China, the world's biggest maker and consumer of steel, produced 489.2 million tons of crude steel and 469.4 million tons of pig iron last year, both up more than 15 percent year on year, according to CISA data. Net exports of crude steel soared 58 percent to 54.88 million tons.

But rising prices for iron ore, coal, electricity and transport have pushed up production costs and will eventually cut into profitability, said Zhang. Zhang is worried that the rising costs could narrow the steel companies' profit margin. But he is also optimistic that major mills like Baosteel Group Corp. and Wuhan Iron and Steel Corp. will still make a profit.

Zhou Xizeng, analyst with CITIC Securities, said steel companies could transfer the raw material price surge to downstream manufacturers. Zhou said the steel companies must raise product prices by at least 10 percent to make ends meet.

Baosteel, China's largest steel company and the one that calls the shots in the country's steel industry, announced at the end of February that it would raise prices around 20 percent, up 500-1,000 yuan ($70-$140) per ton. Other major steel companies had followed suit.

In spite of suspicions about the profitability of steel companies, Zhao Zhicheng, a steel analyst with Essence Securities, contended that rising iron ore prices could be "good news" for large mills. On the one hand, the surging costs could force small and medium-sized steel companies to shut down, resulting in a reduction in the steel supply which would help prop up domestic steel prices. On the other hand, domestic steel companies would be able to turn to the needs of domestic market and improve their products due to the government policy of reducing steel exports.

Making changes

In order to get rid of their disadvantaged position in both the domestic and international iron and steel markets, CISA President Zhang urged mills to pursue the following efforts.

First, domestic iron and steel companies must strengthen their efforts to invest in overseas mines. "They can build up a long-term and stable iron ore and coking resource base by investing in overseas companies such as acquiring a certain amount of their stocks," said Zhang. Some researchers assume China could secure a better position in iron ore negotiation if it controls 200 million tons of iron ore.

Currently, the iron ore price surge has put the Chinese iron and steel industry in shackles. Once the iron ore giants establish a price, the downstream steel manufacturers will have little room for negotiation.

The steel industry in Japan has set a good example for domestic mills. Japanese steel companies are very mature in controlling international iron ore resources. For instance, Mitsui Group controlled over 10 mines in the world equivalent to 45.285 million tons of iron ore, accounting for 7.87 percent of the total trade volume. Therefore, if iron ore prices fall, Japanese companies can enjoy reduced costs; whereas, if the iron ore prices increase, Japanese companies can still enjoy the benefits because they control the mines. Meanwhile, rising iron ore prices offer the Japanese companies an excuse to raise their prices of refined products.

The Chinese companies are relatively weak in this matter. But the Aluminum Corp. of China Ltd. (Chinalco) recently made a milestone contribution. On February 1, Chinalco, jointly with the U.S. aluminum producer Alcoa, announced that they had purchased a 12-percent stake of the Melbourne-based and UK-listed mining giant Rio Tinto with Chinalco taking the lion's share. It was the largest deal ever conducted by a Chinese company. As the largest investor in Rio Tinto, Chinalco can share a large proportion of dividends created by Rio Tinto and can also play an important role in Rio Tinto's operation.

Secondly, the domestic iron and steel companies must restructure and merge to create large conglomerates to improve their overall competitiveness in the international arena. Chinese steel manufacturers are scattered across the country, with several big leaders and numerous small and medium-sized mills. Securities Market Weekly reported that some steel factories in Hebei and Shanxi provinces, where there are many small mills, were forced to stop production due to the rising raw material and transportation costs.

"They (Chinese steel companies) must have a collective voice in the international market instead of airing their own opinions," said Zhao Zhicheng. In Japan, six of its mills control 81 percent of its total iron and steel industry. But in China, just below 75 percent of production is controlled by more than 40 mills.

CISA Secretary General Luo suggested that incompetent steel companies should be allowed to die off and that larger, powerful industry leaders be allowed to emerge. Moreover, he pointed out that it is critical for the industry to upgrade its current product structure and rely more on domestic raw materials rather than searching for resources overseas.