a strengthening of US

and Eurozone steel-intensive manufacturing after a

particularly depressed Q112-Q313 period. We

expect steel prices to average around US$720/tonne

over coming weeks, slightly higher than current spot

at US$716/tonne.

Core View

We retain our bearish outlook toward steel prices

over the medium term, expecting the MEPS Carbon

Steel Index to head south over the course of 2014 to

average US$695/tonne. Despite the uptick in prices

since mid-2013, the global steel market remains

plagued by serious overcapacity and sluggish

demand growth. Failure to consolidate the bloated

steel industry in China will remain the crucial factor weighing on prices over coming quarters. We expect

Chinese steel to continue to seep onto the global market, offering a cheap alternative to domestic production

elsewhere. Rationalisation of the Chinese steel industry combined with an effective crackdown on Chinese

steel exports and strengthening of global steel demand growth would be the tonic needed to improve the

fortunes of the global steel industry. This prospect remains beyond our forecast period to 2017.

Global Steel Glut To Persist

We expect the global steel market to remain mired in significant overcapacity over our forecast period to

2017, despite a production growth slowdown in China. This slowdown will be insufficient to rebalance the

global steel market, which we anticipate to remain in surplus, albeit a diminishing one, over coming

years. We forecast the global steel surplus to slim from 107mnt in 2013 to 71mnt by 2017. By our

estimates, the global stocks-to-use ratio will grow from 32% in 2013 to 47% in 2017 as global steel

consumption growth decelerates.

Not Out Of The Woods Yet

MEPS Carbon Steel Product World Price (US$/tonne)

Note: Dashed lines represent BMI forecasts for 2014 &

2015. MEPS price updated monthly. Source: BMI,

Bloomberg



Staggering Surplus

Global Crude Steel Production Balance (mnt) & Stocks-To-Use Ratio (%)

Note: Stocks calculated using 2000 as base year. 2013 = estimate, 2014-2017 = forecast. Source: BMI, World Steel Association

(WSA)

Production: Rationalisation In The Long Term

We forecast global steel production growth to average 3.3% y-o-y between 2014 and 2017, slower than an

average of 8.3% y-o-y seen over the period 2010-2013. China currently produces roughly 46% of global

steel. We expect Chinese output to grow on average 4.2% y-o-y between 2014 and 2017, marking a

significant slowdown from the 12.7% average y-o-y growth seen over 2005-2013. Nevertheless, this will be

insufficient to effectively tackle the global glut of steel on the global market.

Despite extensive rhetoric emanating from the Chinese government with regard to the restructuring of its

bloated steel sector, evidence of serious reform has been thin on the ground. We anticipate the

rationalisation of China's steel sector to be a protracted process due to government concerns about

employment. For the foreseeable future government intervention will circumvent the natural process of

consolidation in an oversupplied industry. A key indicator of this trend has been the accelerated growth in

Chinese steel production over the past twelve months, urged on by the mid-2013 enactment of an

infrastructure stimulus. Over 2013, steel production in China surged 9.2 % y-o-y to 782mnt.



China Leading The Pack

Select Countries: Crude Steel Production (% Change y-o-y)


The glut of cheap steel available on the open market combined with country-specific challenges will mean

that production growth ex-China remains modest. For example, although India is on track to become a steel

powerhouse over the long term, steelmakers in the country are struggling with a rising import bill due to a

weak rupee and a shortage of iron ore supply. Indian steel production growth averaged 5.9% y-o-y in 2013,

a slowdown from 6.3% y-o-y growth in 2012.

This trend of slowing production growth or even contraction is common to the majority of the world's

largest steel producing countries. Russian steel production contracted 1.7% y-o-y in 2013 after growth of

2.8% y-o-y in 2012. Steel production in the USA contracted 1.5% y-o-y in 2013, following 2.8% y-o-y

growth in 2012. We forecast 2014 steel production growth of 0.5% in Russia and 1.5% in the USA.



Steel Spillover

China Steel Production (LHS) & Exports (RHS)


Consumption: Growth Decelerating

We forecast global steel consumption to grow on average 4.0% y-o-y from 2014-2017, slower than average

growth of 6.9% y-o-y over the previous four years. Although consumption will continue to recover in

developed states, slower emerging market demand growth, led by China, will offset this rise.

