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Investors applaud but dangers lurk in de-integration

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According to Rio Tinto Alcan's chief executive, aluminum is not yet out of the woods and it may take quite a while, perhaps even a couple of years, until inventories return to healthy levels.

A quick examination of Rio Tinto Alcan's major markets reveals why Jacynthe Côté is wise in her caution. The sector is heavily dependent on three major markets—transportation, construction and packaging—none of which has proven particularly robust this time around.

The trials and tribulations of the U.S. automotive industry have been well reported and it is widely recognized that it may take a number of years for automotive build rates to return to their previous highs. Construction can hardly be described as a safe haven, either, and orders for can sheet—the most important part of the packaging business for aluminum—actually fell 5 percent in March while shipments of sheet, plate and extrusions grew.

Growing aluminum's market share in these recently lackluster sectors is one way to limit the damage of future downturns. At the same time, the industry needs to be on the lookout for completely new applications that can help aluminum retain the same relevance in the 21st Century as it had in the latter half of the 20th Century.

In this regard, however, Rio Tinto Alcan, as well as upstream rivals like BHP Billiton and United Co. Rusal, will soon be dependent on its customers and integrated competitors. When Rio Tinto Alcan finally succeeds in selling its remaining downstream assets it will, to a large extent, be turning over responsibility for market development to customers such as Novelis Inc. and Aleris International Inc., as well as to still-integrated rival Alcoa Inc.

There are good arguments in favor of de-integration of the aluminum sector, and certainly shareholders have shown a greater fondness in recent years for those stocks that offer full exposure to the very fashionable, if somewhat volatile, commodity markets.

But there can be little doubt that the aluminum industry at large suffers when huge multinational conglomerates like Rio Tinto step back from the front line of product development and instead pass the mantle onto companies that for the most part are far smaller and less well-resourced.

Indeed, in the recent past we have seen two of the largest independent fabricators, rolling company Aleris and extruder Indalex, enter bankruptcy protection—not the ideal platform from which to promote the development of aluminum.

Novelis also experienced financial problems in its early days, although it is now performing with some distinction. And it is the Hindalco subsidiary, along with Alcoa, on which much of the burden for market development rests.

To be fair, Rio Tinto Alcan is still an innovator at the upstream level, funneling more than $100 million a year into R&D as the company looks to reduce its energy consumption at the smelting level and eliminate carbon dioxide emissions, Côté told AMM.

But on the downstream level, the exit of a major player like Rio Tinto Alcan could curb new product growth.

It's not as if aluminum doesn't face stiff competition. The steel industry, for example, has been resolute in its defense of market share in the automotive sector, and collaborative efforts by groups such as the Steel Market Development Institute's Automotive Applications Council has seen great advancements in ultra-lightweight steels, which threaten the advance of aluminum in the automotive arena. And with the generally small aluminum fabricators pitted against international behemoths like ArcelorMittal, the aluminum sector's voice in the ever-present push for new applications is not always heard.

Aluminum's own giant, Alcoa, for its part, continues to look for new avenues of growth, and consumer electronics and aluminum-intensive solar cells are held out as potentially significant markets for the light metal in years to come. Alcoa hopes that as the leading light in these developments, it will be the first to benefit.

Of course, if the likes of Alcoa and Novelis are successful in broadening aluminum's horizons, upstream producers like Rio Tinto Alcan will benefit, too. Investors seem quite content with this, and probably snigger quietly that it's great to have others put up the R&D money from which they ultimately can reap rewards.

But if a reliance on such a small number of well-resourced downstream companies to develop markets for aluminum ultimately results in a loss of market share, the entire aluminum supply chain—including shareholders in upstream producers—will suffer.


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