Equity Research
27 May 2005
Asia Pacific/China
Investment Strategy
China’s Capacity Expansion
Investment cycle and major drivers
During the investment upturn of past few years, property and basic materials and machinery/electronics
have been the major drivers. Financial statistics of industrial corporations indicates that investment
behaviour has little relationship with profitability, gearing and profit growth.
Global impact
To assess the global impact of different sectors, there are three issues to be considered: 1) whether they
can be traded internationally, 2) if they are complementary to or substitutes and 3) existing capacity
utilisation and inventory/sales positions. Considering these factors, industries globally facing more
downside risk in terms of pricing are apparel & textiles, furniture, communication equipment, computer &
electronic products, motor vehicle & parts and fabricated metals.
Capacity impact by sector
We looked at: white goods (including refrigerators, air-conditioners, washing machines and microwaves),
autos, industrial commodities (including coal, cement, aluminium, cement, glass and steel), oil &
chemicals, power, semiconductors and mobile handsets. The demand-and-supply balance of autos,
power, aluminium and steel products (particularly flat steel products) will worsen in next few years.
When the dragon strikes ...
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Research team
Vincent Chan
852 2101 6568
@
Jonathan Garner
44 20 7883 6887
@
Trina Chen
852 2101 7031
@
Jeannie Cheung
852 2101 7663
@
Prashant Gokhale
852 2101 6944
@
Angello Chan
852 2101 6314
@
Neelkanth Mishra
65 6212 3370
@
Alison Yip
852 2101 7196
@
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Focus tables
Figure 1: ‘Capacity utilisation’* by sector
% 2001 2002 2003 2004 2005E 2006E 2007E Remarks
Refrigerators Utilisation remains low
Air-conditioners Sharp deterioration in utilisation
Washing machines Deteriorating
Microwave ovens Deteriorating
Passenger cars A major deterioration
Aluminium Improving, a significant portion for exports
Cement Improving
Crude steel Improving
Steel products (flat) Deteriorating, reducing import dependency
Steel products (long) Stable
Power Deteriorating
* Defined as demand over capacity.
Source: China Household Electrical Appliances Association, China Building Materials Association, CCID, Antaike,
Credit Suisse First Boston (CSFB) estimates
Figure 2: Exports (imports) as % of total demand
2001 2002 2003 2004 2005E 2006E 2007E 2008E
Refrigerators
Air-conditioners
Washing machines
Microwave ovens
Aluminium
Steel products (long)
Steel products (flat)
Ethylene
Oil
Handsets
Source: China Household Electrical Appliances Association, China Building Materials Association, CCID,
Antaike, CSFB estimates
Figure 3: Net capex of major industrial sectors
(RMB bn) 2000 2001 2002 2003 2004
Mining
YoY (%)
% of sales
Light industry
YoY (%)
% of sales
Basic materials
YoY (%)
% of sales
Machinery & electronics
YoY (%)
% of sales
* Net capex is defined as the year-on-year difference of net fixed assets
Source: CEIC, CSFB estimates.
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The local and global impact
Investment cycle and major drivers
The last trough in China’s investment cycle was in 1999, and investment growth started
to accelerate from that point onwards. During the aggressive investment cycle of the
past few years, property (residential, in particular) and industrial sectors were the major
drivers. Within the industrial sector, basic materials (like steel, non-ferrous metals and
petrochemicals) and machinery/electronics were the areas with the fastest growth. A
study of the financial statistics of China’s industrial corporations (listed and unlisted
together) indicates that the pace of investment (net fixed assets in 2004 versus 1999) in
the past few years seemingly had little relationship with profitability (pre-tax ROE),
gearing (debt-to-asset ratio) and profit growth, but the strongest correlation with revenue
growth. How this investment cycle corrects will have a massive impact on the domestic
economy as well as a global impact in some sectors.
Global impact
To assess the global impact of China’s capacity expansion on different industries, there
are three issues that need to be considered: 1) whether this capacity could be traded
internationally and hence compete with capacity in other markets, 2) whether
international capacity in the industry concerned is complementary to or a substitute for
Chinese capacity expansion, and 3) the pattern of capacity utilisation and the current
inventory/sales positions in that particular industry. After considering all these factors,
we believe that the industries globally that face more downside risk in terms of pricing
are apparel & textiles, furniture & related services, communication equipment, computer
& electronic products, motor vehicle & parts and fabricated metals.
Capacity impact by sector
The sectors included are: white goods (including refrigerators, air-conditioners, washing
machines and microwaves), autos, industrial commodities (including coal, cement,
aluminium, cement, glass and steel), oil and petrochemicals, power, semiconductors
and mobile handsets. Overall, among the sectors we surveyed, the supply-and-demand
balance is worsening distinctively for autos, power, aluminium and steel products
(particularly flat steel products).
The deterioration of the supply-and-demand balance of aluminium and steel products is
likely to have the greatest regional/global impact as these new capacities are
‘internationally tradable’, ., it could result in a big swing in China’s trade balance
position. In contrast, excess capacity in power would mainly affect the profitability of
Chinese power companies. The big unknown is autos. Will the huge excess capacity in
the auto sector translate into a sharp plunge in domestic prices (which would affect the
profitability of multinational companies that have invested heavily in the past few years)
and/or transform China into a major auto export country?
During the investment
upturn in the last few
years, property, basic
materials and
machinery/electronics
were the major drivers
Three factors to consider
in assessing the global
impact of China’s capacity
expansion
Our survey of capacity
expansion reveals that the
demand-supply situation of
auto, power, aluminium
and steel products
(particularly flat steel
products) is likely to
worsen most significantly
in the next few years
China’s Capacity Expansion 27 May 2005
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Table of contents
Focus tables......................................................................................................................2
The local and global impact ..............................................................................................3
Investment cycle and major drivers...............................................................................3
Global impact.................................................................................................................3
Capacity impact by sector .............................................................................................3
Investment cycle and major drivers ..................................................................................5
China’s investment cycle...............................................................................................5
Investment behaviour ..................................................................................................10
Global impact ..................................................................................................................15
US capacity utilisation .................................................................................................15
Japan’s capacity utilisation..........................................................................................17
Eurozone capacity utilisation.......................................................................................18
Capacity discipline and inventory-to-sales trends .......................................................19
Summary conclusions .................................................................................................22
Capacity impact by sector ...............................................................................................27
White goods (refrigerators, air-cons, washing machines and microwaves)................28
Commodities (coal, aluminium, cement, glass and steel) ...........................................30
Individual sector comments ............................................................................................45
Coal.............................................................................................................................46
Aluminium ...................................................................................................................49
Cement .......................................................................................................................52
Steel ............................................................................................................................54
Automobile ..................................................................................................................57
Chemicals ...................................................................................................................60
Crude oil refining.........................................................................................................64
Power ..........................................................................................................................67
Semiconductors ..........................................................................................................71
Handsets.....................................................................................................................73
Appendix I: Aluminium market update ............................................................................77
Appendix II: Global steel industry update .......................................................................91
China’s Capacity Expansion 27 May 2005
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Investment cycle and major drivers
In this report we evaluate the China’s investment cycles, the investment behaviour of
the country’s industrial corporations, the capacity outlook for various industries and their
potential global impact.
China’s investment cycle
In traditional business-cycle theory, there are four most-frequently listed cycles:
1) The Kitchin or inventory cycle, with a usual length of three to five years (from peak
to peak), in which economic fluctuations are driven by inventory adjustments by
corporations.
2) The Juglar or investment cycle, with a length of seven to 11 years, of which
corporate investment activities are the major reason for the cyclical fluctuations of
the economy: investment overshoots at the peak, giving excess capacity, and
undershoots at the trough, resulting in shortages during the next upturn.
3) The Kuznets or building cycle, of 15-25 years duration. This cycle pattern is most
obvious in the US during the period between 1840 and 1914 (not so obvious in
other places and at other times), and is driven by a strong interaction between
economic (residential property construction) and demographic variables (massive
immigration from Europe and family formation); and
4) The Kondratieff cycle or the long wave, which is widely said to last 45-60 years,
which is widely attributed to being driven by major technological innovations.
For stock market investors, and probably global commodity investors, the most
important question is whether the Chinese economy is at the peak of the ‘Juglar’ cycle:
• The correction of an investment cycle could be very severe, given the ‘self-fulfilling’
nature of investment spending: one company’s investment spending is the revenue of
another, and improving sales will induce the company concerned to invest more, and a
virtuous cycle starts. The reverse could easily happen in a downturn. The inter-
relationship between China’s heavy industrial (mostly commodities) and power
industries can be seen below. Any major correction in the country’s investment demand
could have huge ramifications on a wide spectrum of sectors.
Figure 4: Sales exposure of various sectors to investment demand
Sales exposure to investment demand
Cement 100% construction – 35% real estate and 40% infrastructure
Steel 54% construction
Aluminum 34% construction, 16% power
Copper 40% power, 14% construction
Coal 52% power, 13% steel, 18% building materials
Power 75% industrial sector, within which 80% to heavy industry
Source: CSFB estimates
• The duration of the down-cycle could be a three- to four-year affair (at least), as
suggested by various studies of business cycles. Incidentally, as shown below,
China’s investment cycle has basically followed a four-year up and four-year down (in
relative growth terms) cycle since the early 1980s. The only exception was the last
down-cycle, which lasted for six years, due to the start of the Asian financial crisis in
1997, when the downtrend almost reached its trough.
When the investment cycle
starts to correct, the extent
could be very severe
The duration of the down-
cycle could be quite long
China’s Capacity Expansion 27 May 2005
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Figure 5: China's fixed asset investment cycle
-20
-10
0
10
20
30
40
50
60
70
1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003
Dow n Dow nUp Up Up
Total fix ed asset inv estment (YoY%)
Source: CEIC
• The global impact of a slowdown in China’s demand growth, particularly for industrial
commodities, is much larger in this down-cycle compared to ten years ago. With
continuous strong growth throughout the past decade, China is consuming almost
50% of cement globally, around 30% of steel and iron ore, and over 20% of most non-
ferrous metals such as copper and aluminium. Most importantly, China contributes
almost all of the consumption growth of these items in the world. The global impact of
a sharp slowdown in China’s investment cycle would have an immense global impact.
