LONDON: You can see why Rio Tinto is keen to reduce its exposure to aluminum.
What is often dubbed the metal of the future for its impressive demand growth profile has been an albatross for the resources giant ever since it made that fateful $ 38-billion acquisition of Alcan back in 2007.
Five years on and $ 29 billion of write-downs later and aluminum is still a highly problematic part of Rio’s portfolio.
Earnings before interest, tax, depreciation and amortization (EBITDA) in its Alcan business slumped by 38 percent to $ 1,085 million last year.
Underlying earnings, which Rio describes as “the key financial performance indicator which management uses internally to assess performance,” collapsed to just $ 3 million from $ 442 million in 2011.
Well, $ 3 million is something at least and in Rio’s defense it took a one-off hit from the prolonged strike and part closure of its Alma smelter in Canada.
The picture, however, deteriorates when it comes to the company’s Pacific Aluminum business, a catch-all for the assets Rio has already earmarked for disposal.
What Rio describes as its “other operations,” primarily Pacific, generated an underlying loss of $ 528 million last year, compared with a loss of $ 120 million in 2011.
Pacific Aluminum itself represents a staging post on Rio’s long retreat from the aluminum business.
When first separated out of the Alcan business in October 2011, Pacific Aluminum included the Gove bauxite mine and alumina refinery in Australia, three Australian aluminum smelters, the Tiwai Point smelter in New Zealand, the Lynemouth smelter in the UK, the Sebree smelter in the US and four specialty alumina plants. The latter have already been divested.
Lynemouth has been permanently closed and its previously captive power station sold.
Sebree’s fate is hanging in the balance after Rio rejected a proposed power rate hike by the Big River electricity cooperative. Full closure is an option once the current power contract runs out at the end of this year.
Even smelters within the core Alcan business are coming under scrutiny. That at St. Jean de Maurienne in France, almost a century old, is up for sale ahead of an upcoming power contract renewal.
The company in essence is reducing its aluminum footprint to its core Canadian smelters, which benefit from ample and competitively-priced power supply from the Quebec hydro-electric system, plus a couple of other low-cost plants in Iceland and Oman.
Rio is belatedly learning the fallacies of cost curve economics in the aluminum sector.
When it bought Alcan five years ago, the then current consensus thinking was that even high cost smelters such as those now on the sales block would survive because the highest-cost smelters of all, those in China, would close.
That would open up a structural shortfall in China’s domestic market, requiring accelerated imports of metal from the rest of the world.
Alas for Rio and every other Western aluminum producer, those Chinese closures never came. The country ended last year churning out record amounts of aluminum.
Cost-curve economics only work if the bills are paid. If, however, local governments subsidize their smelters, whether by permitting them discounted power rates or soaking up surplus stocks, costs become stretchable rather than fixed. And in China they become very stretchable.
This leaves everyone else having to move down the cost curve to survive.
It’s a message finally being grasped by others as well.
Oleg Deripaska, chief executive of Russian aluminum giant UC RUSAL, has shifted his rhetoric from simply urging fellow producers to cut output to calling for “rational supply responses” to “the beginning of a new commodity cycle.”
“In the aluminum industry, this implies production optimization aimed at substitution of the less cost-effective smelting capacities with advanced cost-competitive and energy-efficient facilities,” Deripaska said in the company’s Q4 production report. RUSAL is accordingly moving its production emphasis away from its higher-cost plants in the west of the country to its bigger, lower-cost smelters in Siberia.
Rio is doing the same.
Which still leaves the thorny question of who precisely is going to take Rio’s Pacific Aluminum business.
The decision not to close the Gove alumina refinery may be key.
The plant, still suffering from the legacy of an expansion which ran over budget and behind schedule, is high cost because of its dependence on diesel.
A tentative agreement with the government of Australia’s Northern Territory means it could be converted to lower-cost gas power within a couple of years.
That, logically, should be good news for the Pacific Aluminum business. The four smelters in Australia and New Zealand start to look a bit more viable if they can be supplied with captive, competitively-priced alumina.
Yet the real benefit of keeping Gove running and converting it to gas might prove to go much further than supplying local smelters.
After all, China, the biggest global user of aluminum, doesn’t need more metal.
What it does need, however, is more raw materials to supply its own smelters.
As the graphic below shows, China’s implied domestic alumina deficit has started to widen again after a period of being close to balance.
This is in part due to problems securing bauxite from Indonesia over the middle of last year, an issue that has only been temporarily resolved ahead of a planned total export ban.
Lacking sufficient high-quality bauxite reserves itself, China’s dependence on bauxite to make its own alumina looks increasingly problematic.
Moreover, alumina capacity expansions in China have become few and far between in stark contrast to the continued build-out of smelter capacity.
Both trends point to a likely increase in Chinese demand for alumina over the coming years.
Owning an efficient alumina refinery located in Australia starts to look a whole lot more appealing than just using it to feed high-cost smelters to produce surplus metal.
Overshadowed by Rio’s financials today was the announcement by Australia’s Alumina Ltd. that it has sold a 15-percent stake to China’s CITIC. Alumina, via its AWAC joint venture with Alcoa, does have exposure to the aluminum smelter business in the form of stakes in the Point Henry and Portland plants in Australia.
But its real business, as the name suggests, is alumina.
Chen Zhen, vice-chairman and chief executive of CITIC Resources, said the stake would provide “CITIC with the opportunity to invest in one of Australia’s leading companies with a world class, global portfolio of upstream mining and refining operations in the aluminum sector.”
Note the lack of reference to “smelting” operations.
Aluminum may indeed be the metal of the future, but in Australia at least it’s starting to look like the future of aluminum is alumina.
— Andy Home is a Reuters columnist. The opinions expressed are his own.
