China under the spotlight

Published: Monday, 22 September 2014

As China has been a driving force in TiO2 and zircon demand Ed Barlow, China country manager at TZ Minerals International, looks at whether the slowdown in the country’s construction sector is a cause for concern.

The now much documented slowdown in China’s construction sector should have come as no surprise to the local mineral sands industry. Sales of titanium dioxide (TiO2) and zircon, which are heavily used in late-stage materials such as paint and tiles, have been flat since 2012. While a rash of new building starts had continued in the face of growing resistance to pricing levels - some 30 to 40 times annual income - these were left as empty shells and not being painted or tiled.

The reason, perhaps as equally well documented, is the capital restrictions and dearth of alternative asset classes that have contrived to make property in China function as a bank account. In fact, for the past 15 years real estate has performed much, much better.

A Chinese renminbi (Rmb) 100,000 investment in property in 1998 is worth well over Rmb 1m today, whereas an inflation-adjusted savings deposit made a paltry Rmb 8,000 during the same period. For much of the past decade if you were Chinese, and could afford it, you bought an apartment. Or two. Or seven.

There were two outcomes to this trend: prices went up and developers began building as much as they possibly could. The Chinese central government tried to intervene by making it difficult to buy multiple homes and penalising owners wanting to flip theirs, but the policies never got buy-in at the regional level because local governments, that generated GDP from land sales, were being rewarded professionally and financially.

The policy was quietly put on the back burner after the Lehman meltdown and once the global financial crisis began to bite, banks were told to lend liberally again. Barring a wobble in late 2008, house prices continued to rise and property remained the bank of first resort.

When the dust from China’s Rmb 4 trillion stimulus package had settled in mid 2010, it had become clear that housing had transformed into a financial instrument. Reports of countless pre-purchased apartments left as empty shells became as commonplace as the spiralling asking prices and pre-dawn viewing queues in every city. A frenetic goldrush-like charge to start as many projects as possible ensued. Suddenly, China couldn’t get enough iron, titanium or zircon.

China’s new leadership never hid its intention to take away the punch bowl. The 12th Five Year plan, which would be the Party’s tempo primo under later incumbent President Xi Jinping and Premier Li Keqiang, was to strike a change of tone in government policy. Targets for affordable housing, responsible lending and environmental protection were publicised. As the influence of the new administration grew, so too did the pressure to address the gulf between average incomes and average house prices. In 2012, restrictions on speculative purchases were again strengthened and the government doubled down on the affordable housing programme.

Unfortunately, too much wealth creation was tied to the old system. With the brakes applied too firmly to construction and finance (among other forms of fixed asset investment), China’s economy seized up in the middle of the year. Not wanting the incoming leadership to be marred by a lacklustre economy, stimulus, which came in the form of approvals and loans to various projects in China’s enormous fixed asset investment pipeline, was fired up and the economy was reinvigorated. But this also triggered a widespread round of de-stocking. With a slowdown in construction starts, suddenly there was an excess of timber, tiles and paint, meaning there was also an excess of TiO2 and zircon.

Late 2012 was to the mineral sands industry what late 2008 was to the financial services industry: a brutal reality check. By the end of the year it was widely believed that DSI (inventory levels as production days) had reached triple figures for pigment and zircon. It was the start of a protracted period of de-stocking as prices began their 18 month tumble, weighed down under a mountain of inventories. Reverse-clock auctions ran down on once scarce lots of mineral sands. The Year of the Dragon had gone down in flames.

A cyclical slowdown in early 2013 was especially deep, with many pigment plants closing down for ‘maintenance’ over Chinese New Year. In its regular in-depth survey of the market, TZMI’s team in Shanghai found that prices had fallen well below the costs of production for some of the smaller plants. It wasn’t just a differential between inventory costs and market pricing; so precipitous was the decline that ilmenite orders became uneconomic while still in transit. In the space of 12 months the sea had turned from blue to red.

Zircon, being the smaller market, corrected more quickly. Prices fell by 40% between October 2012 and February 2013. The three majors adjusted their production and the market began to clear, with prices sinking, but no longer plummeting during the course of 2013.