In short, China might be in the upstream of a long wave, or even only in the middle of a
15-25-year building cycle, but if the country’s investment cycle is right at the peak now,
its downturn will override most of the other positive structural factors in the next few
years, even if one decides to neglect China’s other negative structural factors, such as a
weak financial system.
Looking again at Figure 5 above, one could argue that since the absolute growth rate of
fixed asset investment is much slower compared to the mid-1990s, the downturn could
probably be less painful. However, this argument misses two points: 1) the early 1990s
were a period with much higher inflation, thus the real growth of investment in the past
two years was much closer to the last cyclical peak than suggested by the nominal rate
of growth and 2) indeed, the nominal growth rate of industrial investment during 2003 is
comparable to that of 1993 and 1985 (we use investment by SOEs as a proxy for total
investment by sectors not available by that time), ., much higher growth in real terms
(see Figure 6 below). The slower rate of growth in total nominal investment is due
mainly to a much lower rate of growth in property investment (not slow in absolute terms
though). This is due mainly to the base effect, as 1993-94 was the first property bubble
in modern Chinese economic history, and at that time the base was much smaller. The
relatively ‘low’ rate of property investment growth now does not mean that China’s
property sector is very healthy.
Bigger global impact
compared to the last
downturn
China might be in a long-
term structural upswing,
but the next few years do
not look good
The growth of industrial
investment is comparable
to the peak of the last
cycle
China’s Capacity Expansion 27 May 2005
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Figure 6: Industrial investment Figure 7: Property investment
-20
-10
0
10
20
30
40
50
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Total SOE
Up Up UpDow n Dow n
Industrial Inv estment (YoY%)
-20
0
20
40
60
80
100
120
140
160
180
1987 1989 1991 1993 1995 1997 1999 2001 2003
Up UpDow nDow n
(YoY% of real estate inv estment)
Source: CEIC Source: CEIC
Every investment cycle has its leading sectors. Usually its leading sectors enjoyed the
strongest growth during the upturn, but suffered most during the downturn. During the
last upturn of the Chinese economy, the driving sectors were property (particularly
residential property) and its related industrial sectors. The chart below shows the
change of China’s fixed asset investment ratio (as a percentage of GDP, broken down
by major sectors) compared to 1997, and it is obvious that investment in property and
industrial sectors are the major reason for the sharp rise in the investment ratio in the
past few years.
Figure 8: Fixed asset investment ratio
-4
-2
0
2
4
6
8
10
12
14
16
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Infrastructure Residential prop Other prop Industrial Serv ices
% of GDP (dev iation from 1997)
Source: CEIC, CSFB estimates
The property and industrial
sectors are likely to lead
this round of correction
China’s Capacity Expansion 27 May 2005
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Doing the same analysis on industrial investment by various sub-sectors, as shown
below, raw materials (sectors such as steel, non-ferrous metals and petrochemicals)
and machinery/electronics are the major sectors driving investment growth. In contrast,
energy and light industry are not the major drivers.
Figure 9: Fixed asset investment ratio for industrial sectors
-2
-1
0
1
2
3
4
5
1996 1997 1998 1999 2000 2001 2002 2003 2004
Energy Raw materials Machinery and Electronics Light Industry & Tex tile Others
% of GDP (dev iation from 1997)
Source: CEIC, CSFB estimates
This observation is consistent with the data from the corporate level. The table below
shows the net capex, . gross capex net of depreciation, deduced from the change in
net fixed assets, of various industrial sectors, based on the financials of China’s
industrial enterprises (including both domestic and foreign-funded companies). Net
capex of basic materials (such as steel and petrochemicals) grew fastest – it doubled in
both 2003 and 2004 – and as a percentage of sales it increased from % in 2001 to
% in 2004. This is followed by machinery and electronics, while capex in the light
industry and mining sectors was much lower. A more detailed sector-by-sector net
capex breakdown is shown in Figure 11.
Figure 10: Net capex of major industrial sectors
(RMB bn) 2000 2001 2002 2003 2004
Mining
YoY (%)
% of sales
Light industry
YoY (%)
% of sales
Basic materials
YoY (%)
% of sales
Machinery & electronics
YoY (%)
% of sales
Source: CEIC
Within the industrial sector,
raw materials and
machinery/electronics are
the major drivers of growth
This is consistent with data
from the corporate level
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Figure 11: Net capital expenditure by detailed sectors
RMB bn YoY (%) % of sales
2000 2001 2002 2003 2004 2001 2002 2003 2004 2000 2001 2002 2003 2004
Upstream mining 90 40 60 54 61
Coal mining 10 15 16 32 28
Petroleum & natural gas 71 20 40 26 24
Ferrous metals mining 1 1 2 2 3
Non ferrous metals mining 3 1 1 -0 0 -ve capex Turnaround
Non-metal minerals mining 5 4 1 -5 5 -ve capex Turnaround
Light industry 46 38 53 82 96
Food manufacturing 3 4 7 4 11
Beverage manufacturing 4 4 4 4 4
Tobacco processing 6 -2 0 1 0 -ve capex Turnaround
Textile -2 5 16 31 30 Turnaround
Garment & footwear 2 4 5 7 9
Leather, fur, down & related 0 1 3 4 7
Timber processing 3 4 2 3 4
Furniture manufacturing 1 1 2 3 6
Paper making & paper products 23 12 10 16 14
Printing & record reproduction 4 4 3 6 7
Cultural, educational & sport article 1 1 2 1 4
Basic materials 147 48 72 144 287
Petroleum processing & coking 46 -0 -7 0 20 -ve capex -ve capex Turnaround 4,
Raw chemical materials 29 16 24 24 39
Medical & pharmaceutical 7 11 13 18 23
Chemical fibre -0 -11 -3 0 11 -ve capex -ve capex Turnaround 2,
Rubber products 0 5 1 4 5 1,
Plastic products 4 11 4 9 19
Non-metal minerals products 13 2 6 26 51
Smelting of ferrous metal 39 -3 20 50 73 -ve capex Turnaround
Smelting of non-ferrous metal 5 10 3 17 32
Metal products 4 6 10 -4 15 -ve capex Turnaround
Machinery & electronics 50 60 62 151 168
Ordinary machinery 5 2 10 12 25
Special purpose equipment 2 1 1 38 3 6,
Transport equipment 12 20 11 30 35
Electric machinery & equipment 4 5 6 21 19
Electronic & communication equipment 28 31 33 40 83
Instrument & office machinery -0 1 1 10 2 Turnaround
Electricity, gas and water 171 209 173 249 196
All industrial enterprises 533 393 441 671 844
Source: CEIC, CSFB estimates
China’s Capacity Expansion 27 May 2005
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Investment behaviour
Before we discuss the impact of this round of capacity increases, it is probably
worthwhile to take a step back and consider the investment behaviour of China’s
industrial corporations. Below we look at the relationship between the capex of China’s
industrial corporates (comparing the net fixed assets by year-end 2004 with year-end
2004) with profitability (average ROE between 1999 and 2004), gearing (average debt-
to-asset ratio between 1999 and 2004), revenue growth (2004 revenue over 1999) and
pre-tax profit growth (2004 pre-tax profits over 1999). Scatter charts of this comparison
are shown below (Figures 12 to 15), but we can make the following observations:
• profitability, in terms of ROE, is seemingly not a major factor driving investment
growth;
• debt burden is not a major constraint factor in the investment activities of corporations;
• resource constraints are seemingly a major constraint on investment, considering the
limited investment in the mining sector, despite its high profitability in the past few
years;
• revenue growth seemingly has the strongest correlation with investment behaviour,
which probably indicates that the potential for business scale expansion is a key
consideration for corporate management to invest; and
• it is very surprising to find that profit growth actually has a negative correlation with
investment. However, due to the low correlation co-efficient, we could neglect this
observation.
The implications of these observations are that if profitability (and profit growth) has little
correlation with investment behaviour, one could question the business rationality of a
lot of industrial investment in the past few years, even though a significant amount of it
has been undertaken by either private or foreign-funded companies. In addition, the
relatively stronger importance of revenue growth in driving investment is also not a good
sign. If the business outlook is so important in driving investment, then those companies
which invested heavily in the last few years could cut back on investment drastically
once the outlook turns cloudy – and this would have a self-fulfilling effect on investment
demand. Finally, the limited impact of high gearing on containing investment growth is
also not a very nice phenomenon – it means that once the downturn comes, these
investors will be more than willing to dump their products into the market in order to
generate enough cash flow to pay off the debt.
Investment behaviour has
more to do with revenue
growth than profitability
If current profitability and
gearing are not the major
concern for these
companies, how will they
behave when market
conditions turn bad?
