China: HRCs have an edge over rebar this winter; spread may widen

Since late October 2022, the price difference between hot rolled coils (HRCs) and rebar futures contracts for January 2023 has risen from nil to around RMB 120/tonne (t), and the trend is continuing. Demand for rebar has declined significantly. As the weather continues to turn cold, demand will face further weakening. Thus, it is expected, mills will start to accumulate inventory over the next 1-2 weeks.

However, there is no obvious seasonal disturbance seen in the demand for hot coils. The current output is low, and mills continue to destock. Thanks to the lower production of HRCs, it is expected that demand for the same will continue to remain stronger than for rebar.

Rebar faces pressure

Beginning mid-November, data revealed that demand for rebar began to weaken. Weekly data also showed that demand for rebar dropped from 3.2 million tonnes (mnt) to 2.9 mnt. Analysts say, as the weather turns cold, there is room for further decline in demand. The daily trading volume of building materials has dropped from 160,000-170,000 t t around 130,000 t, indicating demand for rebar will remain weak in the short term.

Recent indications are that financing of real estate companies is expected to improve. However, the impact of this policy on the demand for rebar is limited. If steel offtake has to improve, demand for real estate needs to rise first. But this will take time.

In November, rebar prices rebounded significantly after hitting a bottom, allowing mills to make profits. Therefore, it is expected that drop in rebar output is limited. Rebar stockpiles will appear in the next 1-2 weeks. Although the current rebar inventory is as low as 5.32 mnt, if companies start to accumulate inventory from next week, it will rise to 6.2 mnt before January 2023.

HRCs sees higher demand

Compared with rebar, the demand for hot coil is not disturbed by seasonal factors. On the contrary, demand for HRCs is still in its peak season in the fourth quarter, mainly because production and sales of automobiles are at this year's peak in the fourth quarter. Despite the fall in the manufacturing PMI, the overall demand for HRCs has been resilient, and there is an expectation of a m-o-m rise in demand in December. Steel Federation data says HRC weekly demand needs to be kept at around 3 mnt, and this is expected to remain in the future.

The inventory of hot coils is expected to get depleted till January 2023, and fall to below 2.5 mnt, which will be a record low.

There is still room for recovery

The production cost of HRCs is usually RMB 50-100/t higher than that of rebar. At present, the price differential between HRCs and rebar futures for January 2023 is around RMB 120/t, which is at an average level. In the past five years, the price difference has reached a maximum of RMB 391/t, with an average value of around RMB 120/t.

Outlook

Demand for real estate steel will not rise sharply in the short term, due to weather issues. The accumulation of rebar inventory will suppress the futures January 2023 contracts. On the other hand, demand for HRCs has been resilient, and is expected to improve further, and mills will be able to destock before January 2023.

Even if the price difference is moderate currently, HRC is better positioned than rebar in the short term. Thus, there is room for the spread to widen further.