Weak demand growth for steel will be a key contributing factor to the aforementioned increasing stocks-to-

use ratio and ultimately to steel price weakness. This view is predicated on our expectation for a sharp

slowdown in Chinese fixed asset investment, which will directly impact the steel sector as the huge steel

tonnages produced by steel mills will become increasingly difficult to absorb. We expect China's export

outlet to become increasingly tenuous over coming years as countries from the USA to Indonesia threaten

greater protectionism as they challenge China on anti-dumping grounds. Equally importantly, the quality of

Chinese steel has come under intense scrutiny as large projects including a number of bridges in the USA

have had to undergo serious repair work due to the use of low quality imported steel.



Sluggish Consumption Growth Despite Promising PMIs

Select Countries: Crude Steel Consumption (% Change y-o-y), LHC & Manufacturing PMI Readings,RHC

Note: PMI reading above/below 50 indicates expansion/contraction. e/f= BMI estimate/forecast. Source: BMI, WSA, Bloomberg

Aside from China, other countries in Asia and the EU will also suffer from lacklustre demand growth for

steel products. In Japan, automakers have been shifting their production overseas, while domestic

shipbuilders are reducing capacity in light of shrinking orders and rising competition from Chinese and

Korean shipyards. Similarly, many European markets will see negligible growth in steel demand due to low

GDP growth and declining investment in infrastructure.

We forecast steel consumption growth in Japan to average 2.1% y-o-y over 2014-2017, slower than 5.9% y-

o-y over the previous four years. Similarly in South Korea, steel consumption growth will average 1.9% y-

o-y over 2014-2017, a slowdown from 5.3% average y-o-y over 2010-2013. Consumption growth

deceleration will be equally pronounced in the Eurozone, with growth set to average 1.1% y-o-y over

2014-2017, in contrast to 7.7% y-o-y average growth over 2010-2013.

Excessive Chinese Exports

China's excesses will continue to spill onto the global market despite anti-dumping initiatives embraced by

North American, European and Asian countries. Chinese steel exports have continued in their secular

uptrend since the start of 2011, growing from a total of 45.8mnt in 2011 (6.5% of total output) to 55.8mnt in

2012 (7.8% of total output) to 62.3mnt in 2013 (8.0% of total output). The seepage of cheap Chinese steel



onto the global market will continue to be a major factor weighing on prices over our forecast period to

2017.

Growing Arbitrage Between East & West

Although cheap steel from Asia will keep a lid on global steel prices, we expect growing arbitrage between

the MEPS Carbon Steel North America price (current spot: US$813/tonne) and the MEPS Carbon Steel

Asia price (current spot: US$636/tonne). The North America price could head up towards US$850/tonne on

the back of US economic recovery bolstering steel demand, while the US government cracks down on

Chinese steel imports both to protect domestic producers as well as to ensure high quality steel is utilized in

major infrastructure projects. Conversely, the Asia price could head down towards US$600/tonne as the

fixed asset investment slowdown takes hold in China and the Chinese government fails to tackle

overcapacity in the steel sector.

Arbitrage To Grow

MEPS Carbon Steel Prices (US$/tonne)


Risks To Price Outlook

The risks to our forecast are weighted to the upside. More impressive than anticipated recovery in the US

and Eurozone could lead to greater demand for steel products in the West providing tailwinds for steel



prices. A serious move on the part of the Chinese government to tackle overcapacity in the sector could see

much needed consolidation, resulting in excess production cutbacks. Further significant restructuring in the

rest of the world ex-China could also provide upside to prices as major producers including ArcelorMIttal

and Severstal reduce output and restructure their businesses in an attempt to address the global glut. There

is even the more remote possibility of a shock to the system in the form of another infrastructure stimulus

similar to that enacted by the Chinese government in 2013 in response to flagging economic growth. Such a

development would be contrary to the new leadership's aim of rebalancing the economy away from

infrastructure-led investment, but cannot be ruled out.