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Figure 12: Pre -tax ROE versus net fixed assets
Coal Mining
Petroleum & Natural Gas
Ferrous Metals Mining
Non Ferrous Metals Mining
Non-Metal Minerals Mining
Food Manufacturing
Bev erage Manufacturing
Tobacco Processing
Tex tile
Garment & Footw ear
Leather & Fur products
Timber Processing
Furniture
Paper & Paper Products
Printing & Record Reproduction
Cultural, Educational & Sport Article
Petroleum Processing & Coking
Raw Chemical Materials
Medical & Pharmaceutical
Chemical Fiber
Rubber Products
Plastic Products
Non-Metal Minerals Products
Smelting of Ferrous Metal Smelting of Non-Ferrous Metal
Metal Products
Ordinary Machinery
Special Purpose Equipment
Transport Equipment
Electric Machinery & Equipment
Electronic & Communication Equipment
Instrument & Office Machinery
Electricity , Gas and Water
y = +
R2 =
0
2
4
6
8
10
12
14
16
18
20
1 2
Net fix ed assets (X, 04 v s. 99)
Av erage pre-tax ROE (%, 99-04)
Source: CEIC, CSFB estimates
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Figure 13: Debt-to-asset ratio versus net fixed assets
Coal Mining
Petroleum & Natural Gas
Ferrous Metals Mining
Non Ferrous Metals Mining
Non-Metal Minerals Mining
Food Manufacturing
Bev erage Manufacturing
Tobacco Processing
Tex tile
Garment & Footw ear
Leather, Fur, Dow n & Related
Timber Processing
Furniture Manufacturing
Paper Making & Paper Products
Printing & Record Reproduction
Cultural, Educational & Sport Article
Petroleum Processing & Coking
Raw Chemical Materials
Medical & Pharmaceutical
Chemical Fiber
Rubber Products
Plastic Products
Non-Metal Minerals Products
Smelting & Pressing of Ferrous Metal
Metal Products
Ordinary Machinery
Special Purpose Equipment
Transport EquipmentElectric Machinery & Equipment
Electronic & Communication Equipment
Instrument & Office Machinery
Electricity , Gas and Water
y = +
R2 =
1 2
Net fix ed assets (X, 04 v s. 99)
Av erage debt-to-asset ratio (X, 99-04)
Smelting & Pressing of Non-Ferrous Metal
Source: CEIC, CSFB estimates
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Figure 14: Revenue growth versus net fixed assets
Electricity , Gas and Water
Instrument & Office Machinery
Electronic & Communication Equipment
Electric Machinery & Equipment
Transport Equipment
Special Purpose Equipment
Ordinary Machinery
Metal Products
Smelting of Non-Ferrous Metal
Smelting of Ferrous Metal
Non-Metal Minerals Products
Plastic Products
Rubber Products
Chemical Fiber
Medical & Pharmaceutical
Raw Chemical Materials
Petroleum Processing & Coking
Cultural, Educational & Sport Article
Printing & Record Reproduction
Paper & Paper Products
Furniture
Timber Processing
Leather & Fur products
Garment & Footw ear
Tex tile
Tobacco Processing
Bev erage Manufacturing
Food Manufacturing
Non-Metal Minerals Mining
Non Ferrous Metals Mining
Ferrous Metals Mining
Petroleum & Natural Gas
Coal Mining
y = +
R2 =
Net fix ed assets (X, 04 v s. 99)
Rev enue (X, 04 v s. 99)
Source: CEIC, CSFB estimates
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Figure 15: Profit growth versus net fixed assets
Petroleum & Natural Gas
Ferrous Metals Mining
Non Ferrous Metals Mining
Non-Metal Minerals Mining
Food Manufacturing
Bev erage Manufacturing
Tobacco Processing
Tex tile
Garment & Footw ear
Leather & Fur products
Timber Processing
FurniturePaper & Paper Products
Printing & Record Reproduction
Cultural, Educational & Sport Article
Petroleum Processing & Coking
Raw Chemical Materials
Medical & Pharmaceutical
Chemical Fiber
Rubber Products
Plastic Products
Non-Metal Minerals Products
Smelting of Ferrous Metal
Smelting of Non-Ferrous Metal
Metal Products
Ordinary Machinery
Special Purpose Equipment
Transport Equipment
Electric Machinery & Equipment
Electronic & Communication Equipment
Instrument & Office Machinery
Electricity , Gas and Water
y = +
R2 =
0
5
10
15
Net fix ed assets (X, 04 v s. 99)
Pre-tax profits (X, 04 v s. 99)
Source: CEIC, CSFB estimates
China’s Capacity Expansion 27 May 2005
15
Global impact
In considering the impact of China’s current and future capacity expansion, it is
important analytically to distinguish on an industry basis as follows:
• First, one needs to consider the ease with which Chinese capacity can be traded
internationally, and hence compete with local capacity. This is a function of 1) the
fungibility of the product (commodities are generally much more homogenous than
manufactured goods), 2) the selling price as a percentage of transportation and
distribution costs and 3) any government or intellectual-property derived restrictions
on trade: for example, in the European Union there is a much greater degree of trade
in electricity capacity than there is in Asia.
• At one extreme, within the commodities group, the cement industry is largely local,
with only a fraction of production traded across borders, while at the other extreme,
the oil industry operates on a truly global basis. Meanwhile, low-value added toy and
white goods production can much more easily be operated on a global basis (with
design and marketing separated from manufacturing) than high-valued added and
more complex manufactured goods production, such as semiconductor equipment.
• Second, one needs to assess whether international capacity in the industry concerned
is complementary to or a substitute for Chinese capacity expansion. Again, at one
extreme China’s rapid build-out of airport facilities and its desire to develop the
aviation sector is clearly complementary to the activities of Boeing (BA, US$,
OUTPERFORM, TP US$, OW) and Airbus under EADS (, €,
UNDERPERFORM, TP €, MW) who operate a duopoly in large-sized aircraft
over 200 seats. At the other end of the spectrum, much greater installed flat steel,
autos and aluminium capacity may well be a substitute for current capacity in
international markets.
• Third, in order to provide an assessment of pricing pressure in the industry concerned,
one needs to consider the pattern of capacity utilisation and the current
inventory/sales positions on an industry-by-industry basis. Major expansion in
Chinese capacity in an industry where excess capacity is minimal and where
inventory-to-sales ratios are healthy will be less likely to have a negative price impact
than where international capacity expansion has also been strong and where
inventory-to-sales ratios already show problems.
In this section, we focus mainly on the third issue by undertaking a cross-industry
comparison of capacity utilisation, capital discipline and inventory-to-sales positions
using government statistics for the US, Japan and the Eurozone.
US capacity utilisation
The US is the world’s largest economy and has the most comprehensive and longest
time series on capacity utilisation in the developed world. In aggregate, as shown in
Figure 16, US all-industry capacity utilisation is currently at %, slightly below the 30-
year average of %. Capacity utilisation has been recovering steadily since troughing
at % in December 2001. This recovery has been associated with a recovery in
pricing power in many industries. However, capacity utilisation remains well below the
most recent peak of % reached in May 2000.
Can Chinese capacity in
the industry concerned be
traded internationally?
Is Chinese capacity
complementary to or a
substitute for international
capacity?
What is the capacity
utilisation and inventory
position in the internal
industry?
Capacity utilisation
recovers in aggregate, but
remains well below
peak levels
China’s Capacity Expansion 27 May 2005
16
Figure 16: Total US capacity utilisation – all industries
65
70
75
80
85
90
Jan 70 Jan 74 Jan 78 Jan 82 Jan 86 Jan 90 Jan 94 Jan 98 Jan 02
Source: US Federal Reserve, CSFB Research
Crucially, there are very significant differences in capacity utilisation at the industry level
currently in the US. As we show in Figure 17, capacity utilisation varies at one extreme
from % in the petroleum and coal products industries to just % in the case of
communications equipment.
Figure 17: US capacity utilisation by industry (% of total capacity as of 31 March 2005)
Current capacity Long-run average Std deviation in
Industry utilisation capacity utilisation capacity utilisation
Petroleum & coal products
Mining
Paper
Plastics & rubber products
Motor vehicles & parts
Food, beverages & tobacco
Non-metallics
Electrical. Equipment. Appliances & comp.
Primary metal
Computers. & peripheral equipment
Wood products
Semiconductors
Chemicals
Textile & product mills
Computer & electronic products
Furniture & related. services
Printing & support
Fabricated metal products
Apparel & leather
Aircraft & other transportation
Communication equipment
Note: Current capacity utilisation as of 31st March 2005. Long-run average is for 30 yrs from 1975.
Source: US Federal Reserve, CSFB Research
Major variations at the
industry level
China’s Capacity Expansion 27 May 2005
17
Relatively few US industries have high current capacity utilisation (versus other industries
and relative to their own history). They are petroleum and coal products, mining, paper,
plastics & rubber products and motor vehicles and parts. Petroleum and coal products
have the most positive near-term momentum in terms of capacity utilisation.
CSFB’s global strategy and global oil team have emphasised frequently the role that
capacity constraints have been playing, and are likely to continue to play, in supporting
the oil price. Most recently in their 23 March 2005 report ‘US$40+ through 2009’, the
global oil team argued that the WTI oil price would not revert to mid-cycle levels of US$30
for WTI until after 2009, due to a combination of continued robust demand growth in the
emerging world – particularly China – and a slow build-up of production capacity.
In contrast, we would note that the recent high capacity utilisation in the US motor
vehicle industry has, to a significant degree, been purchased via the use of extensive
financial incentives to customers and that the most recent data point for March 2005
shows a very large 3 . drop in utilisation relative to February, as these price
incentives begin to be reduced by General Motors (GM, $, OUTPERFORM, TP
$, UW) and Ford (F, $, NEUTRAL [V], TP $, UW), due to the financial
pressures they are currently suffering. We would also note that the motor vehicles and
parts sector has had the second-highest standard deviation in capacity utilisation over
the past 30 years of any industry in the US after communications equipment. (See the
discussion below on inventory-to-sales trends for more on the near-term picture.)
There are a much larger number of US industries with low current capacity utilisation
versus other industries and relative to their own history. They are communications
equipment, aircraft & other transportation, apparel and leather, fabricated metal
products, printing & support services, furniture & related services, computer & electronic
products and textile and product mills. Of these industries, only aircraft and computer &
electronic products currently have positive momentum in terms of capacity utilisation.
In the last two years, the US has taken direct measures to attempt to restrict Chinese
access to its market in one of these lower capacity utilisation industries – apparel – in
the form of quantitative restrictions on women’s brassieres and in mid-May 2005 on
cotton knit shirts, cotton trousers and underwear.
Between these two extremes are industries with capacity utilisation closer to long-term
average levels and to the current mean for all industries. They are food, beverage &
tobacco, non-metallic products, electrical equipment appliances & components, primary
metal, computers & peripheral equipment, wood products, semiconductors and
chemicals. We would note that capacity utilisation is falling currently somewhat in
primary metals.
Japan’s capacity utilisation
Japan also has useful capacity utilisation data stretching back for many industries to
1978. However, the industry definitions are somewhat different from those used in the
US, while data are presented with respect to utilisation in the base year 2000 rather
than with respect to estimated total capacity, as in the US.
