This June, Chen Bendong, a businessman from Fujian Province, was prosecuted by Wujin Procuratorate in Jiangsu Province and sentenced to a one-year imprisonment and a RMB 350,000 (around $42,000) fine — all as a result of his dealings with the steel industry in Changzhou since 2004.


Chen, once the owner of a small steel business called New China Steel, was just one of the many Chinese entrepreneurs springing up at the beginning of the century. However, his “uncommon” steel products, made with shoddy techniques, were illegitimate junk billets locally known as “fissured ingots.”       


Having been punished by administrative bodies for the making of fissured ingots in the second half of 2004, Chen went on with his steel-making business, using junk steel as raw material and churning out 1525 fissured ingots worth RMB 390,000 ($47,000).


A fissured ingot is a type of “furrowed steel” made by melting junk iron and steel in a cheap electric furnace, then pouring them into a furrow dug in the earth. Steel bars are created once the mixture cools off. Not only does this steel-making technique inflict great harm on the environment, but construction steel products — such as wire rod coil, angle iron and deformed steel bars rolled out of “furrowed steel” — are poor in anti-seismic performance and pose great risks for construction. As a result, the Chinese government long ago set forth a policy explicitly banning the making of “furrowed steel” and “fissured ingots,” and confiscating them and their raw materials.


However, furrowed steel manufacturers are nowhere near extinct, and Chen Bendong is just one of the few who have been brought to justice.  A big army of furrowed steel manufacturers hide in In Xinqiao Town, Jiangsu, and play hit-and-run with law enforcement. In Hebei, the biggest steel province of China, many small steel mills shut down by the government obediently toe the line during the day, until night comes and they can engage in illegal activity full throttle.


In Jiangsu Province, the usual peacefulness of Taihu Lake was broken in June by a sudden bloom of blue-green algae, which led to the serious deterioration of water quality. Drinking water in most parts of Wuxi city gave off a bad smell to the point where local water suppliers reportedly had to spend over RMB 60,000 ($7,200) every day on chemicals to purify one million tons of water. Despite all these efforts, a trace of the bad smell still persists. 


Beijing, located in Hebei Province, is going to host a “Green Olympics” next August. Nevertheless, this June an official from Beijing’s environment monitoring department admitted in public that the air quality goal Beijing set for itself this year could be out of reach. Beijing Municipality aimed at 245 good air quality days throughout the year, yet its sky has been enshrouded with a heavy layer of smog since June.


The blue-green algae outbreak in Taihu Lake and the air pollution problem in Beijing have rung the alarm bell for China’s environmental protection efforts once again. The central government, aware of its responsibility, has called on the whole nation to “save energy and reduce pollution.” On June 13, Premiere Wen Jiabao re-emphasized the necessity of energy conservation and pollution reduction in an executive meeting of the State Council. The Chinese government is determined to tackle the problem in the steel industry. However, pollution control efforts face a number of challenges and, in some ways, epitomize the clash between full-steam-ahead economic development and environmental protection initiatives.


Failure in Pollution Reduction


The Comprehensive Plan for Energy Conservation and Pollution Reduction finally launched by the State Council at the beginning of June clearly states that during “The Eleventh Five-Year” (2006-2010), the energy consumption per unit GDP and the total emission of major pollutants shall be reduced by 20% and 10%, respectively.


“Policies and measures launched one after another within these several years reflect the seriousness of the situation,” says Dai Yande, deputy director of the Energy Research Institute, National Development and Reform Commission, who voiced his worry in public. “Last year saw only a minor drop of 1.23% in energy consumption per unit and an unexpected rise in the total emission of major pollutants. The goal for energy conservation and pollution reduction set in the ‘Eleven Five-Year Plan’ will be hard to achieve without more effective control. ”


His concern is supported by abundant evidence and is shared among experts. Statistics shows that steel, non-ferrous metals, chemicals, electrical, petroleum refining and construction materials industries are the six biggest energy consumers in China, accounting for about 70% of the total industrial energy consumption in the first quarter, which witnessed a big soar in the export of some high-energy-consuming products. Among these six energy consumers, the steel industry is second to none in pollution emission. “Therefore, the government has good reason to start with the steel industry in its energy conservation and pollution reduction plan,” Luo Bingsheng, executive vice president of the China Iron and Steel Association told China Knowledge at Wharton.


Indeed, the State Council mapped out Steel Industry Policy as early as 2005 to control investment and eliminate inefficient production capacity. The policy places various restrictions on the examination and approval of the establishment of new steel enterprises. For example, it shuts the door on new integrated steel corporations and independent iron and steel producers in principle, discourages the establishment of new rolling mills and advocates that the increase of production capacity should be based on the elimination of inefficient production capacity. The policy also orders a shutdown of blast furnaces with a dischargeable capacity less than 300 cubic meters.


However, Chinese steel adjustment policies in recent years are always loud in announcement but slow in implementation. Last June, the NDRC (National Development and Reform Commission), joined with seven other ministries and issued a Notice for the Steel Industry to Control Total Production, Eliminate Inefficiency and Expedite Adjustment. But no local government has made any move since then, except Hebei Province, which announced a list of inefficient capacities to be shut down.


Inefficient production capacity, instead of dropping, increased. Numbers from China’s National Bureau of Statistics shows that inefficient iron production capacity (iron production capacity of blast furnaces with a dischargeable capacity less than 300 cubic meters) increased by 5.1 million tons from 2004 to 2006. Inefficient and conventional iron and steel production capacity together accounted for two-thirds of the total, while production capacity of the advanced equipment only increased by 6.78%, to 22.5%.


