Thoughts on the Chinese Steel Industry

Colin Liang E-mail: Tel: Mobile: colinliang@cbichina.com +86-21-5155-0040 +86-13818344493

CBI Research & Consulting

Outline

Who We Are and What We Do

The Features of Chinese Steel Market - An Overview

Hot Topics in the Current Market

Slide 1

Who We Are

CBI China is the largest Chinese commodity research and consulting firm. We specialize in the industry chains of: petrochemical, steel, oil & gas, non-ferrous metal, pulp & paper; providing our clients with real-time market intelligence and in-depth industry value-chain analysis. We aim to offer value driven consulting services and support our clients in making strategic decisions on market entry, seeking business development opportunities and market penetration here in China. Bringing together over 350 local professionals, we have served over 73,000 multi-national and local clients with customized consulting and proven solutions since 1999.

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Slide 2

What We Do

Maintain a database containing 100,000+ companies, which is continually being updated. Call directly to industry players to collect first-hand information and monitor major industries throughout China. Deliver more than 8,000 phone calls, 30,000 emails and 50,000 short messages everyday to serve our 11,000 customers all over the world. More than 350 full-time professionals are working in CBI, 20% with Masters degrees and the rest with a minimum Bachelor degree. More than 100 employees are bilingual.

We completed more than 100 projects and assignments for MNCs last year.

Slide 3

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Slide 4

Outline

Who We Are and What We Do

The Features of Chinese Steel Market - An Overview

Hot Topics in the Current Market

Slide 5

The Features of Chinese Steel Market - An Overview

1. The Importance of the Chinese Steel Industry

2. Players and Their Relationship

3. Product Mix and Geographic Distribution of Steel Mills

4. Supply and Demand Dynamics

5. Export Evolution

Slide 6

1. The Importance of the Chinese Steel Industry

China is The Major Driver of World Steel Production
Steel Production Growth Rate in China and Rest of the World, 2001 - 2006 Steel Production of China and the World, 2000 - 2006

Unit: Million tonnes

35% 30% 25% 20% 15% 10% 5% 0% -2.9% -5% 2001 2002 2003 ROW 2004 China 3.2% 3.6% 5.5% -0.3% 2005 2006 4.4% 15.9% 21.9% 21.2% 23.8% 29.2% 19.7%

1,400 1,200 1,000 800 600 400 200 0 2000 2001 China 2002 ROW 2003 2004 2005 15.0% 20.2% 17.7% 22.9%

40% 35% 33.8% 30% 31.0% 25% 26.2% 20% 15% 10% 5% 0% 2006

China % of the World

Data Source: International Iron and Steel Institute

Slide 7

2. Players and Their Relationship

Players in the Value Chain

Central Government

Local Government

Steel Mills

Traders

End Users

CISA

Slide 8

2. Players and Their Relationship

Central Government

Goal: Smooth Growth with strategic long term planning Lack of experience for the transition from Planning Economy to Market Economy

Steep or flat learning curve? Protect the interest of bigger Stated Owned Enterprises

Keep the steel price reasonable to downstream industries

Pollution control Energy conservation

Industry consolidation

Slide 9

2. Players and Their Relationship

Local Government

Social stability GDP growth Tax revenue Employment Other related industries Different interest from central government

Slide 10

2. Players and Their Relationship

Steel Mills

State owned enterprises: The bigger, the better Economy of scale More clout to raw material suppliers, government, and competitors Ownership Top leaders are nominated by the government Whom they are responsible to? Government, shareholders, employees, or clients? Agency problem Mentality of leaders: Top line vs Bottom line, Market Share vs Profit margin Whats their top priorities within their tenure? Capacity, production, profit, or market share? Game theory What if I cut the capacity and production? Sales & marketing strategies and channel management need to improve Private mills: Low-value added product Hit and run, small in scale Not responsible to the government, CISA, National Bureau of Statistics, and public shareholder Strive to survive, maximize the profit More self-disciplined in terms of capacity and production

Slide 11

2. Players and Their Relationship

Traders or Distributors

Traders behavior adds more short term volatility to spot market price

Most small-medium size and private Low entry barrier for speculative traders: financing, relationship with steel mills, few industry knowledge, and guts