Figure 18 sorts the Japanese data to rank industries in order from those with the highest
current capacity utilisation versus the 2000 level. We also show long-term average
capacity utilisation and the historical standard deviation in capacity utilisation.
Few industries have high
capacity utilisation
Petroleum products
Motor vehicles and parts
A much larger number of
industries have low
capacity utilisation
China’s Capacity Expansion 27 May 2005
18
Figure 18: Japan’s capacity utilisation by industry – (as at March 2005, rebased to 100 in
calendar year 2000 for each industry)
Current capacity Long-term average Standard deviation in
utilisation vs base year capacity utilisation capacity utilisation
Transport equipment
General machinery
Iron & steel
Rubber products
Petroleum & coal products
Non-ferrous metals
Chemicals
Pulp paper & paper prod.
Ceramics clay & stone prod.
Manufacturing
Machinery
Textiles
Fabricated metals
Electronic parts & devices
Electrical machinery
Precision instruments
Information & com. equipment
Note: Base of 100 set for calendar year 2000; long-run average for all industries from Jan 1978 except
electrical machinery (Jan 1993) and electronic parts & devices (Jan 1998)
Source: Ministry of Economy, Trade and Industry, CSFB Research
Japanese industries with high capacity utilisation versus their own long-term average
levels are transport equipment, general machinery, iron & steel, rubber products, and
petroleum & coal products, and non-ferrous metals. The short-term momentum in
capacity utilisation is particularly strong in the case of transport equipment and
petroleum & coal products and non-ferrous metals.
Japanese industries with low capacity utilisation versus their own long-run average
levels are information and communication equipment, precision instruments, electrical
machinery, fabricated metals, and textiles. Information and communication equipment
has particularly weak near-term momentum in terms of capacity utilisation.
Precision instruments, general machinery and information and communications
equipment have the highest volatility in terms of historical capacity utilisation.
Eurozone capacity utilisation
Available Eurozone data for capacity utilisation has been constructed from constituent
member countries on a survey basis back to 1985. However, it operates on a broader
industry basis than either the US or Japanese data and also shows a surprisingly low
degree of variation over the cycle. This makes it less helpful for our purposes than the
US or Japanese data.
Industries with relatively high capacity utilisation currently versus their own history and
peers include base metals, investment goods, machinery & equipment, and medical &
optical instruments.
Industries with low capacity utilisation currently versus their own history include
consumer goods, printing & publishing and in particular textiles. Textiles has by far the
worst near-term trend in terms of capacity utilisation and we would note that EU trade
commissioner Peter Mandelson has recently proposed emergency talks on two out of
nine categories of textile imports from China – T-shirts and flax yarn.
Japanese industries with
high capacity utilisation
Japanese industries with
low capacity utilisation
Eurozone industries with
high capacity utilisation
Eurozone industries with
low capacity utilisation
China’s Capacity Expansion 27 May 2005
19
Capacity discipline and inventory-to-sales trends
Turning to nearer-term issues impacting pricing, we discuss CSFB’s proprietary
measure of capacity discipline, as well as recent trends in inventory-to-sales trends.
Figure 19 provides CSFB’s global strategy team’s proxy for the degree of capital
discipline currently exhibited for major industries in the developed world as a whole (.,
excluding emerging markets). This is designed as a more forward-looking measure than
the historical capacity utilisation data just discussed. The proxy measure is derived by
considering the recent behaviour of capex both relative to sales and relative to
depreciation versus their long-term trends, as well as changes in the sales
concentration ratio.
Using this proxy measure, industries exhibiting good capital discipline versus their peers
currently include media, pulp & paper, chemicals, technology hardware, household
products and hotels and leisure. Industries with poor capital discipline include capital
goods, general retailing, pharmaceuticals, food & staples retailing and energy.
Figure 19: CSFB capital discipline proxy scores for developed market industries
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Source: Company data, CSFB estimates
Looking at inventory-to-sales trends, Figure 20 provides strong evidence that the current
slowdown in forward-looking indicators of US activity – such as ISM new orders – is
related to involuntary inventory building. The inventory-to-sales ratio in the US is
currently more than one standard deviation from its long-term trend.
Developed country capital
discipline proxy
Inventory-to-sales trends
China’s Capacity Expansion 27 May 2005
20
Figure 20: US overall inventory-to-sales ratio versus trend
-6
-4
-2
0
2
4
6
8
Jan 89 Jan 91 Jan 93 Jan 95 Jan 97 Jan 99 Jan 01 Jan 03 Jan 05
(% dev iaiton from trend)
-6
-4
-2
0
2
4
6
8
(% dev iaiton from trend)
Source: Company data, CSFB estimates
Figure 21: provides industry-level data for the deviation of inventory-to-sales ratios from
their own trend in the US currently. Industries with high inventory-to-sales ratios versus
their own trends are iron & steel mills, apparel, industrial machinery, light trucks,
construction machinery, auto components and heavy-duty trucks.
Industries with low inventory-to-sales ratio versus their own trend are consumer goods,
beverages, tobacco, furniture, automobiles and food products.
Figure 21: Inventory/sales deviation from trend for US industries (March 2005)
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Source: Company data, CSFB estimates
China’s Capacity Expansion 27 May 2005
21
Meanwhile, Figure 22: provides industry-level data for the deviation of inventory-to-sales
ratios from their own trend in Japan. Industries with high inventory-to-sales ratios versus
their own trends are electronic parts & devices, finished capital goods, finished
investment goods, transport equipment, and machinery, ex. ships and rolling stock,
among others. Industries with a low inventory-to-sales ratio versus their own trend are
textiles, petroleum & coal products, furniture, non-ferrous metals and rubber products.
Figure 22: Inventory/sales deviation from trend for Japanese industries (March 2005)
Fi
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+ 1 standard dev iation aw ay from trend
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(No. of standard dev iations aw ay from trend)
Source: Company data, CSFB estimates
In some of the industries with adverse inventory-to-sales ratios, CSFB analysts report
that de-stocking is already underway. CSFB’s global steel team notes that US
inventories have recently fallen for the first time in ten months, while European
producers are now committed to reducing output. In the auto and auto-parts sectors
CSFB’s US analysts report that production cuts are well underway. Meanwhile, CSFB’s
global chemicals team views the current price weakness in ethylene in Asia and the US
as part of a significant inventory correction process. Ethylene is now US$710 per tonne
in Korea, some 22% below the European spot price, but in line with the US price, which
has suffered from weaker supply/demand patterns than Europe. The team argues that
some of the blame has been laid at the door of the expansion underway in China in
particular the two BASF (, €, OUTPERFORM, TP €, UW)-Yangzi
(, NOT RATED) and CNOOC (, HK$, NEUTRAL, TP HK$)-
Royal Dutch (, €, UNDERPERFORM, TP €, MW) (JV projects being
commissioned in 2Q05). However, they point out that growth in supply from China is
only expected to be % of global ethylene capacity in 2005E and 2006E. The team’s
structural concerns are more directed towards the Middle East, where significant supply
growth from 2008 could adversely impact cash returns for European and US producers
for a sustained period.
Industries where the
inventory adjustment
process may already be
underway
China’s Capacity Expansion 27 May 2005
22
Summary conclusions
Taking into account the current state of play in the US, Japanese and Eurozone
capacity utilisation, as well as the discussion above on CSFB’s proprietary capex
discipline proxy and inventory-to-sales trends, we have made the following conclusions.
It appears that industries with the most downside risk in terms of pricing are apparel &
textiles, furniture & related services, communication equipment, computer & electronic
products, motor vehicle & parts and fabricated metals.
In contrast, we would be more constructive on the pricing environment for petroleum &
coal products, plastics & rubber products, paper and aircraft.
The situation with chemicals, as discussed above, and in primary metals is considerably
more equivocal. In the case of primary metals, Eurozone and Japanese capacity
utilisation is still reasonably strong, but we would note that the inventory-to-sales ratio in
the iron & steel industry in the US has swung towards rapid inventory build-up in recent
months. Finally, in both the US and Japan, we would note that inventory build-up
appears to be underway in parts of the transportation & construction machinery sectors.
