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Global aluminum market: a tale of two outlooks

Apr 30, 2013 | 08:00 PM | Gregory DL Morris

Tags  United Co. Rusal, Oleg Deripaska, Boguchansk Energy and Metals, aluminum, aluminum demand, IHS Global Insight, China, aluminum production Ma'aden smelter

If the global aluminum market were a classic Western movie, this would be the scene where the young bucks rush breathlessly into the saloon warning of calamity riding down on the town, and the old hands exchange glances, take a long drink and drawl, “Well, we’ll just see about that.”

Industry analysts are looking at a worldwide business that is facing rising inventories despite some regional price premiums, as well as lingering economic uncertainty in most industrialized markets, and they see imminent upstream additions, especially in China, as very bad news. Producers themselves are certainly alert to the implications of fresh tons in a softening market, but they’re more philosophical about the risks.

Some producers are taking the opportunity to rationalize their own operations on top of investments they’ve made in recent years to gain economies of scale through horizontal integration. It wouldn’t be too much of an oversimplification to say that smelters are sanguine about long-term demand for their metal. They feel relatively secure in their current production economics, and as for a couple of years of overcapacity, the devil take the hindmost.

“The market developments we observed over the past year signify the beginning of a new commodity cycle,” Oleg Deripaska, chairman and chief executive officer of Moscow-based United Co. Rusal, said when his company released its 2012 results. “This new cycle highlights the need for rational supply responses. This implies production optimization aimed at substitution of the less-cost-effective smelting capacities with advanced, cost-competitive and energy-efficient facilities.”

To that end, Rusal began a long-term optimization program in the second half of last year, which will continue through this year. Following the start of the curtailment program, the company’s fourth-quarter aluminum production fell 2 percent from the same period a year earlier to 1.038 million tonnes, despite the company’s restart of its Sayanogorsk smelter to full capacity. The company plans to cut about 300,000 tonnes of primary aluminum production at less-efficient smelters through the end of the year. On the other side of the ledger, Rusal is pressing ahead with its new 600,000-tonne-per-year Boguchansk Energy and Metals Complex smelter in Siberia, a venture with Moscow-based JSC RusHydro expected to produce its first metal in the third quarter.

With that underway, Deripaska has his sights on the future. “Although the pace of global recovery remains open to debate, there were clear signs towards the end of 2012 that key markets in China, other Asian countries and North America have begun to increase their aluminum consumption,” he said. “These markets will remain at the forefront of aluminum demand during the year ahead, driven by the automotive sector and continued investment in large-scale infrastructure projects.”

Rusal expects global demand to rise by 6 percent to around 50 million tonnes in 2013 from 47.4 million tonnes last year while producers will idle between 1 million and 1.5 million tonnes of capacity, leaving the world market balanced.

However, the outlook for the eurozone is “less encouraging,” he said. Despite the European Central Bank’s efforts to solve the debt problem, European countries are still suffering from weak economic activity, large budget deficits and cuts in capital spending, which in Rusal’s assessment are unlikely to stimulate economic growth and consumption. European aluminum consumption fell 3 percent to 7.7 million tonnes in 2012, while the automotive industry, a key aluminum end-user, remains depressed in Europe. The current rate of capacity cuts will be inadequate for a sustained upward trend in aluminum prices.

“While some production cuts were made during the first half of 2012, more recent data show an industry reverting to its old bad habits,” according to a global pricing and purchasing report issued in March by Lexington, Mass.-based IHS Global Insight Inc. “Western producers did rein in production early last year, with capacity being rationalized in North America and Russia and closed permanently in Europe and Australia. But Chinese production has continued to gallop ahead at a double-digit rate. China’s internal market has actually moved toward a balance, though this is a bit misleading. It is clear that an inventory build is taking place, but not all of that stockpiling is showing up in the data.”

Current production in China is estimated at 20 million tonnes annually out of an installed nameplate capacity of 22 million to 24 million tonnes, with about 2 million tonnes of new primary metal capacity slated to come into service this year. “China policymakers claim that new capacity is moving them down the cost curve and that they will retire older, less-efficient plants,” John Mothersole, an IHS senior principal analyst of pricing and purchasing, said. “It is true that the new units are more efficient. But when it comes to closing older units, it never seems to happen. Local authorities raise concerns about employment and these zombie plants just continue to produce, often at lower, even less-efficient rates.”