Little bargaining power to steel mills due to fragmentation Provide financing and distribution services to steel mills and end users Highly leverage on bank loan First tier traders are highly speculative with small percentage of direct sales

Future trend

Economy of scale with consolidation Distributors rather than speculators: service center Compete on sound financing, distribution network, and JIT services

Slide 12

2. Players and Their Relationship

End Users Purchasing Pattern

Large end users:

Direct orders from steel mills JIT inventory control Long-term contract with price lock-up

Middle size end users:

Order from traders Keep certain level of inventory Purchase at spot market price Get financing from traders with credit ranging from 15 to 30 days

Small size end users:

Orders from traders Few inventory Purchase at spot market price Get financing from traders with credit ranging from 15 to 30 days

Slide 13

3. Product Mix
Flat Production Is Catching Up Quickly
2001 Finished Steel Production Total= 160.7 Million tonnes
Others 13%

2006 Finished Steel Production Total= 469.5 Million tonnes

Others 21%

Flat Products 26%

Long Products 47.4%

Long Products 61%

Flat Products 31.6%

Data Source: NBS; CBI Research & Consulting.

Slide 14

3. Geographic Distribution of Steel Mills

Proximity to Resources, Ports and Markets

Steel Mills

Iron Ore Coal

Data Source: CBI Research & Consulting, Google Earth

Slide 15

4. Supply and Demand Dynamics

Production and Demand of Crude Steel
Production and Demand of Crude Steel, 2000-2006
Unit:Million tonnes

450 400 350 300 250 200 150 100 50 0 2000 2001 2002 Demand 2003 2004 2005 2006 Production Production GR Demand GR

30% 25% 20% 15% 10% 5% 0%

Data Source: NBS, CBI Research & Consulting.

Slide 16

4. Supply and Demand Dynamics

Growth Rates of Long Products and Flat Products
Production and Demand Growth Rate of Steel Products, 2001- 2006
Long Products Flat Products
38.2% 34.9%
35% 30% 25% 23.3% 19.6% 20% 23.2% 19.3% 15% 10% 5% 0% 2001 13.5% 13.3% 13.8% 15.1% 18.1% 19.2% 19.7% 22.5%

45% 40%

45% 40%

35.1% 30.5%

35% 30% 25% 20% 19.3% 15% 11.7% 10% 5% 0% 2001 10.8% 9.6% 20.4% 21.0% 23.9%

26.5%

2002

2003 Production

2004 Demand

2005

2006

2002

2003 Production

2004 Demand

2005

2006

Data Source: NBS, CBI Research & Consulting.

Slide 17

4. Supply and Demand Dynamics

Regional Supply and Demand in China, 2005
Million tonnes North-West +1 21 20 North +42 113 71 HEILONGJIANG Production Demand North-East +8 39 31

JILIN XINJIANG GANSU INNER MONGOLIA LIAONING BEIJING HEBEI SHANXI SHANDONG

East-29 156 127

QINGHAI

NINGXIA

TIBET South-West 18 14 32

SHAANXI HENAN JIANGSU ANHUI SHANGHAI SICHUAN HEBEI ZHEJIANG JIANGXI GUIZHOU HUNAN FUJIAN YUNNAN

Middle and South -9 67 58

GUANGDONG HAINAN
Data Source: CBI Research & Consulting.

TA IW AN

GUANGXI

Slide 18

5. Export Evolution
China Exports & Imports by Destinations
China's Finished Steel Exports by Destinations, 2004 - 2006
14.2
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2004 2005 2006
24% 26.9% 21.6% 13.7% 11.6% 12.3% 9.1% 6.6% 17.4% 19.3% 20.4% 15.1% 33.9% 34.5% 33.6%

China's Finished Steel Imports by Origins, 2004 - 2006

29.3
100% 90%
17.1% 31.9% 29.9% 3.0%

20.5

43

Total Million tonnes

25.8

Total 18.5 Million tonnes

Others
80%

Others Russia Taiwan

EU ASEAN USA

70%
8.0% 9.9%

22.2%

60% 50% 40%

16.7% 18.9% 19.8%

Korea Japan

Korea

16.8%

30% 20% 10% 0% 2004

26.6%

17.2%

37.9% 24.2%

2005

2006

Data Source: China Customs, CBI Research & Consulting

Slide 19

5. Export Evolution
Changes in Net Exports
20 15 10 5
0.5 0.3 0.0 -0.2 0.2 -2.9 -8.8 -6.8 -1.2 -0.7 -1.9 -9.5 -6.2 -1.6 -2.1 0.4 0.5 0.4 2.5 1.6 -1.9 -6.8 -1.7