China’s Capacity Expansion 27 May 2005
23
Figure 23: China imports 1999 to 2003 (sorted in ascending order based on China's rank among importing countries in 2003)
China % Top
Value Value Value Value Value China % World world China ranked Top
1999 2000 2001 2002 2003 increase imports total rank importer ranked
Product group US$ mn US$ mn US$ mn US$ mn US$ mn 1999-2003 US$ mn in 2003 in 2003 ex. China exporter
776 – valves/transistors, etc. 13,391 21,156 23,612 35,167 52,523 293,901 1 Sing US
728 – special industrial machine nes 4,566 5,877 6,648 8,149 10,602 65,617 1 US Germany
575 – plastic nes-primary form 1,971 2,414 2,733 3,444 4,363 42,797 1 Germany Germany
673 – flat rolled iron/steel product 2,461 3,153 2,857 3,896 8,045 37,835 1 Italy Japan
651 – textile yarn 2,207 2,840 3,038 3,466 3,937 34,073 1 HK China
682 – copper 2,479 3,498 3,507 4,437 5,602 31,022 1 US Chile
511 – hydrocarbons/derivatives 1,215 2,023 1,968 2,388 4,124 28,637 1 Belgium US
533 – pigments/paints/varnish 1,012 1,321 1,404 1,606 1,996 28,096 1 Germany Germany
675 – flat rolled alloy steel 1,753 2,211 2,676 3,689 5,127 25,265 1 Italy Japan
513 – carboxylic acid compound 1,403 2,234 2,471 3,473 4,357 24,625 1 US US
674 – rolled plated m-steel 1,335 1,809 1,809 2,594 4,250 23,764 1 Germany Japan
251 – pulp and waste paper 1,660 2,678 2,735 2,900 3,892 23,269 1 US Canada
574 – polyacetals/polyesters. 1,319 1,773 1,668 2,193 2,836 23,133 1 Germany US
571 – primary ethylene polymer 1,837 2,360 2,917 3,027 3,423 22,975 1 US Belgium
871 – optical instruments nes 447 1,012 1,565 4,666 12,860 22,802 1 Japan Japan
653 – man-made woven fabrics 3,483 3,838 3,434 3,178 3,209 22,780 1 HK China
724 – textile/leather machinery 1,569 2,368 2,939 4,017 4,845 22,126 1 Turkey Germany
222 – oil seeds, etc. – soft oil 1,527 2,942 3,194 2,637 5,514 21,271 1 Japan US
512 – alcohols/phenols/derivs 1,030 1,604 1,928 2,305 3,533 20,779 1 US US
611 – leather 1,965 2,381 2,382 2,548 2,860 17,079 1 HK Italy
731 – mach-tools remove material 982 1,252 1,638 2,074 2,904 16,978 1 US Japan
281 – iron ore/concentrates 1,379 1,858 2,503 2,769 4,856 16,007 1 Japan Brazil
572 – styrene primary polymers 2,543 2,970 2,850 3,208 3,433 12,908 1 HK S Korea
288 – nf base metal waste nes 763 1,538 1,502 1,330 1,807 10,551 1 Germany US
737 – metalworking machine nes 875 863 913 1,394 1,749 10,411 1 US Germany
247 – wood in rough/squared 1,249 1,656 1,694 2,138 2,447 10,281 1 Japan Russia
573 – vinyl chloride, etc. polymer 1,153 1,442 1,556 1,456 1,669 8,793 1 Germany Germany
232 – rubber synth/waste/etc. 616 736 800 962 1,188 8,678 1 US US
718 – power generating equ nes 563 1,041 726 846 1,198 8,306 1 US Germany
263 – cotton 105 137 117 200 1,218 8,258 1 Turkey US
654 – woven textile fabric nes 727 881 901 924 1,018 8,200 1 US Italy
285 – aluminum ores/concs/etc. 344 650 633 763 1,391 6,965 1 US Australia
231 – natural rubber/latex/etc. 282 584 592 694 1,155 6,517 1 US Thailand
733 – mtl m-tools w/o mtl-rmvl 524 638 766 1,076 1,225 6,499 1 US Germany
266 – synthetic spinning fibre 771 1,097 963 1,063 1,240 5,899 1 US S Korea
772 – electric circuit equipment 3,732 5,420 6,295 7,870 11,012 98,259 2 US Germany
598 – misc. chemical products nes 1,664 1,957 2,061 3,224 4,308 47,865 2 US US
741 – indust heat/cool equipment 1,392 1,573 2,104 2,533 3,707 47,453 2 US Germany
723 – civil engineering plant 762 733 879 1,278 2,601 36,869 2 US US
771 – elect power transm equip 1,452 1,904 2,129 2,555 3,470 36,100 2 US China
657 – special yarns/fabrics 1,405 1,581 1,557 1,636 1,757 21,226 2 US Germany
652 – cotton fabrics, woven 1,592 1,787 1,777 1,875 2,037 20,612 2 HK China
749 – non-elec parts/acc machine 1,045 1,121 1,281 1,362 1,417 15,221 2 US Germany
672 – primary prods iron/steel 424 1,065 1,562 895 1,578 14,725 2 Belgium Russian
282 – ferrous waste/scrap 317 509 1,061 896 1,405 14,065 2 Turkey US
726 – printing industry machinery 712 873 1,282 1,107 1,447 13,250 2 US Germany
421 – fixed veg oil/fat, soft 477 171 53 461 1,136 12,713 2 Italy Argentina
655 – knit/crochet fabrics 1,183 1,339 1,336 1,432 1,640 12,647 2 HK S Korea
422 – fixed veg oils not soft 704 584 539 950 1,601 10,954 2 India Malaysia
283 – copper ores/concentrates 475 806 898 811 1,296 7,237 2 Japan Chile
764 – telecomms equipment nes 9,117 12,231 13,121 13,893 18,537 210,426 3 US China
759 – office equip parts/accs. 4,212 5,982 7,371 10,043 12,542 150,675 3 US China
778 – electrical equipment nes 3,388 4,772 5,081 6,779 9,098 106,961 3 US Japan
874 – measure/control app nes 2,202 2,982 3,861 4,600 6,537 81,073 3 US US
743 – fans/filters/gas pumps 1,354 1,483 2,115 2,763 3,521 51,477 3 US Germany
716 – rotating electric plant 1,619 2,019 2,102 2,542 2,950 37,392 3 US Germany
China’s Capacity Expansion 27 May 2005
24
Figure 23: China imports 1999-2003 (in ascending order based on China's rank among importing countries in 2003) (cont’d)
China % Top
Value Value Value Value Value China % World world China ranked Top
1999 2000 2001 2002 2003 increase Imports total rank importer ranked
Product group US$ mn US$ mn US$ mn US$ mn US$ mn 1999 - 2003 US$ mn in 2003 in 2003 ex. China exporter
562 – manufactured fertilizers 2,242 1,725 1,552 2,350 1,758 19,608 3 US US
884 – optical fibres 424 745 1,331 1,063 1,846 18,937 3 US Japan
774 – medical etc. el diag equipment 501 683 1,048 942 1,257 18,533 3 US US
342 – liquid propane/butane 720 914 955 999 1,920 17,066 3 Japan Algeria
335 – residual petrol. products 292 412 490 669 1,034 12,350 3 US US
582 – plastic sheets/film/etc. 1,528 1,766 1,778 2,073 2,648 39,817 4 US Germany
744 – mechanical handling equip 1,025 990 1,073 1,346 1,912 31,858 4 US Germany
748 – mech transmission equipment 300 410 509 718 1,100 21,557 4 US Germany
664 – glass 667 954 1,003 1,116 1,291 19,911 4 US Germany
516 – other organic compounds 348 522 546 617 1,011 15,927 4 US US
881 – photographic equipment 637 813 756 910 1,040 13,834 4 US Japan
333 – petrol./bitum. oil, crude 4,641 14,861 11,661 12,757 19,782 409,357 5 US Saudi Arabia
792 – aircraft/spacecraft/etc. 3,174 2,170 4,543 4,051 4,461 94,911 5 US US
641 – paper/paperboard 3,368 3,296 3,057 3,540 3,727 79,276 5 US Germany
684 – aluminium 1,738 2,545 1,854 2,055 2,718 54,188 5 US Germany
773 – electrical distrib equipment 1,206 1,467 1,550 1,807 2,077 45,066 5 US Mexico
898 – musical instruments/records 629 888 1,053 1,436 1,893 37,611 5 US US
248 – wood simply worked 674 990 998 1,183 1,220 28,909 5 US Canada
745 – non-electr machines nes 601 708 893 1,095 1,441 28,111 5 US Germany
679 – iron/steel pipe/tube/etc. 632 618 799 1,207 1,174 27,299 5 US Germany
514 – nitrogen function compounds 830 1,092 1,080 1,264 1,569 25,768 5 US US
752 – computer equipment 3,253 4,516 4,981 6,733 11,411 217,965 6 US China
747 – taps/cocks/valves 518 549 701 970 1,454 31,346 6 US Germany
034 – fish, live/fresh/chilled/frozen 624 773 917 1,066 1,280 28,993 6 Japan Norway
742 – pumps for liquids 411 466 571 776 1,151 24,766 6 US Germany
334 – heavy petrol/bitum oils 2,698 3,657 3,745 3,798 5,863 160,112 7 US Russian Fed
667 – pearls/precious stones 522 779 760 1,091 1,362 61,053 8 US Belgium
784 – motor vehicle parts/access 1,273 2,128 2,550 3,005 6,267 178,283 9 US US
713 – internal combustion engines 1,074 1,145 1,371 1,757 2,789 83,244 9 US Germany
699 – base metal manufacture nes 978 1,130 1,183 1,375 1,865 62,355 9 US Germany
515 – organo-inorganic compounds 593 827 873 933 1,256 66,886 10 US Ireland
893 – articles nes of plastics 896 1,097 1,066 1,245 1,649 65,859 13 US Germany
781 – passenger cars etc. 457 762 1,266 2,609 4,444 380,460 15 US Germany
931 – special transactions nes 1,370 1,723 1,676 1,563 1,265 185,369 18 Germany Germany
542 – medicaments include vet 548 697 872 962 1,208 154,812 24 US Belgium
Note: This table includes only the top 25 product categories by total world imports.
