Financiers’ lifeline to aluminum producers

LONDON: Global production of aluminum edged up by 131,000 tons annualized in April, according to new figures released by the International Aluminum Institute (IAI) and the China Nonferrous Metals Industry Association (CNIA).
A 212,000-ton increase in annualized production in China offset a modest 73,000-ton decrease in the rest of the world.
That captures the twin production trends so far this year, Chinese output rising a net 954,000 tons annualized and offsetting a 912,500-ton drop in annualized production outside of China.
Both parts of that supply dynamic challenge a market narrative centered on supply restraint in response to the London Metal Exchange price falling into the light metal’s production cost curve.
Since Chinese smelters are widely assessed as occupying the very top part of that cost curve, the resilience of the country’s production might appear surprising.
But pinpointing exactly where China’s giant aluminum sector sits on the global cost curve is no easy task.
Chinese smelter costs are a moving target, quite literally, as higher-cost capacity closes in the east of the country and is replaced by lower-cost capacity in northwestern provinces.
So far this year the net result has been a 13-percent increase in national production to 6.160 million tons, albeit with a high degree of monthly volatility in collective run-rates.
There is no reason to expect any significant change to this underlying dynamic, given the amount of new production capacity either in ramp-up or in pre-commissioning stage.
Analysts at Standard Bank London, for example, dismiss the Ministry of Industry and Information Technologies’ 2012 target of closing 270,000 tons of inefficient capacity as representing less than 10 percent of the new capacity scheduled to come on stream this year.
Nor is anyone yet getting too excited about the impact on China’s metal production of Indonesia’s planned clampdown on exports of bauxite.
The combination of quotas and new taxes on mineral exports should in theory disrupt the flow of bauxite to China, or at the very least add extra costs to a sector that is already in part operating on wafer-thin or even negative margins.
But no-one is yet quite sure just how effective the new rules will be, or even how effective the Indonesian authorities want them to be.
Chinese bauxite importers, meanwhile, have rushed to stock up just in case.
Imports of Indonesian bauxite hit a new all-time record of 4.6 million tons in April, bringing the cumulative year-on-year increase to 53 percent.
That will provide a partial safety net over the short term at the very least.
But even in the event of a severe hit on export flows, the impact on China’s metal production will be filtered through the prism of the intermediate alumina market.
In the world outside of China, annualized production has fallen by 1.06 million tons since October last year. That would seem to accord with the aluminum market’s narrative of price-induced production constraint.
But the numbers are deceptive.
Around half of that figure reflects involuntary cutbacks, primarily the lock-out at Rio Tinto’s Alma plant in Canada and what BHP Billiton has called “a major unplanned outage” at its 715,000-ton per year Hillside smelter in South Africa.
That said, price-related cutbacks are starting to impact operating rates in both Europe and Australia.
Annualized production in Western Europe dropped to 3.6 million tons in April, the lowest level since 2009, while that in the IAI’s Oceania category has also sunk back to 2009 levels.
Conspicuous by their absence, though, have been further cutback announcements since the flurry at the start of this year.
UC RUSAL has said it is “considering” cutting 300,000-600,000 tons of higher-cost capacity in the second half of this year, adding a little flesh to the bones of an even vaguer previous statement of (possible) intent.
Germany’s 115,000-ton per year Voerde smelter has launched insolvency proceedings, attesting to the current squeeze on producer margins, but is intending to carry on producing during financial restructuring.
More cutbacks may come but it looks like anyone expecting a wholesale global reduction in aluminum production is going to be disappointed.
Which begs the question. If prices really are low enough to force smelters such as Voerde into insolvency, why are so many able to hold out?
The answer is because smelters receive more than just the aluminum price for their products.
Physical premiums provide an extra revenue boost to smelters’ bottom line and right now premiums are soaring across the globe.
Those in the US Midwest market, for example, hit all-time highs above the 10-cents per pound ($220 per ton) level earlier this month.
Those in Europe are at similar levels for duty-paid metal, while Rio Tinto has just tossed a hand-grenade into the Asian market with a proposal to jack quarterly premiums from the current $121-122 per ton up to a record $200 per ton for July-September shipments.
Physical premiums over and above the LME basis price have historically reflected the interaction of regional supply and demand.
Not any more.
Now they reflect the global tug of war between physical and investment buyers for aluminum units.
It is a tussle which investment buyers are winning, witness the huge tonnages of metal earmarked for physical drawdown from the LME system, the accompanying load-out queues at key locations such as Detroit and Vlissingen and the consequent dearth of units for industrial buyers.
Stocks financing was explicitly referenced by Rio Tinto in its communication with Japanese buyers, according to one directly-involved source.
And, unlike fabricator demand, investment demand is almost unlimited, or limited only by the availability of metal to finance. By underpinning rising global premiums, investment demand for aluminum is generating an important source of extra revenue, equivalent to around 10 percent of the basis price, for the world’s smelters.
Stocks financiers are in effect providing a financial lifeline to aluminum producers everywhere, partly cushioning them from prolonged weakness in the terminal market price for their metal.
Good news for smelters and good news for financiers seeking ever more units to earn a turn on.
Not such good news for physical buyers, but they might console themselves with the thought that while they are being hit on physical premiums, those premiums are basis a price defined by the cost of
production.
— Andy Home is a Reuters columnist. The opinions expressed are his own.