Supply-side reform has profoundly changed the metallurgical industry in the past two years, China's steel industry supply-side structural reform is undoubtedly one of the most important policies affecting the commodity market.In the years before the implementation of the supply-side reform, the global steel industry was severely oversupplied and enterprises suffered large losses.Now the reform has achieved remarkable results, and the profitability of the industry as a whole has greatly improved.

At the end of 2015, the Chinese government set a target of reducing crude steel capacity by 150 million tons by 2020.In the initial stage, the main focus is to eliminate idle arc furnace and old converter steelmaking capacity.Later, the central government announced the second round of measures: shut down more than 120 million tons of medium frequency furnace capacity nationwide in 2016.When terminal demand remains strong, the move has strained the supply and demand relationship in the steel market.

With the implementation of the supply-side reform, China's steel capacity utilization rate rose about 15 percentage points from the cycle trough (from less than 70 percent to about 85 percent).Although the price of metallurgical coal has risen sharply as the coal industry has also been positively affected by the supply-side reform policy, the profit margin of the steel industry has improved dramatically with the increase of capacity utilization rate.

Now we need to think about the question: to what extent will the progress of the whole steel industry chain be sustained by the impact of supply-side reform dividend?

BHP estimates that about two-thirds of the industry's capacity utilization growth will be sustained over the long term.We believe that throughout the cycle, if the steel industry can achieve 80 per cent capacity utilisation and long-term net profit margins of 3-4 per cent on average for steel mills, steel producers can achieve sustainable and healthy development without putting too much cost upward pressure on downstream end users.

This transformation has a profound impact on the raw material market of iron and steel metallurgy.According to our experience, the purchasing managers of steel mills will focus on different factors and the final choice in different profit situations.When profit margins are low or negative, mills are less willing to increase productivity and are more inclined to use more lower-quality raw materials to control production costs.As a result, premium prices for high-quality metallurgical coal and iron ore will be compressed, and discounts on lower-quality ingredients will be reduced.On the contrary, under the incentive of higher profit margin of the steel plant, the procurement team will change the policy and prefer to choose relatively higher quality raw materials to meet the urgent demand for production efficiency improvement.At the same time, the demand for low-quality raw materials is correspondingly reduced.

The rebound in steel mill margins since the end of 2016 has been a key factor leading to an increase in premium prices for quality raw materials and an increase in discounts for low-quality raw materials.

Last winter, the "2+26" cities in the beijing-tianjin-hebei region and surrounding areas implemented environmental measures to produce at wrong peaks, sending steel mills' profit margins to a record high.Affected by this, steel plants outside the production limit area to close to full capacity to expand production.In the meantime, we note that the price difference between 62 per cent grade iron ore and lower grade iron ore (including 58 per cent grade and lower grade) is at an all-time high.Premium low volatile coking coal (platts PLV index) and medium volatile coking coal (PMV index) and weak coking coal price differences also significantly widened.At the same time, the premium for lumps and pellets has also risen sharply.

We believe that China will continue to push forward the policy of supply-side reform, and the following strategic focus will be shifted from de-capacity to industrial structure optimization and upgrading, and higher quality steel products will be produced through larger capacity and more efficient blast furnaces and coke furnaces.

At the same time, China is paying more and more attention to environmental protection and ecological civilization.This has forced the steel industry to explore greener production models to meet increasingly stringent environmental pollutant emission standards, especially the atmospheric emission standards for ultra-low sulphur oxides (SOx) and nitrogen oxides (NOx) that have been issued in China.

We have always believed that the development blueprint of China's steel industry in the next decade is "" bigger blast furnaces, closer to coastal areas, and more environmentally friendly" ".China's proactive supply-side reform policy has brought this goal much forward, which is equally significant for decision-making in downstream industries, such as mines.