Table: Steel Data & Forecasts

2010 2011 2012 2013 2014f 2015f 2016f 2017f

Price, average (US$/tonne) 733 854 757 708 695 690 685 690

Production, thousand tonnes 1,432 1,582 1,612 1,694 1,764 1,825 1,877 1,928

Consumption, thousand tonnes 1,400 1,485 1,512 1,587 1,661 1,726 1,792 1,856

Inventories, thousand tonnes 209.2 306.2 406.0 512.7 615.4 714.5 799.6 871.1

Stocks-to-Use, % 14.9 20.6 26.9 32.3 37.0 41.4 44.6 46.9

Stocks-to-Use, wks 7.8 10.7 14.0 16.8 19.3 21.5 23.2 24.4

f= BMI forecast. Source: BMI, WSA

Table: Global Steel Prices By Region & Product, US$/tonne (ave)

Description 2006 2007 2008 2009 2010 2011 2012 2013

Flat Products

USA Domestic Hot Rolled Coil (FOB Midwest mill) 676 596 958 538 678 822 703 696

China Domestic HR Sheet 494 564 722 546 629 723 634 599

China Import - HR Sheet 3mm (Shanghai) 619 625 893 541 666 773 668 631

China Export - HRC 3mm Shanghai 560 607 899 551 676 766 653 601

Persian Gulf - HRC CFR na na 908 510 630 731 628 589

Europe - HRC Ex-Works 717 944 1,460 728 911 1,050 836 819

Russia HRC FOB 514 603 868 462 610 694 580 558

CIS - HRC Ex-Works (Inc. VAT) na na 857 464 605 715 592 533

Turkey Domestic - HRC (ex-works) na na 1,002 542 663 743 634 598

Turkey - HRC Import CFR na na 966 479 633 710 613 565

Turkey Export - HRC FOB 518 619 847 485 629 733 631 586



Global Steel Prices By Region & Product, US$/tonne (ave) - Continued

Description 2006 2007 2008 2009 2010 2011 2012 2013

Latin America - HRC (dry) FOB 505 545 987 485 588 728 614 582

Long Products

USA - Rebar CFR FO USG 513 626 911 496 613 721 655 603

China Domestic - Rebar 25mm 382 484 686 538 619 733 623 581

China Export - Rebar 25mm (Shanghai) 447 564 890 583 663 756 652 581

EU Import - Rebar CFR 544 665 948 495 605 740 667 631

EU Export - Rebar FOB na na 903 487 592 703 641 605

CIS - Rebar Ex-Works na na 939 452 590 699 649 578

Turkey Domestic - Rebar (ex-works) na na 911 468 580 702 638 602

Turkey Export - Rebar FOB 487 597 901 468 586 694 628 591

Persian Gulf - Rebar CFR na na 921 477 596 694 642 603

Latin America - Rebar Export FOB 441 530 1,140 464 580 686 645 596

na= not available/applicable. Source: Bloomberg, Metal Bulletin, Steel Orbis



Competitive Landscape

BMI View: State-owned companies will gain increasing dominance in China's metals industry over the

coming years. In contrast, a large number of smaller, inefficient and often private players will struggle to

survive with the downshift of the Chinese economy and the government's aggressive push to consolidate the

metals and mining industries.

In our view, state-owned companies are set to become increasingly dominant in China's metals industry

over the coming years. A large number of smaller, inefficient and often private players will come under

duress with the economic slowdown in China. Furthermore, the Chinese government's aggressive push to

consolidate the metals and mining industries should eventually weed out many of the smaller players over

the medium term.

As part of China's 12th Five-Year Non-ferrous Industry plan, the government plans to cut the annual

average growth of metal output to 8% between 2011 and 2015 compared with 13.7% during 2006 to 2010.

To achieve this, the government is pushing for consolidation of ownership and expects the top ten smelters

in the country to account for 90% of copper and aluminium production and 60% of the total lead and zinc

output. State-owned companies will continue to play a dominant role in China's metals industry given these

consolidation plans. Despite comprising only a small proportion of total mining and metal companies, state-

owned outfits play outsized roles in their respective sectors. In China, the top miners are often the country's

top downstream players, as companies in the industry are often vertically-integrated. Shenhua Energy has

both a power business and a coal mining business. Angang Steel has vast assets of iron ore mines. Jiangxi

Copper is a major copper producer and is also a major copper miner. Chinalco has both sizable bauxite

assets and is also the largest aluminium player in the country.



