The greatest problem
Published by Jonathan Rowland,
Emir Adiguzel, World Cement Association.
The global cement industry today employs 1.2 million people and has production capacity of around 6.2 billion t. However, it suffers from substantial overcapacity issues: it is estimated that current capacity can already fulfil the world’s needs for the next 20 years at least.
Since the turn of the century, driven in large part by China’s domestic boom, global cement capacity has increased exponentially, nearly tripling over the last two decades. Meanwhile, the number of producers has grown to more than 5000.
Although in periods of high demand, this increased capacity could mostly be absorbed, we have seen sluggish demand in recent years, creating global excess capacity, especially in China, Europe, the Eastern Mediterranean, and the Middle East. This is the result of a longer-than-expected global recession following the 2008 Global Financial Crisis, combined with major regional political and economic instability: the 2010/11 Eurozone debt crisis, the Arab spring, a slowdown in the Chinese economy, and collapsing commodity prices.
This excess capacity and demand shortage have combined to trigger a race to the bottom among cement manufacturers, dragging down prices in domestic and international markets. Low utilisation rates have also pushed up fixed costs per unit, while the hike in coal and petcoke prices towards the end of 2016 put further pressure on margins. As a result, companies have seen a drastic slump in their earnings, with returns just above or even below the cost of capital, with some beginning to burn through cash reserves.
Current overcapacity continues to increase and is negatively distorting global cement markets, though the impact does vary across regions. Currently China has the greatest excess capacity with 895 million t, representing 45% of global overcapacity, of which only a fraction is earmarked for export due to higher inland logistics costs. Meanwhile, Europe has a capacity-to-consumption ratio of 200%, the highest in the world. In addition to low demand in the region, political pressure to reduce CO2 emissions and CO2 emission allowance programmes have helped keep capacity utilisation rates low.
Developing regions, such as India, Southeast Asia, Sub-Saharan Africa, and Latin America, have seen significant capacity growth over the last decade, representing more than twice the equivalent growth in consumption. Despite a capacity-to-consumption ratio of more than 150% in these regions, further capacity expansion is still anticipated. Southeast Asian (including Indian) manufacturers plan to add more than 100 million t of capacity by 2018, while 50 million t of new capacity is planned for Sub-Sharan Africa, mainly in Tanzania, Kenya, and Nigeria.
Political turmoil and low oil prices over the past three years have severely reduced domestic cement demand in the Eastern Mediterranean and Middle East, resulting in large excess capacity. The lack of export markets in neighbouring countries across the Eastern Mediterranean region in particular, where Turkey remains a major exporter with 10 million t of export volume, has created a regional exportable surplus.
Recent project announcements indicate that, in the years ahead, domestic producers in Turkey, Egypt, Iraq, Iran, and Saudi Arabia will expand their operations. This new capacity will be coming online, even as demand remains subdued, contributing to further growth in exportable surplus.
In the long term, current excess capacity in developing regions is expected to shrink to some extent, as demand for urbanisation increases over time. However, mature markets, such as Europe and North America, will continue to struggle with this surplus for some time, even though new capacity growth will be extremely limited.
The problem of overcapacity has been experienced by different industries throughout history and still continues to be a crucial threat for many. Notable examples include the UK’s steel industry in the 1980s, the global freight market today, China’s steel industry, the worldwide oil market, airlines, and the fishing industry. In their search for a solution, different industries can learn from one another, though some aspects of the challenge can also be very sector-specific.
Cement, with its cost efficiency, energy efficiency, and very long durability, is a unique product and has no real substitute. Moreover, the industry is very capital intensive, so has a lower ROCE than other industries. It is also highly regional in nature, due to relatively high land-based transportation and distribution costs. Because of this, strategies for the cement sector can differ from other industries.
China: an industry leader
With a slowdown in China’s economy, the first real attempts to resolve the issue of excess capacity are being put in motion. The Chinese government and China Cement Association have started to encourage companies to cooperate more, in particular through joint investment enterprises, while state-owned enterprises are growing through mergers and acquisitions. Even though a joint investment enterprise might be considered an anti-competitive agreement, Chinese anti-monopoly law allows for such actions under certain circumstances, for example, if the goal is deemed to be in the public interest, such as reducing high levels of emissions.