Unit:Million tonnes
0.9 3.3 5.1

GI M-H Plate HR Wire Rod DeBar CR

4.9 1.6 1.0 -3.4 3.7 -2.5

0 -5 -10 -15 -20 -25 -30

-1.9 -5.2

-2.7 -3.0

2001

2002

2003

2004

2005

2006

Data Source: China Customs, CBI Research & Consulting

Slide 20

Outline

Who We Are and What We Do

The Features of Chinese Steel Market - An Overview

Hot Topics in the Current Market

Slide 21

Hot Topics
1. When will the current oversupply end? 2. How strong will demand be in the future? 3. Will Chinese net exports continue to soar? 4. Potential impact of anti-dumping 5. Consolidation is on the way!

Slide 22

1. When Will The Current Oversupply End?

Crude Steel Capacity
Crude Steel Capacity, 2006 - 2010
Unit:Million tonnes 800 18.9% 700 600 500 400 300 200 100 0 2006 2007E Capacity 2008E 2009E Y-o-Y Growth Rate 0.7% 2010E 6.9% 3.9% 535 12.3%

601

642

667

672

20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%

Data Source: CBI Research & Consulting.

Slide 23

1. When Will The Current Oversupply End?

Crude Steel Capacity by Products
Long Products
Million tonnes 400 350 300 250 200 150 100 50 0 2006 2007E 2008E 2009E 10.8% 239.1 245 247.6 25% 20% 15% 10% 4.2% 5% 2.5% 1% 2010E 0% 0 2006 2007E 2008E 2009E 2010E Y-o-Y Growth Rate 40% 35% Wire Rod 29.8% 30% DeBar 300 250 200 150 100 50 1.3% 0% 236.9 19.8% 283.7 Million tonnes 400 360.1 350 311.4 30% 25% 20% 15% HR 9.7% 10% 5% Y-o-Y Growth Rate 364.8 35% GI 40%

Flat Products

221.6

230.9

Plate

CR

15.7%

3.5%

Data Source: CBI Research & Consulting.

Slide 24

2. How Strong Will Demand Be in The Future?

Steel Demand
Steel Demand, 2006 - 2010
Unit:Million tonnes 600 500 400 300 200 100 0 2006 2007E Demand 2008E 2009E 2010E Y-o-Y Growth Rate 12.1% 10.7% 375.4 415.5 8.1% 8% 7.3% 8% 6% 4% 2% 0% 448.7 485

520.6

14% 12% 10%

Data Source: CBI Research & Consulting.

Slide 25

1. How Strong Will Demand Be in The Future?

Main Steel Demand by Industries
2006 Total=375.38 million tonnes 2010 Total=520.6 million tonnes

Railway 1.0%

Pipes 1.6% Hardware 4.1%

Shipbuilding 1.8% Container 1.1% Home Appliance 1.4%

Railway 1.3%

Others 21%

Others 18.5%

Pipes 1.4% Hardware 3.6%

Shipbuilding 2.5%

Container 1.0% Home Appliance 1.3%

Automobile 4.3% Machinery 13.4% Construction 48.5%

Automobile 6.2%

Machinery 15.8%

Construction 50.3%

Data Source: NBS; CBI Research & Consulting.