An Outsized Role

Share of State-Owned Enterprises, 2012 (%)

Source: BMI, 2012 China Statistical Yearbook

Differences between private mining companies and state-owned miners are significant. The average coal,

ferrous, and non-ferrous mining company employs around 585, 157 and 227 people, respectively. In

contrast, the average state-owned mining company in the coal, ferrous, and non-ferrous sectors employed

around 4,046, 913 and 675 people, respectively. We expect state-owned mining companies to contribute to

a larger percentage of said metrics as national consolidation initiatives increase compliance costs and reduce

the overall profitability of smaller mines.

Consolidation And Overseas Extraction

China's plans to curb metal production growth are faced with the country's structural deficit for metals such

as copper and iron ore. Although the need for domestic supply will diminish with a slowdown in the

Chinese economy, stable and cheap access to raw material supply remain key concerns for companies.

Indeed, iron ore import demand from China is unlike to collapse in the coming quarters due to the low

grade, and subsequent high cost, of domestic production. To highlight, costs of production in Brazil and

Australia are in the US$30-50/tonne range, significantly more competitive than Chinese costs. Chinese



companies have been aggressively acquiring overseas assets and will continue to do so in a bid to secure

supply.

Profit Crunch

Price Ratio - China Steel Rebar/Iron Ore Import Price


According to the Chinese Iron & Steel Association (CISA), high iron ore prices relative to steel prices have

left the Chinese steel industry as the least profitable of the country's 39 industrial sectors. Unsurprisingly,

the waterfall decline in margins over recent years is forcing a growing number of steelmakers to diversify

their operations into non-steel businesses such as technology, real estate and farming.

Table: China - Largest Listed Metal Producers

CompanyMarket Cap

(USDmn) EmployeesRevenue(USDmn)

Net Income(USDmn)

Profit Margin(%)

Baoshan Iron & Steel Co Ltd 11,020 32,598 30,304 1,646 5.4

Aluminum Corp of China Ltd 7,980 103,493 23,691 -1,305 -5.5

Fosun International Ltd 6,113 37,000 8,204 588 7.2

Inner Mongolian Baotou Steel UnionCo Ltd 5,144 29,512 5,827 41 0.7



China - Largest Listed Metal Producers - Continued

CompanyMarket Cap

(USDmn) EmployeesRevenue(USDmn)

Net Income(USDmn)

Profit Margin(%)

Wuhan Iron & Steel Co Ltd 3,856 41,150 14,469 33 0.2

Angang Steel Co Ltd 3,728 36,172 12,296 -659 -5.4

China Hongqiao Group Ltd 3,719 31,872 3,931 864 2.2

Hebei Iron & Steel Co Ltd 3,308 49,890 17,664 17 0.1

Pangang Group Vanadium Titanium &Resources Co Ltd 3,225 16,227 2,407 94 3.9

Gansu Jiu Steel Group Hongxing Iron &Steel Co Ltd 2,773 23,961 10,078 77 0.8

Shanxi Taigang Stainless Steel Co Ltd 2,428 22,227 16,385 175 1.1

Maanshan Iron & Steel 2,147 49,797 11,767 -612 -5.2

Shandong Iron and Steel Co Ltd 1,805 35,980 11,593 -608 -5.2

na = not available. Note: All data refers to latest financial year. Source: BMI, Bloomberg



Company Profile

Aluminum Corporation of China (Chalco)

Strengths ■ Dominant position both domestically and globally. It is the world's second-largest

alumina producer (and the only producer in China) and third-largest aluminium

producer (and the largest in China).

■ Expanding its portfolio into the power industry. To benefit from consistent energy

supplies and reduced exposure to a surge in energy prices.

Weaknesses ■ Closed 380kt of annual aluminium capacity (or 9% of its annual output in 2012) in

2013.

■ Significant overcapacity and weak margins in the aluminium industry will continue to

weigh on margins.

Opportunities ■ As part of China's 12th Five-Year Plan (2011-2015), the Chinese government is on a

drive to shut excess capacity in the metals industry with the closure of smaller

aluminium smelters. This could benefit Chalco given its dominance in the Chinese

market.

■ It can leverage its position as the largest shareholder in Rio Tinto and benefit from

Rio's investment in the Oyu Tolgoi project, the world's largest untapped copper and

gold deposit.

Threats ■ Could be disadvantaged by its relative inexperience in the power sector, especially

against established power suppliers in the domestic market.

■ Ongoing probe into metals warehousing could unleash a flood of aluminium onto the

market and push down prices over the coming quarters.