Source: International Trade Centre, CSFB estimates
China’s Capacity Expansion 27 May 2005
25
Figure 24: China imports 1999 to 2003 (sorted in descending order of % increase in China's Imports between 1999 and 2003)
China % China Top
Value Value Value Value Value China % World world rank ranked Top
1999 2000 2001 2002 2003 increase Imports total in in importer ranked
Product group US$ mn US$ mn US$ mn US$ mn US$ mn 1999 - 2003 US$ mn 2003 2003 exc. China exporter
871 – optical instruments nets 447 1,012 1,565 4,666 12,860 22,802 1 Japan Japan
263 – cotton 105 137 117 200 1,218 8,258 1 Turkey US
781 – passenger cars etc 457 762 1,266 2,609 4,444 380,460 15 US Germany
784 – motor veh parts/access 1,273 2,128 2,550 3,005 6,267 178,283 9 US US
282 – ferrous waste/scrap 317 509 1,061 896 1,405 14,065 2 Turkey US
884 – optical fibres 424 745 1,331 1,063 1,846 18,937 3 US Japan
333 – petrol./bitum. oil, crude 4,641 14,861 11,661 12,757 19,782 409,357 5 US Saudi Arabia
231 – natural rubber/latex/etc 282 584 592 694 1,155 6,517 1 US Thailand
285 – aluminum ores/concs/etc. 344 650 633 763 1,391 6,965 1 US Australia
776 – valves/transistors/etc. 13,391 21,156 23,612 35,167 52,523 293,901 1 Singapore US
672 – primary/prods iron/steel 424 1,065 1,562 895 1,578 14,725 2 Belgium Russian Fed
748 – mech transmission equmnt 300 410 509 718 1,100 21,557 4 US Germany
222 – oil seeds etc. – soft oil 1,527 2,942 3,194 2,637 5,514 21,271 1 Japan US
335 – residual petrol. prods 292 412 490 669 1,034 12,350 3 US US
281 – iron ore/concentrates 1,379 1,858 2,503 2,769 4,856 16,007 1 Japan Brazil
752 – computer equipment 3,253 4,516 4,981 6,733 11,411 217,965 6 US China
512 – alcohols/phenols/derivs 1,030 1,604 1,928 2,305 3,533 20,779 1 US US
723 – civil engineering plant 762 733 879 1,278 2,601 36,869 2 US US
511 – hydrocarbons/derivatives 1,215 2,023 1,968 2,388 4,124 28,637 1 Belgium US
673 – flat rolled iron/steel prod 2,461 3,153 2,857 3,896 8,045 37,835 1 Italy Japan
674 – rolled plated m-steel 1,335 1,809 1,809 2,594 4,250 23,764 1 Germany Japan
513 – carboxylic acid compound 1,403 2,234 2,471 3,473 4,357 24,625 1 US US
724 – textile/leather machinery 1,569 2,368 2,939 4,017 4,845 22,126 1 Turkey Germany
898 – musical instrumnts/records 629 888 1,053 1,436 1,893 37,611 5 US US
759 – office equip parts/accs. 4,212 5,982 7,371 10,043 12,542 150,675 3 US China
874 – measure/control app nes 2,202 2,982 3,861 4,600 6,537 81,073 3 US US
731 – mach-tools remove mtrial 982 1,252 1,638 2,074 2,904 16,978 1 US Japan
772 – electric circuit equipment 3,732 5,420 6,295 7,870 11,012 98,259 2 US Germany
675 – flat rolled alloy steel 1,753 2,211 2,676 3,689 5,127 25,265 1 Italy Japan
516 – other organic compounds 348 522 546 617 1,011 15,927 4 US US
747 – taps/cocks/valves 518 549 701 970 1,454 31,346 6 US Germany
742 – pumps for liquids 411 466 571 776 1,151 24,766 6 US Germany
283 – copper ore/concentrates 475 806 898 811 1,296 7,237 2 Japan Chile
778 – electrical equipment nes 3,388 4,772 5,081 6,779 9,098 106,961 3 US Japan
342 – liquid propane/butane 720 914 955 999 1,920 17,066 3 Japan Algeria
741 – indust heat/cool equipment 1,392 1,573 2,104 2,533 3,707 47,453 2 US Germany
667 – pearls/precious stones 522 779 760 1,091 1,362 61,053 8 US Belgium
743 – fans/filters/gas pumps 1,354 1,483 2,115 2,763 3,521 51,477 3 US Germany
713 – internal combust engines 1,074 1,145 1,371 1,757 2,789 83,244 9 US Germany
598 – mis chemical prods nes 1,664 1,957 2,061 3,224 4,308 47,865 2 US US
774 – medical etc. el diag equip 501 683 1,048 942 1,257 18,533 3 US US
745 – non-electr machines nes 601 708 893 1,095 1,441 28,111 5 US Germany
771 – elect power transm equip 1,452 1,904 2,129 2,555 3,470 36,100 2 US China
421 – fixed veg oil/fat, soft 477 171 53 461 1,136 12,713 2 Italy Argentina
288 – nf base metal waste nes 763 1,538 1,502 1,330 1,807 10,551 1 Germany US
251 – pulp and waste paper 1,660 2,678 2,735 2,900 3,892 23,269 1 US Canada
733 – mtl m-tools w/o mtl-rmvl 524 638 766 1,076 1,225 6,499 1 US Germany
728 – special indust machin nes 4,566 5,877 6,648 8,149 10,602 65,617 1 US Germany
422 – fixed veg oils not soft 704 584 539 950 1,601 10,954 2 India Malaysia
682 – copper 2,479 3,498 3,507 4,437 5,602 31,022 1 US Chile
575 – plastic nes-primary form 1,971 2,414 2,733 3,444 4,363 42,797 1 Germany Germany
542 – medicaments include vet 548 697 872 962 1,208 154,812 24 US Belgium
334 – heavy petrol/bitum oils 2,698 3,657 3,745 3,798 5,863 160,112 7 US Russian Fed
574 – polyacetals/polyesters.. 1,319 1,773 1,668 2,193 2,836 23,133 1 Germany US
718 – power generating equ nes 563 1,041 726 846 1,198 8,306 1 US Germany
515 – organo-inorganic compnds 593 827 873 933 1,256 66,886 10 US Ireland
034 – fish, live/frsh/chld/froz 624 773 917 1,066 1,280 28,993 6 Japan Norway
China’s Capacity Expansion 27 May 2005
26
Figure 24: China imports 1999 to 2003 (sorted in descending order of % increase in China's imports 1999-2003) (cont’d)
China % China Top
Value Value Value Value Value China % World world rank ranked Top
1999 2000 2001 2002 2003 increase Imports total in in importer ranked
Product group US$ mn US$ mn US$ mn US$ mn US$ mn 1999 - 2003 US$ mn 2003 2003 Exc. China exporter
764 – telecomms equipment nes 9,117 12,231 13,121 13,893 18,537 210,426 3 US China
726 – printing industry machny 712 873 1,282 1,107 1,447 13,250 2 US Germany
737 – metalworking machine nes 875 863 913 1,394 1,749 10,411 1 US Germany
533 – pigments/paints/varnish 1,012 1,321 1,404 1,606 1,996 28,096 1 Germany Germany
247 – wood in rough/squared 1,249 1,656 1,694 2,138 2,447 10,281 1 Japan Russian Fed
664 – glass 667 954 1,003 1,116 1,291 19,911 4 US Germany
232 – rubber synth/waste/etc. 616 736 800 962 1,188 8,678 1 US US
699 – base metal manufac nes 978 1,130 1,183 1,375 1,865 62,355 9 US Germany
514 – nitrogen function compds 830 1,092 1,080 1,264 1,569 25,768 5 US US
744 – mechanical handling equi 1,025 990 1,073 1,346 1,912 31,858 4 US Germany
571 – primary ethylene polymer 1,837 2,360 2,917 3,027 3,423 22,975 1 US Belgium
679 – iron/steel pipe/tube/etc. 632 618 799 1,207 1,174 27,299 5 US Germany
893 – articles nes of plastics 896 1,097 1,066 1,245 1,649 65,859 13 US Germany
716 – rotating electr plant 1,619 2,019 2,102 2,542 2,950 37,392 3 US Germany
248 – wood simply worked 674 990 998 1,183 1,220 28,909 5 US Canada
651 – textile yarn 2,207 2,840 3,038 3,466 3,937 34,073 1 HK China
582 – plastic sheets/film/etc. 1,528 1,766 1,778 2,073 2,648 39,817 4 US Germany
773 – electrical distrib equip 1,206 1,467 1,550 1,807 2,077 45,066 5 US Mexico
881 – photographic equipment 637 813 756 910 1,040 13,834 4 US Japan
266 – synthetic spinning fibre 771 1,097 963 1,063 1,240 5,899 1 US S Korea
684 – aluminium 1,738 2,545 1,854 2,055 2,718 54,188 5 US Germany
611 – leather 1,965 2,381 2,382 2,548 2,860 17,079 1 HK Italy
573 – vinyl chloride etc. polymers 1,153 1,442 1,556 1,456 1,669 8,793 1 Germany Germany
792 – aircraft/spacecraft/etc. 3,174 2,170 4,543 4,051 4,461 94,911 5 US US
654 – woven textile fabric nes 727 881 901 924 1,018 8,200 1 US Italy
655 – knit/crochet fabrics 1,183 1,339 1,336 1,432 1,640 12,647 2 HK S Korea
749 – non-elec parts/acc machin 1,045 1,121 1,281 1,362 1,417 15,221 2 US Germany
572 – styrene primary polymers 2,543 2,970 2,850 3,208 3,433 12,908 1 HK S Korea
652 – cotton fabrics, woven 1,592 1,787 1,777 1,875 2,037 20,612 2 HK China
657 – special yarns/fabrics 1,405 1,581 1,557 1,636 1,757 21,226 2 US Germany
641 – paper/paperboard 3,368 3,296 3,057 3,540 3,727 79,276 5 US Germany
931 – special transactions nes 1,370 1,723 1,676 1,563 1,265 185,369 18 Germany Germany
653 – man-made woven fabrics 3,483 3,838 3,434 3,178 3,209 22,780 1 HK China
562 – manufactured fertilizers 2,242 1,725 1,552 2,350 1,758 19,608 3 US US
Note: This table includes only the top 25 product categories by total world imports.
Source: International Trade Centre, CSFB estimates
China’s Capacity Expansion 27 May 2005
27
Capacity impact by sector
We look at the capacity and demand outlook for different sectors below, and assess the
possible impact of China’s capacity additions. The sectors included are: white goods
(including refrigerators, air-conditioners, washing machines and microwaves), autos,
industrial commodities (including coal, cement, aluminium, cement, glass and steel), oil
& petrochemical, power, semiconductors and mobile handsets. Overall, among the
sectors we surveyed, the demand-and-supply balance is distinctively worse for auto,
power, aluminium and steel products (particularly flat steel products). Of these, the
deterioration of the supply-and-demand balance of aluminium and steel products will
probably have the largest regional/global impact as these new capacities are
‘internationally tradable’, ., it could result in a big swing in China’s trade balance
position. In contrast, excess capacity in power would mainly affect the profitability of
Chinese power companies. The big unknown is autos. Will the huge excess capacity in
the auto sector translate into a sharp plunge in domestic prices (which would affect the
profitability of multinational companies that have invested heavily in the past few years)
and/or transform China into a major auto export country?