China’s State Reserve Bureau bought 100,000 tonnes of ingot in November, and some local observers suggest it is the first in a series of purchases that may total more than 400,000 tonnes, IHS said in its March report. “It is true that those purchases are timed to a low price point and that, therefore, the claim can be made that the actions are ‘strategic.’ Our view, however, is that these purchases are an implicit or explicit subsidy to the domestic industry. Shanghai inventory has doubled since late 2011, with the strong suspicion that this is only the tip of the proverbial iceberg.”

Mothersole lays the responsibility at the top. “The overinvestment in primary smelting reflects a misallocation of capital. The investment in exports is being pushed to an extreme and sets up potentially deflationary forces. What worked as a short-term strategy is now becoming a chronic reversion to type.” Beyond the misallocation of capital, he cited excessive energy consumption and environmental degradation as problems. “I don’t know how this is going to end, but in the past such imbalances have not ended well,” he said.

Beyond China, there is significant other primary metal capacity on the horizon, IHS said. The new 740,000-tonne-per-year Ma’aden smelter in Saudi Arabia is due to start up later this year, and the 600,000-tonne Boguchansk smelter in Russia is expected to start to come on line in the third quarter.

On the demand side, the IHS report projects primary consumption growth of 4.1 percent this year, just a few dozen basis points better than the year-end estimate for 2012. Not until 2014 could annual growth hit 5 percent, which would be considered a “true recovery.” Consumption growth in Asia is projected at close to 6 percent in 2013, with weakness in Japan, sluggish growth in South Korea and slower growth in India dampening the outlook. Chinese consumption growth continues to drive the region, with forecast increases above 8 percent in both 2013 and 2014. North American markets have seen a slowdown in new orders that will affect the first half of the year, according to the IHS report, which forecast consumption growth slowing to around 2 percent in 2013 from more than 5 percent last year.

Beyond the trend lines, IHS noted a disconnect in the price chain. “A key development, perhaps leading to a transformation of the industry, will be what happens upstream,” it said. “Like iron ore in the steel industry, bauxite and alumina prices are becoming decoupled from the price of primary aluminum. The reason is the growing size of spot purchases by Chinese smelters, who are dependent on imports for much of their feed. Integrated producers look to have a building advantage, as do large mining companies. Value has traditionally been captured by the downstream segments of the industry. It looks to be migrating upstream.”

The big story in North America is that demand, especially in construction, is looking up, according to Aluminum Association president Heidi Biggs Brock. “Overall demand has grown 30 percent from the lows of 2009 and now exceeds 2008 levels,” she said. “Automobile demand is strong, with more pounds per vehicle and more vehicles. In housing starts, there were 780,000 units in 2012, which is a 28-percent improvement from the year before.” A return to the significant 1-million-house milestone may be possible this year, she added.

“Commercial and industrial construction consumes more aluminum than does residential (construction), but housing is still a good market,” Nick Adams, the association’s vice president of business information and member services, said. “It varies greatly by region, and there has been significant change in the type of demand. We have pretty much lost the siding market, but there is huge volume in trim coil and downspouts. People are spending more on repairs now that they are staying in their homes longer. That has really helped us through the recession.”

As for transportation, aircraft builders are very optimistic, Brock said. “Their order books are full. And in automotive, we have seen 40 years of uninterrupted growth.”

“The increases in aluminum demand vary by maker and by model, but the higher-end car companies are experimenting with many more and different applications,” Adams said.

Pulling back to the macroeconomic view, Adams said the industry is aware of the new tons due on the market, but association members are keeping their eyes on the prize. “We are looking at an economy that is starting to recover,” he said. “Capacity is always an issue when you are coming out of a recession. There may be some short-term overcapacity, but (in the) long term we are going to have to add smelters, not take them away.”