Company Overview

Aluminum Corporation of China (Chalco) is a producer of alumina, primary aluminium and aluminium

fabrication. The company is relatively vertically integrated. It has its own captive bauxite mines, engages in

alumina trading and manufacturing, primary aluminium and aluminium fabrication and also trades non-

ferrous metal products sourced from external suppliers. Chalco is an industry leader in processing non-

ferrous minerals and has a number of large copper mines. Chalco and its 34 subsidiaries have operations

across 22 provinces in China and 15 offices in 10 other countries. The company operates in four segments:

alumina, primary aluminium, aluminium fabrication and trading.

Revenue To Fall As China Slows

Chalco - Revenue By Product Segment (2012)

Source: BMI, Company Report. Note: Data for 2013 unavailable.

Latest Financial Results

Chalco returned to profit in 2013 after efforts to slash costs and sold assets to its parent company reached

fruition. The company posted a net income of CNY1.0bn (US$165mn) last year, compared with a record net

loss of CNY8.2bn in 2012. However, the turnaround in Chalco's fortunes was mainly due to the sale of a

65% stake in its subsidiary iron ore company at CNY12.9bn to its parent group. The company has also



restructured its high-cost refineries and alumina assets in southwest Guizhou and gave up nine downstream

plants in 2013.

Company Strategy

In a bid to improve profit margins, Chalco has been undertaking considerable efforts in coal-power-

aluminium integration over the past years. However, this has yet to reap significant cost benefits for the

company as persistent weakness in the aluminium market continues to weigh on profit margins. In our view,

further headwinds are in store for Chalco over the medium term. We expect the aluminium industry to be

plagued by persistent overcapacity in the coming years, and forecast prices to average US$1,900/tonne in

2014, compared with an average of US$1,887/tonne in 2013.Crucially, proposed reforms by the LME could

unleash a flood of aluminium onto the market and pull down prices more than we anticipate in the coming

months.

Little Respite Ahead

Select Equity & Indices, Rebased

Source: BMI, Bloomberg. Note: Jan 2006 = 100.



Company Details

■ 62 North Xizhimen Street

■ Hai Dian District

■ Beijing 100082

■ China

■ +86 10 82298103

■ www.chalco.com.cn

Table: Chalco - Key Financial Data

2006 2007 2008 2009 2010 2011 2012

Revenue (US$mn) 8,132 11,204 11,044 10,286 17,879 22,518 23,691

% chg y-o-y na 37.8 -1.4 -6.9 73.8 25.9 5.2

EBITDA (US$mn) 2,660 2,735 1,095 443 1,433 1,406 273

% chg y-o-y na 2.8 -60.0 -59.6 224.0 -1.8 -80.6

Net Income (US$mn) 1,485 1,414 3 -680 115 37 -1,305

% chg y-o-y na -5 -100 -24,331 -117 -68 -3,644

Profit Margin (%) 18.3 12.6 0.0 -6.6 0.6 0.2 -5.5

Debt to EBITDA 1.0 1.4 7.7 21.6 7.4 8.2 62.0

P/E Ratio 7 18 2,567 na 100 137 na

na = not available. Source: BMI, Company Report. Note: Data for 2013 unavailable.



Baoshan Iron & Steel

SWOT Analysis

Strengths ■ Bulk of its 26.5mnt production capacity is located at its district headquarters in

Shanghai. This provides direct access to ports for iron ore imports and also brings

Baoshan closer to its key customer base of automobile and home appliance

manufacturers.

■ Major revenue drivers are in the high-end high-margin products of automobile steel

sheets and silicon sheets. Hence, it is able to charge a premium for its products and

has better margins than its competitors.

Weaknesses ■ Highly exposed to fluctuations in input prices due to a lack of upstream investment

into iron ore.

■ Our below consensus view on the Chinese economy, particularly the real estate

sector, will significantly weaken domestic demand for steel products and force

steelmakers to adopt further price cuts.

Opportunities ■ As a state-owned company, Baoshan is well-placed to benefit in the long-term

urbanisation process of China, albeit at a slower pace than during the previous

decade.

■ Asset injection by its parent company, Baosteel Group, could substantially boost

Baoshan's value.

