Issue link: https://read.dmtmag.com/i/241540
U.S. Coal and Steel Companies: Be Careful What You Wish l t can be hard to comprehend the impact that four days can have on global markets. When that four-day stretch involves China's Third Plenary Session, though, all bets are thrown out the window. The Third Plenary Session of China's Central Committee in 1978 was the defining moment when the country plotted a course toward a more market driven economy, and it cemented China's rapid growth to become the world's second largest economy in less than 40 years. This year, China's Central Committee has laid out its new vision for the country, including one detail for which U.S. steel and coal manufacturers Nucor (NYSE: NUE) and Peabody Energy (NYSE: BTU) have been hoping: a plan to scale back the Chinese production capacity flooding the market with uneconomical products. Let's take a look at what the new Chinese government has in store and how it could impact steel and coal companies. Chinese Politics 101 For many Americans, the idea of the Third Plenary Session is a bit foreign. This meeting is a four-day retreat of the 200 or so most senior members of the Communist Party at the beginning of each new president's term to lay out policy for the next several years. Many people who follow China closely were very excited by this plenary session for two major reasons. In 2012, the Chinese economy saw its slowest growth rate in almost a quarter century, with GDP growth of about 7.8 percent. Even though we would probably all jump for joy if we saw 7.8 percent growth in a year in the U.S., China has only seen GDP growth below 8 percent twice since 1991. Many analysts believe that the new president of China, Xi Jinping, has the ability to enact meaningful reforms, as Deng Xiaoping did in 1978. One of the largest challenges for China is how to deal with the major state-owned enterprises. Combined, these entities have assets totaling $7.35 trillion. While much of the growth in China can be attributed to these industry giants, they have slowly become less efficient, and many believe they hold massive amounts of overcapacity in various industries. Two industries that have suffered greatly from the oversupply from state-owned enterprises are coal and steel. During a recent conference call, Arch Coal (NYSE: ACI) CEO John Eaves stated that the global coal market is oversupplied by about 15 million tons per year, and a majority of that is from inefficient Chinese coal mines. Peabody Energy CEO Greg Boyce has also gone on record making similar statements. He recently said that 40 percent of the metallurgical coal produced in Shanxi province – the major coal region of China – is out of money, but still producing. IDA UNIVERSAL January-February 2014 In other industries, such as steel, some companies are even making the case that these Chinese state-owned enterprises are illegally dumping excess capacity on the market. Nucor, a low-cost steel manufacturer in the U.S., estimates Chinese steel has over 300 million tons of excess production capacity, and has been lobbying hard to see reforms to address the issue of dumping. decision to increase private ownership of state-owned enterprises may seem like a blessing, but at the same time, it could actually make life much harder for them further down the road. The addition of private ownership in these state-owned enterprises would put a much greater focus on efficient operation, which could potentially lead to the shuttering of some of these inefficient Be careful what you wish One of the major reforms linked to the recent Third Plenary Session is a new allowance for private ownership of stateowned enterprises. According to China's director of enterprise reform, the government is looking to open up 10-15 percent of these companies' equity to private investment, through either investment firms or the establishment of a holding company that would be traded on the open market. For companies like Arch, Peabody, and Nucor, the recent coal mines and steel plants. At the same time, striving for even more efficient operations could also drive down operational costs, which would make them more competitive with U.S. coal and steel manufacturers. Since China still has some major cost advantages, including cheap labor and access to cheap financing through the government, this could be a major long term threat to manufacturers outside China. ● www.fool.com/investing, by Tyler Crowe, Dec 3, 2013 49