Adams also said that the trend in corporate structure is toward horizontal rather than vertical integration. “If you look around the world among the major corporations, the fact of life is that the vertical integration we used to have is no longer prevalent. Primary producers have shed downstream operations and concentrated upstream.” That should be no surprise, he said, because the verticals such as Pittsburgh-based Alcoa Inc. and Foothill Ranch, Calif.-based Kaiser Aluminum Corp. got into downstream businesses to develop those markets. “Now that they are mature demand sectors, it makes sense for the smelters to invest upstream and in other developing markets,” he said.

That said, he noted that at least two major producers, Alcoa and Montreal-based Rio Tinto Alcan Inc., still maintain research and development facilities, and that all the smelters work closely with their customers on developing new applications. “The nature of R&D has changed,” Adams said. “It is not just internal anymore, but a joint effort with other partners.”

One recent development, the acquisition of Alcan Cable by Highland Heights, Ky.-based General Cable Corp., serves to illustrate several of those trends, Brock said. “We are seeing strong inroads in competition with copper wire,” she said, adding that the growth is being driven by consolidation in the power grids and the need to upgrade infrastructure. Also, the retirement of older power plants in favor of newer, more-efficient ones usually means major new transmission apparatus.

Jessica Fung, commodities analyst with Toronto-based BMO Capital Markets Corp., agreed that the overall trend is for horizontal integration, but she added that Alcoa has been notable for its push downstream. “That is where they make their money, not in primary,” she said. The global shift to horizontal focus is being driven by the buyers. “In China, all the downstream users have long-term contracts with the primary suppliers that factor in both volume and price, so the producers don’t need to hedge,” she said. “Their concern is just processing costs. The primary guys could invest more downstream, but it would not help them in their current situation.”

On the larger capacity issue, Fung said it’s reasonable for industry observers to fret about overcapacity while producers feel sanguine about long-term demand. “The near-term overcapacity is definitely cause for concern. Producers are not profitable, and investors are asking why they should buy in. Producers can wait 10 years for the macroeconomic trends to kick in, but investors are looking out maybe three years at the most,” she said.

Fung is somewhat more optimistic about the situation in China than most analysts. “The stated goal in China is to bring aluminum production under just 10 organizations for better control and planning, but I can’t really see that happening anytime soon unless the central government gets more control out in the provinces,” she said. “That may be possible, because there is a lot of debt at the local level. Financing that debt may give the central government more leverage and might allow some production to be taken out of the market, but we are talking in a five- to seven-year time frame.”

Further over the horizon, a different challenge could figure into the next round of primary metal additions, Fung said. “The good bauxite sources tend not to be where the cheap energy is, and neither of those tend to be where the downstream demand or manufacturing operations are,” she said. “Historically, the smelters have been near the customers. But that may not necessarily be true in the future.” She speculated that decisions about future capacity could come down to where producers want to place their bets--raw materials, power or logistics.

Chris Bayliss, deputy secretary-general and director of global projects at the London-based International Aluminium Institute, said the boom-and-bust cycle in primary metal goes back more than half a century. It is endemic to any commodity market, but especially aluminum. The first big boom came after World War II, when the huge amount of smelting and fabricating capacity created for the war effort was turned to civilian uses.

“We saw steady growth from there to the 1970s and the energy crises,” Bayliss said. “That is when we started to see production move away from high-cost energy places like Japan to lower-cost energy centers like North America, Australia and Brazil.” That cycle of shifting production to places with cost advantages continues, usually driven more by power than by raw material costs. “The places to watch in the years ahead are the ones with stranded power that is looking for outlets,” he said. “In contrast, places with power shortages will not be able to keep up.”

In that equation, China is clearly constrained in power, which tends to be coal-fired. Bayliss noted interesting internal shifts in the domestic supply chain in China: power and raw materials and downstream processing are being concentrated in different parts of one of the world’s largest countries. “It will be interesting to see how they sort it all out in the end,” he said.

In the long run, Bayliss comes down on the side of more capacity rather than less. “Worldwide, we will need 75 million tonnes by 2020 or 2025, which means we will have to double primary metal production from 2010 levels,” he said. “We have a robust outlook on fundamental demand. There is a short-term oversupply and an imbalance in China, but out to 2020, 2025 and beyond, the outlook is positive.”

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