“The increase of steel production demands more raw materials like coke and iron ore, and in turn stimulates the exploitation of coal and iron mines, which is also a very contaminative and energy consumptive industry,” says Wu Wenzhang, general manager of the Shanghai-based Steel Industry Consultancy Site “Steelhome Information Technology”.


Steel Prices Keep Rising


The boom in infrastructure construction and real estate and the explosion in export demand are the drivers behind the development of the steel market. Statistics show that in 2006 profits for the whole steel industry in China hit a record high of RMB 169.9 billion ($20.5 billion), a 30% increase over last year. Profits for conventional construction steel and steel sheet were RMB 300-500 ($36-60) per ton and RMB 1,000-1,200 ($120-145) per ton, respectively. In 2006, there was an increase of 17% over the previous year in the output of steel, iron and sheet from key producers.


The Steel market, characterized by large demand and high profit margins, draws many domestic investors who don’t have to be experts to know that production of two million tons of construction steel — such as deformed steel bars – only needs an investment of RMB 200 million ($24 million), while the same amount of production of hot rolled steel used for high-end industries like shipbuilding and automobile manufacture needs RMB 4 to 5 billion ($480-600 million). Thus, most Chinese private steel mills engage in the production of construction steel, which, despite being a big source of pollution, generates quick returns on small investments and needs no complex equipment. It’s these private mills that cause headaches for government supervisors.


At the end of 2005, Wu Qiuming, former vice general manger of Tieben Iron & Steel, which was shut down during the 2004 macro-adjustment of the national steel industry because of its illegal operations, disclosed to the media that it’s not hard for private enterprises to enter the steel business if they can first win support from local governments to acquire the use of land. What they do next is mortgage the land to a bank to get a loan, which they then use to purchase some simple equipment. Then they again mortgage their equipment to the bank and buy raw materials with the loan. They don’t bother with integrated marketing and advanced techniques, nor do they care about the environment. The big market and huge demand allow them to make money hand-over-fist by capitalizing on the price margin. Finally, they pay back the loan and interest, and contribute significant taxes to the local government in return for future protection. Everyone is happy.

An analysis report from JP Morgan predicts that the steel price rise in China will not come to a halt until 2009. Production capacity of crude steel is expected to increase by 11% this year and 6% next year. Wu Wenzhang believes that means the further expansion of some steel corporations. Currently, it is impossible to rely on the market for the elimination of inefficient production capacity. Chen Bendong and others like him won’t back out if there’s still demand in the market.

Experts believe that the unfavorable rise in inefficient production capacity should be attributed to the lack of effective supervision in the macro-adjustment policy of the central government. At present, NDRC is only authorized for the examination of large projects. Small steel projects need only the approval of local governments, which — stimulated by tax revenue and unwilling to or incapable of taking care of workers laid off in case those steel mills are closed — often give a green light to the expansion and restoration of inefficient production capacity. That’s why the inefficient capacity survives.  


Launch of More Practical and Tougher Policy


Hindered by resistance from different dimensions, the central government’s macro-adjustment policy in 2005 and 2006 hasn’t achieved its desired effect. Nonetheless, its effort continues. 


On April 27, 2007, the State Council held a conference on the “Shutdown and Elimination of Inefficient Production Capacity in the Steel Industry,” which proposed economic support for regions that closed small steel mills. Meanwhile, the NDRC and some provincial and municipal governments signed the “Responsibility Document on the Shutdown and Elimination of Inefficient Production Capacity in the Steel Industry.” This policy not only looks after the local governments’ interests, but also specifies their responsibilities. Supported by further measures to be launched, it makes the elimination of inefficient production capacity realizable in practice,” Dai Guoqing, director of Shou Gang Group (Capital Steel Group) Development and Research Institute, told China Knowledge at Wharton.


An expert from the Economic Development and Research Center of the metallurgical industry recently told media in Shanghai:” NDRC did urge the Development and Reform Commission of Hebei Province to strengthen the elimination of inefficient production capacity last year. But it never went so far as to sign a responsibility document with local governments. The central government has shown great determination by incorporating the elimination of inefficient production capacity into its appraisal system for local governments. Now local governments have to consider the responsibility of environmental protection besides tax revenue and investment attraction.”


Furthermore, the Comprehensive Plan for Energy Conservation and Pollution Reduction launched this June, mentioned earlier, urges the building of a responsibility system for the examination and approval of the establishment of new projects and calls for transparency in the once disorderly investment landscape through open reports of new projects. It also orders elimination of inefficient production capacity for regions that want to set up new projects that are highly polluting.


It is noteworthy that provinces with huge steel output have vowed to cut their production under political pressure. This February, Guangdong Province promised to eliminate 10 million tons of inefficient steel production capacity from 2007 to 2010. And Shandong Province also decided to cut the same amount by 2010. In fact, it has already closed nine small steel mills since last June and is expected to shut down and eliminate 4.9 million tons of inefficient iron production capacity and 7.9 million tons of inefficient steel production capacity within this year. After announcing the list of the first group of enterprises to be shut down by the end of this year, Hebei Province promised to announce lists of the second and third groups within this year. 

“Whether the compulsive elimination measure imposed by local governments under the political pressure from central government can achieve its desired effect is still subject to further observation,” suggests Wu Wenzhang. “Local governments should take more consideration of the actual circumstances and construct an applicable back-out and compensation system to motivate the elimination process. For example, they can encourage local steel enterprises to invest in other provinces or even foreign countries, help them shift to other industries and provide professional training for laid-off workers, or support the re-structuring of integrated steel corporations.”