Figure 25: ‘Capacity utilisation’* by sector
% 2001 2002 2003 2004 2005E 2006E 2007E Remarks
Refrigerators Utilisation remains low
Air-conditioners Sharp deterioration In utilisation
Washing machines Deteriorating
Microwave ovens Deteriorating
Passenger cars A major deterioration
Aluminium Improving, a significant portion for exports
Cement Improving
Crude steel Improving
Steel products (flat) Deteriorating, reducing import dependency
Steel products (long) Stable
Power Deteriorating
* Defined as demand over capacity.
Source: Source: China Household Electrical Appliances Association, China Building Materials Association, CCID, Antaike, CSFB estimates
Figure 26: Exports (imports) as % of total demand
2001 2002 2003 2004 2005E 2006E 2007E 2008E
Refrigerators
Air-conditioners
Washing machines
Microwave ovens
Aluminium
Steel products (long)
Steel products (flat)
Ethylene
Oil
Handset
Source: Source: China Household Electrical Appliances Association, China Building Materials Association,
CCID, Antaike, CSFB estimates
The supply-and-demand
balance is likely to be
worse for auto, power,
aluminium and steel
products (particularly flat
sheet products)
China’s Capacity Expansion 27 May 2005
28
White goods (refrigerators, air-cons, washing machines
and microwaves)
Despite the sluggish domestic demand, capacity expansion was rather strong for white
good items in 2002 and 2003. This was due mainly to the sharp rise in export demand.
Figure 27 shows that the share of exports to total demand has increased significantly for
all four items. In the case of microwaves, almost 80% of China’s sales are destined for
other countries, and export demand for air-conditioners reached almost 50% of total.
Figure 27: Export demand as % of total
% of total demand 2001 2002 2003 2004 2005E 2006E 2007E 2008E
Refrigerators
Air-conditioners
Washing machines
Microwave ovens
Source: China Household Electrical Appliances Association
As in most other Chinese export items, the share rise in export demand of Chinese white
goods is due mainly to market-share gains, as evidenced by the sharp rise in China’s
market share of white goods in the US and Europe market in the past few years.
Figure 28: Market share of Chinese white goods in US and Europe
US Europe
% share of total shipment 2001 2002 2003 2004 2001 2002 2003 2004
Refrigerators 14 18 21 25 3 4 6 19
Air-conditioners 34 51 72 71 55 53 75 85
Washing machines 0 0 0 1 0 1 1 5
Microwave ovens 33 51 52 64 43 75 80 90
Source: China Household Electrical Appliances Association
The relatively lower market share of Chinese products of items such as refrigerators and
washing machines is due mainly to the difficulty of transportation. Therefore, they are
sold mainly in the region, to countries like Japan, particularly for washing machines.
Figure 29: Regional distribution of Chinese white goods exports
25 25
66
11
38 36
16
47
30 31
1
35
0
10
20
30
40
50
60
70
Refrigerator Air conditioner Washing machine Microw av e ov en
(% share by region)
Asia Europe North America
Source: China Household Electrical Appliances Association
Capacity expansion of
white goods mainly serving
the export market …
… mainly due to market
share gains
Lower market share in
refrigerators and washing
machines, due mainly to
transportation costs
China’s Capacity Expansion 27 May 2005
29
The sharp increase of China’s export production capacity, as well as the rapid market-
share gains in key export markets, is due mainly to foreign-funded enterprises, while
domestic companies are playing a very limited role. For example, Korean companies
have been very active in transferring their production capacity into China in the past few
years. As shown below, their share of Chinese exports in refrigerators and washing
machines increased rapidly in the past few years, while they also commanded a very
strong position in microwave exports.
Figure 30: % of Chinese exports by Korean-funded operations
% of total 2002 2003 2004
Refrigerators
Air-conditioners
Washing machines
Microwaves
Source: China Household Electrical Appliances Association
After strong growth in the past few years, the global position of Chinese white goods
has reached a very dominant position. For example, China already accounts for 80% of
global output of air-conditioners and microwave ovens, as well as close to 50% and
60% of global exports of these two products, respectively. This raises the question of
how much more market share can China gain in such products. The dominance of
China in products such as washing machines and refrigerators is not so huge, but given
the relatively high transportation costs of these products, the room for China to expand
market share in far away markets such as the US and Europe will be more limited.
Figure 31: China's global position in major white goods
0
10
20
30
40
50
60
Refrigerator Air conditioner Washing machine Microw av e ov en
(nm units)
0
10
20
30
40
50
60
70
80
90
(%)
Output (2004) % of global output (2004, RHS) % of global ex ports (2003, RHS)
Source: China Household Electrical Appliances Association
Overall, as forecasted by the China Household Electrical Appliances Association
(CHEAA), demand growth for these products is expected to slow rapidly in the next few
years, both domestically and externally. Indeed, based on their forecasts, only export
demand for refrigerators could be maintained at over 10% growth from 2006 onwards.
Whether the outlook is too gloomy is debatable, however, it is probably fair to say that
the biggest global impact of China’s capacity expansion in these sectors is already a
story of the past.
Most capacity expansion is
coming from foreign-
funded companies
China is also very strong in
the white goods market
Future growth is
expected to be limited
China’s Capacity Expansion 27 May 2005
30
Figure 32: Capacity, output and demand of white goods
(mn units) 2001 2002 2003 2004 2005E 2006E 2007E 2008E
Refrigerators
Capacity
YoY (%)
Supply
YoY (%)
Demand
YoY (%)
Export
YoY (%)
Domestic
YoY (%)
Capacity utilisation (%)
Air-conditioners
Capacity
YoY (%)
Supply
YoY (%)
Demand
YoY (%)
Export
YoY (%)
Domestic
YoY (%)
Capacity utilisation (%)
Washing machines
Capacity
YoY (%)
Supply
YoY (%)
Demand
YoY (%)
Export
YoY (%)
Domestic
YoY (%)
Capacity utilisation (%)
Microwave ovens
Capacity
YoY (%)
Supply
YoY (%)
Demand
YoY (%)
Export
YoY (%)
Domestic
YoY (%)
Capacity utilisation (%)
Source: China Electrical Household Appliances Association
Commodities (coal, aluminium, cement, glass and steel)
As noted above, this is probably one major area that has undergone major capacity
expansion and which could see the most serious over-capacity problems in the next few
years. Our bottom-up analysis indicates that the situation could be different for different
sectors. Overall, on a two-year horizon, the sectors that seem to be most vulnerable to a
supply glut are coal, aluminium, glass and flat sheet steel.
With a two-year horizon,
coal, aluminium, glass and
flat steel products are most
vulnerable
China’s Capacity Expansion 27 May 2005
31
Coal
We have consistently held the view that the biggest problem for China’s coal supply is
not the absolute level of coal output, but coal transportation, which hinders the supply of
coal from the producing region, mostly north China, to the consumption region, mainly
eastern and southern China. However, major expansion in rail and port handling
capacity should come through in 2005. This is expected to alleviate a lot of the pressure
on coal price increases. Similarly, one should also bear in mind that China’s coal
demand is mainly for power generation, and power demand in China is highly cyclical
and correlated with investment demand (which we discuss in more detail later),
therefore weakened coal demand in the next two years, along with improving coal
transport capacity, could imply a deflating outlook on coal prices ahead.
Figure 33: Demand breakdown – coal
Steel
13%
Building materials
18%
Petrochemicals
6%
Residential
5%
Others
6%
Pow er
52%
Source: CEIC, CSFB estimates
Aluminium
Aluminium smelting capacity increased from mn tonnes . in 2000 to mn
tonnes by the end of 2003. This caused a surge in the price of alumina (the raw
materials to make aluminium, for which China has to rely heavily on imports. In addition,
this has triggered the government to place strong administrative control on any new
investment in this sector. The good news is that with such stringent measures, capacity
increases in aluminium smelting have slowed rapidly since 2004 – actually down to
single-digit levels, and this is likely to continue until 2006. However, this is only half of
the story. Indeed, supply growth from aluminium smelting plants should maintain a
strong pace, given the more abundant supply of alumina globally (again, high prices
induce output expansion). Therefore, the supply-and-demand balance of China’s
aluminium sector is still not too encouraging, evidenced by the fact that China’s net
aluminium exports are expected to increase from mn tonnes in 2004 (% of total
demand) to mn tonnes (% of total demand) in 2006, whilst China was a net
importer of aluminium ( mn, or % of total demand) as recently as 2000. This is
not very good news for aluminium prices globally. In addition, if export demand for white
goods were to slow sharply (a possible scenario considering the discussion in the earlier
section), this could lead to reduced aluminium demand in China, given that a meaningful
portion of aluminium is used in packaging and home appliances.
Transportation capacity
improvements should
alleviate coal shortages
The supply of aluminium
should maintain strong
growth, despite the slowing
pace of capacity additions,
due to more abundant
alumina supply
China’s Capacity Expansion 27 May 2005
32
Figure 34: Demand breakdown – aluminium
Construction
34%
Pow er
16%
Packaging
12%
Home appliance
8%
Manufacturing
8%
Auto
8%
Others
14%
Source: Antaike, CSFB estimates
Cement
Similar to aluminium smelting, this is another sector under tight scrutiny by the
administration during this round of macroeconomic tightening. Cement production
capacity increased from 683 mn tonnes in 2001 to 1,106 mn tonnes in 2004 (a 62%
increase). Combined with rising energy costs, this has led to a substantial decline in the
profitability of cement companies since 2H04. However, there is a reasonable chance that
the worst may already be behind us: based on CSFB forecasts, cement capacity will only
be increased by % from 2004-06. The forecasts by the China Building Materials
Association (CBMA), nevertheless, are much more bearish, as they expect capacity to
rise by another 22% between 2004 and 2006. There are some slight deviations between
the actual number by CBMA and ours for 2004, and for 2006 the difference in the actual
capacity is 76 mn tonnes. This could be a major swing factor in deciding whether cement
companies’ profit performance could improve in the next two years.
Another important point to consider is the geographical distribution of new capacities, as
cement sales in China are usually on a regional (rather than national) basis, given the
high transportation costs involved. Thus, cement price dynamics could be rather
different in various regions. Even based on the more pessimistic assumption from
CBMA, the cement price outlook for east and south China (the two key regions for
cement sales in China) is probably slightly better than for other regions, given their
relatively more modest capacity growth.
