Dry Bulk Shipping:Concern on "2+26"looks overdone,Buy on dip

Let's crunch some numbers first

    Out of 28cities, 18cities would reduce steel output by as much as c.50% fromNovember 15to March 15next year, according to a joint announcement releasedby the Ministry of Environmental Protection and several regional governmentsrecently. The total steel output cut over the four months is estimated to be57mt, accounting for c.7% of China's annual production. Simply basing on a 1.6xconversion ratio, the implied reduction in iron ore consumption would be 91mtover the period. Given the 80% import ratio of iron ore, the potential reduction inimported iron ore would be 73mt. On a monthly basis, this implies about a 20%reduction in iron ore imports from November 15to March 15next year.

    The actual impact is likely to be much smaller

    Here are the reasons why: 1) The estimated steel output cut (i.e. 57mt) iscalculated based on capacity in whole regions (e.g. Henan province), insteadof in the cities (e.g. Anyang and Zhengzhou in Henan province) listed in theannouncement. Hence, the actual output reduction is likely to be smaller. 2)The steel spread remains at the highest level since 2010, which suggests thatsteelmakers in the other regions might be well-motivated to increase output. 3)Coke prices have reached RMB2,530/t, around the highest since 2009. This, alongwith environmental considerations, means that imported iron ore would be morepreferred going ahead. Assuming that the actual steel output reduction comes in1/3lower (vs. 57mt), steelmakers in other regions make up 1/3of lost output (i.e.12mt), and imported iron ore makes up 85% of total consumption, we estimatethat China's monthly iron ore imports would be reduced by 8% (or 8mt) fromNovember to March.