Slide 26

3. Will Chinese Net Exports Continue to Soar?

Steel Net Export Would Peak in 2009
Finished Steel Import and Export, 2006 -2010
Unit: Million tonnes 18.5 16 14 13 13
Unit:Million tonnes 50 49% 40 30 20 23.8 -14.1% 36.5 45.9 39.4 25.8% 60% 40% 20% 0% -20% -40% -48% 2007E 2008E Finished Net Export -60%

Finished Steel Net Export, 2006 -2010

33.5 43 52.5 59.9 2006 2007E 2008E 2009E Finished Import 2010E Finished Export 52.4

10 0

2009E 2010E Y-o-Y Growth Rate

Data Source: China Customs, CBI Research & Consulting

Slide 27

3. Will Chinese Net Exports Continue to Soar?

Steel Export by Products
Long Products
million tonnes 30 40% 30% 25 17.0% 20 10.0% 20% 10% 0% 10.87 10 9.29 11.96 11.01 -10.0% -10% 9.36 -20% 5 -24.1% -30%
-32.9% 5 -30% 0 2006 2007E 2008E 2009E 2010E -40% 1000 tonnes 30 40% 30%

Flat Products

Wire Rod

25 17.6% 209.7 228 20% 226 180.2 15 10% 8.5% 206.6 0% -10% 10 -15.1% -20% Y-o-Y Growth Rate HR CR Plate GI

DeBar

20

15

Y-o-Y Growth Rate

0 2006 2007E 2008E 2009E 2010E

-40%

Data Source: China Customs, CBI Research & Consulting

Slide 28

4. Anti-dumping
China Doubled Its Share in Global Steel Trade in 2006
China Doubled Its Share in Global Steel Trade
2005
China 8%

2006

China 15%

What impacts will anti-dumping activities have on Chinas steel export?

Data Source: China Customs; CBI Research & Consulting.

Slide 29

4. Anti-dumping
What Impacts Will Anti-dumping Activities Have on Chinas Steel Export
China Steel Export Quantities Under Anti-dumping Investigations, Jan 2006 - Jan 2007
CR 0.1 3.1

Million tonnes

Countries Raised Anti-dumping Investigations on Chinas Steel Export, Jan 2006 - Feb 2007 Mexico CR Indonesia HR & 14.8 M-H Plate Mexico USA USA USA Canada

HR & M-H Plate 3.8

0.3

GI

0.8

4.0

GI Thailand USA Debar Indonesia Vietnam Mexico Wire Rod Pipe

Debar

1.4

4.3

Wire Rod

0.1 0.1

5.8

India

Australia Mexico

Pipe

0.7

6.4

Jan Feb Mar Apr May Jun Jul

Export Quantities Under Anti-dumping Investigation Total China's Export Quantities Export Quantities Under EU Anti-dumping Argument

Aug Sep Oct Nov DEC Jan Feb 2007

2006

Data Source: China Customs; CBI Research & Consulting.

Slide 30

4. Anti-dumping
What Impacts Will Anti-dumping Activities Have on Chinas Steel Export
1. Chinese government have minimized Export VAT Refund and imposed
export taxes for semis 2. Flat product export will bear the brunt because of a larger share under investigation. 3. Export to SE Asia could stop increasing due to more anti-dumping investigations. E.U. and the Middle East are still promising for Chinas future steel export.

Slide 31

China's Export to ASEAN Going Flat

China's Semi & Finished Export to ASEAN, 2004 - 2006

Unit: Million tonnes 12 10 8 6 4 2 0 2004 2005 2006 2007E 5.1 7.6 10.6

Source: China Customs, CBI Research & Consulting

Slide 32

China's Semi Export Can Hardly Feed ASEAN Shortage

China's Total Semi Export & Export to ASEAN, 2004 - 2006

Unit: Million tonnes 2004 6.1 2.6 7.1 3.6 9 4.2 5 China's Semi Export to ASEAN China Total Semi Export

2005

2006

2007E

Source: China Customs, CBI Research & Consulting

Slide 33

China's Export to ASEAN by Products

2004 2006 CAGR Rate for Chinas Total Export and Export to ASEAN by Category

Chinas Export to ASEAN by Products, 2006

Pipes 7% Sheets& Coils 28%

100% 90% 80% 84.5% 72% 87%

Semi 40% 70%

60% 50% 40% 30% 20% 10% 43.5%

DeBar 12%

Wire Rod Bars 2% 5%

Section 6%

0% Long Chinas Export to ASEAN Chinas Total Export Flat

Source: China Customs, CBI Research & Consulting

Slide 34

China's Export to ASEAN Going Flat

China's Semi & Finished Export to ASEAN, 2004 - 2006

Unit: Million tonnes 12 10 8 6 4 2 0 2004 2005 2006 2007E 5.1 7.6 10.6

Source: China Customs, CBI Research & Consulting

Slide 35

China's Semi Export Can Hardly Feed ASEAN Shortage

China's Total Semi Export & Export to ASEAN, 2004 - 2006

Unit: Million tonnes 2004 6.1 2.6 7.1 3.6 9 4.2 5 China's Semi Export to ASEAN China Total Semi Export

