Aluminum’s vicious circle

LONDON: Aluminum production outside of China edged marginally higher in September, underlining the fading impact of a round of production cuts initiated earlier this year.
Daily average production crept up to 67,000 tons last month from 66,900 tons in August, according to the latest figures from the International Aluminum Institute (IAI).
It was the first month-on-month increase in non-Chinese production since October 2011.
And it’s one that spells further trouble for the aluminum smelter sector, caught in a vicious circle of over-production and low prices.
Non-Chinese run-rates had fallen by around 1.5 million tons annualized between November 2011 and August 2012.
That largely reflected a series of capacity closures triggered when the London Metal Exchange (LME) price fell below $ 2,000 per ton in the fourth quarter of last year. “Largely” but not totally.
Two of the biggest smelters outside of China, the Alma plant in Canada and Hillside in South Africa, saw production fall sharply in the first part of this year due to labor strife and technical problems respectively.
Both are now in recovery mode and ramping back up.
Output at the 710,000-ton-per-year Hillside plant was running at an annualized 556,000 tons in the third quarter, while the 430,000-ton-per year Alma plant was operating at an annualized 176,000 tons.
As both return to full-capacity operations, expected by the end of the year, they will likely offset any further tail-end production cuts.
These are fading anyway.
Non-Chinese producers have announced around 1.2 million tons per year of price-related curtailments, mostly either late last year or in the early months of this year.
More recently, the flow of announcements has pretty much dried up with the exception of a late-August confirmation by UC RUSAL that it would trim output by 150,000 tons by the end of the year.
That, however, is no more than house-keeping by the Russian giant.
Older, higher-cost capacity will be phased out in tandem with new, lower-cost capacity starting up.
The company’s 600,000-tons per year Boguchansk plant is scheduled to produce first metal next year. The associated 3,000-MW power plant is currently in test-phase commissioning. You’d be hard pushed to find a single analyst who thinks that aluminum production has been cut enough to prevent more surplus metal adding to an already huge historic stocks overhang.
Of course, the current high physical premiums, more than $ 200 per ton over and above the LME basis price in all major regions, have provided an important life-line to smelters that would otherwise have been plunged into negative margins.
It is ironic that these premiums are a direct consequence of systemic over-production.
Metal surplus feeds the LME forward curve contango, which feeds the stocks financing trade, which forces manufacturers to compete head-to-head with financiers for free units.
Such are the core workings of aluminum’s vicious circle.
Premiums offer a cash incentive for marginal producers to keep producing. In doing so they are merely adding to the surplus that keeps premiums high but the outright price suppressed. In a perfect world, it would be China that would break this vicious circle.
The world’s largest producer of the light metal also has some of the highest-cost smelters in the world.
But the most vulnerable are receiving financial assistance, most commonly through power subsidies, from local governments.
High-cost smelters are only high-cost if they have to pay their full bills. If they don’t, cost-curve arguments go out the window.
The IAI’s complementary dataset on China’s production, provided by the China Nonferrous Industry Association, is still pending.
But the alternative data series, from the National Bureau of Statistics, showed Chinese production easing by only a marginal 250,000 tons annualized in September and that was from August’s all-time record run-rate of 20.6 million tons.
Bottlenecks among the new generation of lower-cost smelters in China’s western and northwestern provinces rather than collective cutbacks are widely believed to be restraining Chinese production right now. Such restraint is expected to be only temporary.
This leaves non-Chinese producers fearing that further cutbacks would simply encourage Chinese producers to export into any resulting gap.
The global industry is in a stand-off, everyone waiting for everyone else to do something.
Which is why bank analysts have been taking the red ink to their aluminum price forecasts.
Barclays Capital, for example, has lowered its forecast aluminum price for 2013 to $ 1,988 per ton from $ 2,275.
The bank, normally a bullish voice in the metals space, said it would even “consider being short aluminum as an attractive trade” (’Commodities Weekly’, Oct 12, 2012).
Since the middle of this year, when it became clear that producers were not going to cut more, the bank’s estimate of market surplus for 2012-2013 has doubled to 2.4 million tons.
It’s far from being alone.
Analysts at BNP Paribas have lifted their calculated surplus for this year to 750,000 tons, bringing the cumulative 2008-2012 estimated surplus to nearly nine million tons.
“Although world production looks as if it has topped out, renewed rapid capacity growth means aluminum will remain in physical as well as structural surplus in 2013-14 unless large fresh cutbacks are made,” the bank said in a recent research note (“Aluminum Agonistes, Oct 19, 2012).
BNP Paribas is holding its (relatively) bullish call for aluminum to average $ 2,350 per ton next year, albeit with risks “skewed heavily to the downside.”
Underpinning that call is a belief that the industry’s current mismatch of supply and demand is “unsustainable.”
This assessment cuts to the current heart of the aluminum debate.
Every producer is making a rational decision to keep producing at current rates, whether it be thanks to physical premiums in the West or government subsidy in China.
But the result is collective irrationality, a perpetuation of the “unsustainable” vicious circle of low prices and over-production.
How long can it continue?
No-one knows and there is no reason to believe that the financing trade, which lies at the heart of the industry’s current dynamics, is going to go away any time soon.
The most likely result is a long, drawn-out war of attrition with producers the world over fighting to move down the cost-curve.
Good news for financiers but not for anyone else in the aluminum sector. Not even consumers, who in the form of rising physical premiums are experiencing real scarcity at a time of notional plenty.
— Andy Home is a Reuters
columnist. The opinions expressed are his own.