■ As one of the top five steel producers in the country, Baoshan is set to benefit from

any future M&A activity due to consolidation efforts by the Chinese government.

Threats ■ Exposed to collapsing profit margins resulting from lower steel prices.

■ Growing backlash against Chinese steel products on anti-dumping investigations.

■ Growing number of debt-laden steel traders in China defaulting on loans and leading

to further swelling of inventories at Chinese steel mills.



Company Overview Baoshan Iron & Steel Co. is the biggest-listed steel producer in China and is among the

largest in the world. Its parent company, Baosteel Group, owns a 74% stake. Baoshan

has a high-end, high-margin product mix focused on flat products with a dominant

market share in the domestic automobiles and home appliance markets. The company

also holds sizable market positions in the markets for transmission of oil and natural

gas, engineering machinery, bridges, buildings, ships, containers and rail track

transportation, among others.

China Slowdown To Weigh On Growth

Baoshan Iron & Steel - Revenue By Geography (2012)

Source: BMI, Company Report

Strategy Baoshan recorded a net profit of US$947mn and operating revenue of US$31.2bn in

2013, down 44% year-on-year (y-o-y) and 0.6% y-o-y, respectively.

Baoshan holds a dominant position in the high-margin automotives and home

appliances steel markets. We believe this should offer some cushion to the downside

for the company over the coming quarters as China's rebalancing process begins in

earnest. Unlike most of the industry where steel companies are either being merged or

closed down, Baoshan continues to invest heavily in organic capacity expansion and is

seeking to increase its production capacity to 33mnt by 2015. However, the lack of

upstream investment makes the company vulnerable to spikes in raw material prices.



We believe China's bloated steel sector is set to come under increasing pressure over

the coming quarters. The steel sector is plagued by significant overcapacity, depressed

margins, weak demand and persistent losses due to decades of blind expansion and

artificial government-led support. Apart from the downshift in China's economy, the

increasingly hardline stance of Beijing's new leaders should usher in more consolidation

activity for the steel industry over the medium term.

Underperforming



Company Details ■ Baoshan Iron & Steel

■ South BlockBaoshan Hotel 1813

Mudanjiang Road

Baoshan District

Shanghai

China

■ +86 21/2664 7000

■ www.baosteel.com



Table: Baoshan Iron & Steel - Key Financial Data

2006 2007 2008 2009 2010 2011 2012

Revenue (US$mn) 20,252 25,026 28,705 21,657 29,832 34,418 30,304

% chg y-o-y na 23.6 14.7 -24.6 37.7 15.4 -12.0

EBITDA (US$mn) 3,983 4,151 3,510 3,130 4,415 3,318 2,676

% chg y-o-y na 4.2 -15.4 -10.8 41.1 -24.8 -19.4

Net Income (US$mn) 1,640 1,672 930 851 1,902 1,139 1,646

% chg y-o-y na 2.0 -44.4 -8.4 123 -40.1 44.5

Profit Margin (%) 8.1 6.7 3.2 3.9 6.4 3.3 5.4

Debt to EBITDA 1.0 1.9 2.6 2.9 2.2 3.9 3.4

P/E Ratio 11.5 23.9 12.5 29.3 8.8 11.5 8.2

na = not available. Source: BMI, Bloomberg



Angang Steel

SWOT Analysis

Strengths ■ Largest-listed steel company in Hong Kong in terms of market capitalisation.

Flexibility and relative depth of its Hong Kong shares can mitigate the costs of equity

capital.

■ Enjoys significant economies of scale compared with industry peers.

■ Able to source as much as half of its iron ore needs from its parent company, limiting

exposure to input price fluctuation.

■ Operations are heavily focused on flat steel products. Flats demand will prove more

resilient than longs demand as China re-orientates its growth model away from fixed-

asset investment and towards private consumption.

Weaknesses ■ Market share in the high-margin flat steel segment has slowly eroded in recent years

while its competitor, Baosteel, has gained.

■ Net losses widened in 2012, to reach US$689mn.

■ Tighter credit curbs and environmental regulations in the Chinese steel sector to

weigh on operations.

Opportunities ■ Future asset injections from its unlisted parent company provide an opportunity for

further growth.

■ Ongoing industry consolidation as part of China's Five-Year Plan (2011-2015) could

enhance Angang's productivity and efficiency over the long term.