Figure 35: Cement capacity expansion by region
Forecast by China Building Materials Association CSFB
(mn tonnes .) North China Northeast East China South China Southwest Northwest Total forecast
1990
1995
2000
2004 1, 1,
2006F 1, 1,
% change
1995 versus 1990
2000 versus 1995
2004 versus 2000
2006E versus 2004
Source: China Building Materials Association, CSFB estimates
Capacity additions in
eastern China and
southern China are likely
to be more modest
China’s Capacity Expansion 27 May 2005
33
Indeed, compared to almost all commodities, cement is most susceptible to a slowdown
in construction activities. Thus, weaker-than-expected investment demand would have a
greater impact on cement demand than other commodities.
Figure 36: Demand breakdown – cement
Infrastructure
40%
Rural construction
25%
Real estate
35%
Source: Anhui Conch, CSFB estimates
Float glass
The pace of float glass capacity expansion has been slightly slower than cement in the
past few years, with capacity increasing from mn cases . in 2000 to mn
cases in 2004 (a 48% increase). However, the pace of float glass capacity increases
should be much faster in the next two years and is expected to reach 422 mn cases by
2006, ., 40% over 2004. In terms of regional distribution of capacity expansion, this
was most rapid in eastern China, followed by northern China and the southwest region.
Similar to cement, the transportation costs for glass are also very high, and the three
regions mentioned above are likely to suffer most from capacity problems in the next
one to two years. Overall, glass prices do not look good ahead, in our view, given the
large capacity increases. In particular, eastern China is seemingly most vulnerable,
given that the anticipated property sector correction in key markets such as Shanghai is
likely to hurt the glass sector. Similarly, another major sector using glass heavily, .,
the auto sector, is seeing slowing demand and is expected to suffer huge excess
capacity problems on a three-year horizon.
Figure 37: Capacity of float glass by region
(mn cases .) North China Northeast East China South China Southwest Northwest Total
1990
1995
2000
2001
2002
2003
2004
2006E
% change
1995 versus 1990
2000 versus 1995
2004 versus 2000
2006E versus 2004
Source: China Building Materials Association, CSFB estimates
Cement is very susceptible
to a slowdown in
construction activities
Significant float glass
capacity increases ahead
China’s Capacity Expansion 27 May 2005
34
Steel
The sharp improvement of China’s trade balance in the steel sector during 2004 raised
the question of whether the country has been transformed into a steel exporter (rather
than a perennial steel importer, as seen throughout the last decade) after rapid capacity
expansion over the past few years. The answer to this question is that it may still be too
early to tell. What we can say, at this stage, is that China’s capacity of crude steel
making, as well as rolling capacity for long and flat products, have increased rapidly in
the past few years. In next two years, indeed, capacity growth for higher-end flat
products is expected to increase faster than for long products (which is mostly low-end
stuff mainly serving the construction industry). As far as we understood, whilst the
recent increases in flat product capacity are mostly concentrated in commodity grade
products, by around 2006-07 significant high quality flat steel product capacity will enter
the market, which can replace a large portion of imports. Historically, China’s steel
imports are mainly for flat products, as the country is roughly self-sufficient in long
products. In 2003, China imported 31 mn tonnes of flat steel products (25% of total
demand). This declined to 20 mn tonnes in 2004, and by 2006 we expect net imports to
drop to 6 mn tonnes (% of total demand). A reduction of such a scale is set to have
an impact on regional steel prices, if not steel prices globally.
Figure 38: Net exports of iron & steel Figure 39: Demand breakdown – steel
-2,000
-1,500
-1,000
-500
0
500
Jan 94 Jan 96 Jan 98 Jan 00 Jan 02 Jan 04
US$ mn (3MMA)
Construction
54%
Others
19%
Container
1%
Oil & Gas
1%
Railw ay
2%
Shipbuilding
1%
Machinery
14%
Auto
6%
Home
appliance
2%
Source: CEIC Source: CISA, CSFB estimates
From 2007 onwards, with the expansion of China’s high-quality flat steel capacity, the
regional (and potentially global) demand-and-supply balance may have to do with the
development of China’s machinery and auto industry, which are the largest consumers
for flat products. If China’s auto demand remains weak, and major corporations start to
scale back their auto capacity expansion plans in China (only feasible for capacity
scheduled to come online beyond 2006), this could be negative for steel prices.
Having mentioned the more pessimistic outlook above, due to capacity expansion
concerns, we should probably be balanced, by noting some of other considerations
below. Most notably, there are a couple of points worth mentioning:
China’s net imports of flat
steel products should
reduce substantially in the
next few years
This demand-and-supply
story will also link with
China’s machinery and
auto sector development
China’s Capacity Expansion 27 May 2005
35
• It is one thing that China will reduce its imports of high-quality flat sheet steel, but it is
quite another to say that China will become an exporter. We are more concerned
about a reduction of steel imports into China than China becoming a major exporter,
given that: 1) China’s relatively weak position on the global cost curve (the country still
has quite a lot of inefficient small steel mills) and 2) the Chinese government is not
encouraging steel exports at this stage of development for the economy, as evidenced
by the government’s decision to control slab exports post 1 April 2005.
• China’s actual capacity expansion could be smaller than planned, as the availability of
raw materials, such as iron ore, is a major constraint. This could lead the Chinese
government to adopt more stringent measures to close down small inefficient mills.
However, local protectionism could delay the process.
• Finally, with the sharp turn of China’s trade position in the past few months, the
apparent consumption growth in China slowed to only 4-5% YoY, which is not
consistent with the industrial output growth at mid-teens range. This is probably due to
de-stocking, as Michael Shillaker, our global steel analyst argues (see pages 101-
103). If this is the case, the steel demand outlook from China could improve in the
near term once this process is completed.
China’s net imports could
fall, but it will be difficult for
it to become a major
exporter
Capacity expansion could
be slower than expected
Recent weakness in
demand could be due
partly to de-stocking
China’s Capacity Expansion 27 May 2005
36
Figure 40: Capacity, output and demand for commodities
2001 2002 2003 2004 2005E 2006E
Coal (mn tonnes) Supply 1,398 1,541 1,728 1,949 2,077 2,202
YoY (%)
Demand 1,322 1,457 1,637 1,863 2,009 2,139
YoY (%)
Capacity (railway)
YoY (%)
Capacity (port)
YoY (%)
Aluminium (mn tonnes) Capacity
YoY (%)
Supply
YoY (%)
Demand
YoY (%)
Capacity utilisation (%)
Net Exports
% of total demand
Cement (mn tonnes) Capacity 683 800 913 1,106 1,148 1,178
YoY (%)
Supply 621 725 862 935 1,032 1,125
YoY (%)
Demand 695 817 915 1,003 1,093
YoY (%)
Capacity utilisation (%)
Glass Supply
YoY (%)
Demand
YoY (%)
Crude steel (mn tonnes) Capacity 197 247 300 340 365
YoY (%)
Supply 182 222 267 314 353
YoY (%)
Capacity utilisation (%)
Steel products Capacity 132 155 206 215 233
(long, mn tonnes) YoY (%)
Supply 102 120 148 180 207 224
YoY (%)
Demand 122 148 179 205 225
YoY (%)
Capacity utilisation (%)
Net exports
% of total demand
Steel products Capacity 78 95 129 145 167
(flat, mn tonnes) YoY (%)
Supply 58 73 93 112 132 149
YoY (%)
Demand 93 124 131 140 156
YoY (%)
Net exports
% of total demand
Source: China Building Materials Association, Antaike, CSFB estimates
China’s Capacity Expansion 27 May 2005
37
Autos
If we truly believe the capacity expansion plans announced by both the foreign and
domestic Chinese companies, the sector will be in big trouble in the next three to five
years. Based on current forecasts by CSFB analysts, by 2008, China’s passenger car
(sedan) production capacity will reach mn units ., but domestic demand would only
reach mn units, ., demand will be less than half of designed capacity. This is clearly
not a sustainable situation, and one or more of the scenarios will have to happen.
• Major capacity scale-back. This is not possible for capacity scheduled to come online in
2005 and 2006, given that construction work on them started long ago. There is room
for capacity cuts beyond 2006, which is entirely possible if there is no major rebound in
car sales in the remaining months of this year. In case of a major scale-back in capacity
additions, steel (flat products) and the glass industry are likely to be hurt most.
• China transforming into a major car exporter. This is not impossible. Indeed, China’s
car component manufacturers have already embarked on an aggressive programme
for exports. A substantial increase in Chinese car exports (could be OEM for global
brands) will probably lead to a regional (if not global) deflation of car prices,
particularly for low-end products.
• Substantial price reductions to boost domestic demand. Again, this is not impossible.
China automakers, such as Geely Automobile (, HK$.43, UNDERPERFORM,
TP HK$.32), have launched very aggressive pricing strategies to take the low-end
market, while foreigner players are scrambling for the small high-end segment. In
case the foreign-funded companies find out that demand in the high-end market is not
as large as they wish, they could start tapping the low-end market and compete with
the domestic players.
Figure 41: Capacity, output and demand for passenger cars
(mn units) 1997 1998 1999 2000 2001 2002 2003 2004 2005E 2006E 2007E 2008E
Capacity
YoY (%)
Supply
YoY (%)
Demand (domestic)
YoY (%)
Source: CSFB estimates
Oil and chemicals
While China’s net imports of refined oil products have remained rather stable throughout
the past decade, its net imports of crude oil have exploded, from roughly at balance ten
years ago to around 10 mn tonnes per month in recent years. This reflects the ability of
China to add new refining capacity, but the lack of resources is hindering China’s ability
to boost its crude oil output. CSFB forecasts a 7% CAGR in capacity over the next four
years (or 90 mn tonnes . in total). These new capacities will come partly from large-
scale, state-approved refineries as well as some local expansion, and the biggest
uncertainty will be the small-scale local refineries – they are the key swing factor in the
refinery market outlook. In