TiO2, on the other hand, is a relatively large market with ample domestic production capabilities, and, thanks to high iron ore prices, a mining boom for Sichuan’s Vanadium Titano-Magnetite (VTM) was still under way in 2013. Co-producers in Panzhihua, in south Sichuan, discovered that at $125/tonne, many of the larger operations were getting free, or very cheap, ilmenite. So, of course, they continued.

Visitors to Panzhihua will, upon noticing its sub-Himalayan topography, immediately realise that there is little space for ilmenite stockpiles. Once it has been separated from its orebody it is put on a train and taken to Chongqing for distribution. From Chongqing it can be freighted around the country, either down the Yangtze River, on a train, or, thanks to the recent stimulus, a recently expanded highway network. This meant that pigment plants had access to plentiful supplies of feedstock for almost any price they could name. Costs came down and China’s TiO2 industry was back in business.

Except this was not the case. Chinese property buyers were beginning to push back against the stratospheric amounts of money they were being asked to part with. Floor space finished was not being converted into floorspace sold - this time the apartments were bare because nobody wanted to buy them.

Simultaneously, a corruption campaign was gaining traction, with high profile cases built around the property holdings of government officials and heads of State-owned enterprises. With a major revenue stream stymied, developers had the choice of either lowering prices or slowing the pipeline, choosing the latter to avoid sending their customers into negative equity. Thus, despite a per capita living space of just 25 square metres, closer to the 17 square metres of Hong Kong than the over 35 square metres of Japan, Taiwan or South Korea, China’s real estate juggernaut began to taper.

In almost any other country, TiO2 producers would have slowed production and focused heavily on cost management to ride out the dip. Not in China. The majors all saw this as the prime opportunity to drive smaller competitors out of the market. Operating rates climbed in the second half of 2013 as those that could, riding on $100/tonne ilmenite, made a bid for market share. It worked. During the remainder of 2013, nearly 20 plants closed down, representing nearly 100,000 tonnes of capacity while the two largest producers, Sichuan Lomon and Henan Billions, enlarged their capacities beyond this amount.

The first quarter of 2014 saw a continuation of market share consolidation. By now, prices had fallen by a third since the summer of 2012. Production and DSI remained high and Chinese exports experienced their best quarter ever, reaching far away markets such as Latin America, once thought to be the backyard of the US producers.

And amid this consolidation, there is also

a sense that China’s TiO2 industry is maturing. A handful of producers have made significant improvements to quality and consistency of quality of commodity grade pigment, which increasingly meets the needs of the average formulator. This is evidenced in the coatings, plastics, and to an increasing extent speciality applications, where formulators are using Chinese pigment either on its own or blended with non-Chinese pigment. The bottom line is that Chinese pigment is good value in a market where margins are tight.

The other significant impact on the TiO2 and zircon sectors is the government’s push to enforce environmental regulations. In April this year, China passed changes to its environmental protection policies with harsher penalties for polluters, including daily fines for those that fail to comply. Among the many presentations, delegates to TZMI’s Global Titanium and Zircon Congress to be held in Shanghai this November will be treated to a general manager whose TiO2 plant was recently shut down for environmental reasons. His first-hand account of how and why smaller companies are dying off highlights a paradigm shift for the industry.

Environmental law enforcement is not confined to TiO2. TZMI has documented the shutdown by local authorities of hundreds of ceramics producers across North and South China, as well as foundry and refractory producers. While the zircon industry is relatively more stable in terms of demand and supply, structural changes to its customer base lie ahead.

The future of all building materials, naturally, is shaped by the construction market. TZMI’s ongoing surveys across the value chain have suggested changes to the mineral sands industry in China are ongoing. The dynamics of supply concentration, product improvement, factor costs and environmental regulations are forcing great changes to the business models of players in China. Expect to hear some important revelations at this year’s TZMI Congress in Shanghai.

TZMI’s annual Congress is being held from November 10-14 at the Jing An Shangri-La, West Shanghai. For more information please contact