Threats ■ Our downbeat view on the real estate sector will significantly crimp demand for steel

products amidst the downshift in the Chinese economy.

■ Given the high-margin nature of the flats segment, the industry might face increasing

competitive pressure in the coming quarters as existing steel players move into the

segment.



Company Overview Angang Steel is principally engaged in the production and distribution of steel products.

Approximately 90% of the company's production goes into flat steel products and it is

thus a major supplier to the domestic shipbuilding, automobile and home appliance

industries. In 2012, the company produced around 20.3mn tonnes (mnt) of iron,

19.6mnt of steel and 19.0mnt of steel products, representing a year-on-year (y-o-y)

decrease of 0.8%, 0.8% and 0.4%, respectively. Angang distributes most of its

products within China but also has a sizable export segment.

Diversification Across Steel Products

Angang Steel - Revenue By Product Type (2012)

Source: BMI, Company Report

Strategy Angang Steel is relatively more integrated on the upstream compared with its peers in

the industry. The company can source as much as half of its iron ore needs internally. In

2013, Angang announced that it will be focusing on the development of its mining

subsidiary in a bid to increase its advantage in the raw materials segment. While this

could reduce the company's exposure to input price fluctuations, we believe the

downshift of the Chinese economy will nonetheless, be a significant drag to Angang's

operations over the coming years.

A bright spot, however, is its recent joint venture with Kobe Steel. Kobe Steel signed a

joint-venture agreement with Angang on October 2013 for the establishment of

Kobelco Angang Auto Steel Co. Ltd. The new company aims to tap into China's fast-



expanding automotive industry with the sale of advanced cold-rolled high strength steel

sheet.

Struggles To Continue



Company Details ■ Angang Steel

■ Angang industrial ZoneTiexi District

Anshan

Liaoning

China

■ +86 412/84172713

■ www.ansteel.com.cn



Table: Angang Steel - Key Financial Data

2006 2007 2008 2009 2010 2011 2012

Revenue (US$mn) 6,769 8,486 11,324 10,228 13,583 13,933 12,296

- % chg y-o-y na 25.4 33.4 -9.7 32.8 2.6 -11.8

EBITDA (US$mn) 1,796 2,289 1,360 1,176 1,539 750 248

- % chg y-o-y na 27.4 -40.6 -13.5 30.8 -51.3 -67.0

Net Income (US$mn) 878 991 429 109 304 -335 -659

- % chg y-o-y na 12.8 -56.7 -74.5 177.2 -210.3 96.8

Profit Margin (%) 13.0 11.7 3.8 1.1 2.2 -2.4 -5.4

Debt to EBITDA 1.4 1.3 3.3 4.5 3.5 8.2 21.9

P/E Ratio 10.3 17.8 18.5 146.4 35.5 na na

na = not available. Source: BMI, Bloomberg



Methodology

BMI's industry forecasts are generated using the best-practice techniques of multiple regression analysis,

using a combination of industry indicators, as well as country-specific, regional and global macroeconomic

variables that have statistically significant explanatory power in explaining past movements in industry-

specific indicators. The indicators used vary from industry to industry, and from country to country within

each industry, depending on the structure of supply and demand

When forecasting for some of our industry sub-component variables, however, using a variable's own

history is often the most desirable method of analysis. Such single-variable analysis is called univariate

modelling. We use the most common and versatile form of univariate models: the autoregressive moving

average model (ARMA).

In some cases, ARMA techniques are inappropriate because there is insufficient historic data or data quality

is poor. In such cases, we use either traditional decomposition methods or smoothing methods as a basis for

analysis and forecasting.

Human intervention plays a necessary and desirable part of all our industry forecasting techniques. Intimate

knowledge of the data and industry ensures we spot structural breaks, anomalous data, turning points and

seasonal features where a purely mechanical forecasting process would not.

Cross Checks

Whenever possible, we compare government and/or third-party agency projections with the reported

spending and capacity expansion plans of the companies operating in each individual country. Where there

are discrepancies, we use company-specific data, as physical spending patterns ultimately determine

capacity and supply capability. Similarly, we compare capacity expansion plans and demand projections to

check the chemicals balance of each country. Where the data suggest imports or exports, we check that

necessary capacity exists or that the required investment in infrastructure is taking place.



Documents

BMI China Metals Report Q2 2014