Additionally, the China Cement Association has recently made a policy recommendation to the Ministry of Industry and Information Technology to establish a fund, supported by private companies, to speed up consolidation by compensating firms for losses incurred when leaving the industry and closing their production lines.
The national industry target for 2020 is to concentrate at least 60% of Chinese overall capacity into the top 10 manufacturers. This will be followed by a shutdown of idle capacity to ensure efficient resource allocation, and finally a plan to increase utilisation rates to 80% from 68% by reducing 400 million t of capacity. In the long term, once this local consolidation reaches a certain level, Chinese producers are very likely to benefit from a massive increase in cash generation, giving them greater resources to embark on more aggressive overseas expansion.
While China is taking immediate and drastic measures to optimise production capacity and reduce the environmental exposure of the cement industry, with a view to creating higher profitability and lower emissions, Europe and the Middle East still seem unable to decide upon fast and efficient solutions to implement themselves.
Europe and North America: lagging behind
In Europe, the region with the highest capacity-consumption ratio, a recovery in 2018 seems likely, but discussions are still shaky and far from reaching any implementable solution. In the long term, it is however expected that around 200 million t of idle capacity, as well as the number of kilns, will decline considerably thanks to plant shutdowns. Experts predict that, in landlocked areas, only eco-friendly, high-tech, and optimised plants will remain, while coastal areas will meet their needs through grinding mills and clinker imports. Here, the Eastern Mediterranean region could become a main supplier thanks to its large exportable surplus.
Nevertheless, this transition and restructuring of the European cement industry will not be easy and happen only as a result of natural market dynamics. In spite of recent consolidations between the cement industry giants, the industry still needs to see some more major M&A transactions.
And while the current interventions to combat climate change, covered by the EU’s free CO2 allocation and trading system, are helping control and reduce CO2 emissions, this is also causing a slowdown in the consolidation that will ultimately serve to increase overall production efficiency in the cement industry by creating a windfall gain for small companies. Therefore industry associations, in line with public interest and together with the European Commission, should support the cement industry to undertake the restructuring that is so urgently required.
The North American countries, mainly the US, have similar problems to Europe, with their spare cement capacity and political pressure for CO2 limitations at state level, though they do not have a country-wide trading system to limit CO2 emissions. For the region more generally, greater flexibility on imports, as well as further consolidation, are key areas for improvement. Particularly for the coastal regions, more open international trading can provide significant benefits to the industry.
Cement trading: room for improvement
International cement trading ensures more efficient allocation and better utilisation of global resources, so can be a very useful tool in overcoming the global excess capacity problem. This is particularly important for capital-intensive and highly-localised industries like cement, where regional volatility can have a rapid and significant impact on demand, leaving producers with idle and costly resources that undermine long-term stability.
However, recent protectionist policies, such as non-automatic licenses or tariffs, in many countries have hindered international cement trade, driving global overcapacity up. Today international trade meets only 5% of global cement consumption demand, with a volume of 200 million t. This shows there is plenty of room to improve and, ultimately, a great opportunity to reduce the scale of the overcapacity problem.
Unfortunately, overcapacity is not yet being treated as a serious issue, though this is likely to change if and when the industry faces a downturn in consumption volumes. Such a scenario could be precipitated by a gradual increase of global interest rates, including the LIBOR and EURIBOR, resulting in a period of stagnation in cement consumption volumes. This in turn might lead to a period of consolidation, where the overcapacity problem could hurt the global players, depending on their financial and geographical exposure.
Overcapacity currently represents the biggest challenge for the global cement industry and is a significant issue in many countries. However, right now, it seems that China is the only country fighting against this threat, and has established its own methods for doing so. This issue is particularly acute for mature markets with very low capacity utilisation rates, such as Europe. Despite clear lack of leadership, these countries need to join the fight immediately, taking collective, decisive and effective action to secure a more prosperous and secure cement industry for the long term.
About the author: Emir Adiguzel is Chairman of the World Cement Association.
This article first appeared in the May 2018 issue of World Cement. Interested in reading more like this? Sign up for a FREE TRIAL subscription here.
Read the article online at: https://www.worldcement.com/special-reports/07052018/the-greatest-problem/
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