BEIJING/SHANGHAI (Reuters) - Small steel mills in China are taking advantage of lax environmental enforcement to ramp up production ahead of bigger rivals, industry and government officials said, jeopardizing anti-smog targets and defying industry consolidation.

FILE PHOTO: A poster showing Chinese President Xi Jinping is seen in front of the Xinyuan Steel plant in Anyang, Henan province, China, February 19, 2019. REUTERS/Thomas Peter/File Photo

China’s massive steel sector is a key battleground in the country’s war on pollution, with air quality in major steel-producing cities like Tangshan and Handan routinely listed among the most toxic.

Tougher environmental laws and a 2016 campaign to shut substandard capacity were designed to both cut smog and boost the share of law-abiding but unprofitable state firms by forcing out smaller, irresponsible rivals.

But uneven enforcement has allowed industry minnows to outcompete larger rivals and raise production, say industry and environment ministry officials.

The China Iron and Steel Association (CISA), which represents state-owned and big privately owned producers, holds its smaller rivals responsible for much of a record surge in output in the first half of this year, which has also driven iron ore prices to record highs.

“We must not allow enterprises with low levels of environmental protection ... to compete with enterprises that have invested a lot,” Liu Bingjiang, a senior environment ministry official told an industry conference this month.

Larger firms now pay nearly 300 yuan ($43.63) per ton in environmental compliance costs, compared to as little as 20 yuan for small producers, Liu said.

This puts the cost of curbing pollution at nearly 8% of a large mill’s total outlay, compared to as little as less than 1% at a small, non-compliant rival, according to Reuters calculations.

The discrepancy has helped minnows raise output by nearly a quarter in the first five months of this year, CISA data showed, against 6.2% by the association’s own members.

This compares with 2017, when its member companies grew output by 6.9%, but the crackdown on sub-standard production restricted growth at smaller mills to just 1.1%.

“This is a dereliction of supervision duty and it should be resolutely resisted,” Liu said.

(Graphic: China's top 10 steel makers vs. Total production - tmsnrt.rs/2yhDpGZ)

FAILED CONSOLIDATION

Big steel mills are also being forced to upgrade their facilities and transport systems to meet new “ultra-low” emission standards.

Top steel makers China Baowu Group and the HBIS Group said they have spent nearly 3 billion yuan each a year to ensure they meet new standards.

But smaller mills able to game the system, an official responsible for environmental compliance at a privately owned 10-million-tonne per annum mill in Hebei province told Reuters.

“It’s getting harder to manipulate emissions data, but there are still some tricks to play to cope with inspections. You have to understand, the ultimate goal for bosses at private companies is to make profits,” said the official, who declined to be named due to the sensitivity of the matter.

The environment ministry has frequently accused mills of misplacing sensors, turning off equipment or ramping up production at night to avoid supervision.

“The biggest problem at this moment is the implementation of current emission standards,” Wang Kaiyu, vice director at laws, regulations and standards department at the environment ministry said on Friday.

“In the next step, we will strengthen supervision of the implementation.”

The government is promoting greater state ownership in steel to control output and preventing rapid increases in imported iron ore prices, but small-scale players have instead increased market share.

The combined crude steel output of China’s top 10 steel makers was 329.23 million tonnes in 2018, 35.5% of the country’s total output, according to data from the World Steel Association and the National Bureau of Statistics.

That is down from 37% in 2017 and remains well below Beijing’s aim of putting 60% of total capacity in the hands of the 10 biggest producers by 2020.

“The market can decide how much steel to be produced in the country, but cannot fully decide who produces the steel,” CISA chairman He Wenbo said at the industry conference.

“We should encourage those with high emission standards to produce more while limiting the polluted players,” he said.