2005

2006

2007E

Source: China Customs, CBI Research & Consulting

Slide 36

China's Export to ASEAN by Products

2004 2006 CAGR Rate for Chinas Total Export and Export to ASEAN by Category

Chinas Export to ASEAN by Products, 2006

Pipes 7% Sheets& Coils 28%

100% 90% 80% 84.5% 72% 87%

Semi 40% 70%

60% 50% 40% 30% 20% 10% 43.5%

DeBar 12%

Wire Rod Bars 2% 5%

Section 6%

0% Long Chinas Export to ASEAN Chinas Total Export Flat

Source: China Customs, CBI Research & Consulting

Slide 37

4. Anti-dumping
VAT Refund Adjustment Chart Update
Export VAT Refund and Export Tax Rate Evolutions, 2000- Apr 2007
Export VAT Refund and Export Tax Rate

Finished Steel & Slab/billet Finished Steel & Slab/billet

15% 13% 11% 8% 5%

Pipes
Finished Steel Most of Flat Products Part of Long Products Most of Long Products Part of Flat Products Mostly CR & GI

Slab & Billet 0%

Most Finished Steel Products

Slab & Billet -10% 2000 Jan, 2004 Apr, 2005 Sep, 2006 Nov, 2006 Apr, 2007 Slab & Billet

Data Source: CBI Research & Consulting, NDRC

Slide 38

5. Consolidation
Decreasing Concentration Ratio in the Past 6 Years
A Deterioration in Chinas Top 10 Concentration Ratio, 2001-2006
Unit:Million tonnes 500 450 400 350 300 250 200 150 100 50 0 2001 2002 2003 2004 2005 2006 25% 30% 35% 40% 45% 50%

Top 10 mill's Production

Rest of Mills Production

Top 10 Concentration Rate

Will capacity elimination really happen in China? How much capacity will be eliminated? Where will M & As go ?

Data Source: NBS

Slide 39

5. Consolidation
Will Capacity Elimination Really Happen in China?

Policies :

Elimination of Inefficient Capacity

Criteria on Size of Equipment

Criteria on Energy Consumption

Pollution Control

Elimination of Inefficient Equipment

Current Impact Progress Strong Satisfactory

Discriminatory Power Pricing Normal

Satisfactory

Highly Polluting Project Elimination Weak

Difficult

Slide 40

5. Consolidation
How Much Capacity Will Be Eliminated by 2010?

NDRC s Target: 100 million tons of iron-making and 55 million tons of steel-making capacity are requested to be eliminated by 2010, the 11th Five-year Plan

Key Areas of Capacity Elimination: North China & East China

Conclusion:

Small but solid progress has been seen in key areas since end 2006.
Further strengthening measures are needed to approach the target.
Slide 41

Data Source: CBI Research & Consulting.

5. Consolidation
Where Will M & As Go ?
Intra-Province SOE with SOE SOE with Private Private with Private Overseas Mills Involved
Notes: 1. * refers to successful ones 2. Cases in red are self-initiated 3. SOE for state owned enterprises

Cross-Province Baosteel with Bayi* Baosteel with Jinan

Tanggang Group* Magang with Hefei* Tonghua I/S with Jilin Jianlong* Hangzhou I/S with Ningbo Jianlong* Shagang with Huaigang* Tangshan Guofeng with Yinfeng&Qunli*

Mittal with Valin* Arcelor with Laiwu

Conclusions: 1. More successful intra-province cases than cross-province ones 2. Private mills are taking more active roles in M&As 3. More waiting time for overseas acquirers 4. Catalysts: Market forces rather than government force
Slide 42

Thank You!
Colin Liang E-mail: Tel: Mobile: colinliang@cbichina.com +86-21-5155-0040 +86-13818344493

CBI Research & Consulting