Aluminum still needs more production cuts

LONDON: The aluminum price briefly touched a three-year low of $ 1,827.25 per ton on the London Metal Exchange (LME) last week.
It managed to avoid falling off a technical cliff, just, but the pressure is still on, three-month metal already trading as low as $1,830 in early trading yesterday.
Analysts are near unanimous in their collective view that a significant price recovery will need more producer cutbacks to rebalance supply with demand.
Superficially at least, they will be heartened by the latest set of global production figures released on Monday by the International Aluminium Institute (IAI).
These showed global run-rates falling by an annualized 940,000 tons in July relative to June.
However, there is still little evidence that producers either in China or the rest of the world are yet ready to bite the collective bullet in a way that would satisfy the market.
It’s important to put last month’s drop in global output into context, following as it did all-time record production of 45.2 million tons annualized in June.
Moreover, most of the July fall in production came from China, where annualized run-rates fell by 826,000 tons.
It was the first decline in the country’s output since March and follows a cumulative 2.1-million ton increase over the course of April, May and June.
There’s no denying the pain being felt by local producers. The country’s largest, Aluminum Corp. of China (Chalco), has just flagged a first-half net loss of 3.25 billion yuan ($ 510.8m).
But whether that pain is now translating into producer discipline is another issue.
Chinese production of the light metal has fallen in July relative to June in three of the last four years. That suggests that the latest decline could be primarily seasonal rather than structural.
Proof either way will only come with the next couple of months’ figures.
But the underlying issue is that market forces, namely the low price, are being counteracted by non-market forces, namely government subsidy.
Analysts at AZ China, for example, estimate that provincial governments are propping up around a quarter of domestic production, something like five million tons annualized, through power subsidies. Moreover, the idea of central government support is back on the agenda, smelters lobbying for a revival of a scheme to buy up surplus metal.
The last time this was done in 2009, the State Reserves Bureau bought 590,000 tons of metal at above-market prices via auctions open to only a handful of state “favorites.”
The message, now as then, is that the Chinese state will not contemplate mass closures in a sector viewed as strategically important.
The price can fall further. But whether Chinese production will be allowed to fall with it is quite another matter.
Outside of China aluminum production has been on a gently declining path for several months. Production in July slipped by another 110,000 tons to 24.6 million tons annualized, bringing the cumulative drop to 1.3 million tons since October 2011, when the aluminum price first started moving into cost-curve territory.
That cumulative figure is higher than the one million tons of announced cutbacks because it includes involuntary cuts at Rio Tinto’s Alma plant in Canada (union lock-out) and at BHP Billiton’s Hillside plant in South Africa (technical problems).
Both will ramp back up over the coming period.
As they do so, the impact of other production cuts, most of them announced in the early part of the year, will fade.
What is frustrating aluminum bulls is the lack of new “news” about production cuts.
There have only been two developments over the last month and neither of them is going to set the aluminum world on fire.
In Bosnia, Aluminij Mostar said it will cut output by 12.5 percent, or by around 16,000 tons annualized. US producer Ormet, meanwhile, has said it intends to close one of its six potlines, representing around 44,000 tons of capacity. The fate of the other five are dependent on power price negotiations with local supplier American Electric Power.
There is still the suggestion by Russian giant UC Rusal that it might shutter 300,000-600,000 tons of capacity later this year but the prospect has been around for so many months that any confirmation could hardly be viewed as news.
Outside of China aluminum producers are being kept afloat not by government subsidy, although there are specific examples, but by investment demand for metal.
Stocks financiers still seem to have an almost unlimited appetite for buying short-dated aluminum to earn the contango on the forward curve.
The positive impact on producers is twofold.
Firstly, by soaking up surplus units investment demand is preventing the sort of sales volume collapse experienced by the aluminum production sector in 2008-2009.
Secondly, investment demand is translating into historically high physical premiums, both directly by quarantining large amounts of surplus metal from the physical market and, indirectly, by incentivizing warehouse operators to bid directly for more metal to store.
Physical premiums just about everywhere are either at or close to record highs, providing an important financial lifeline to margin-compressed smelters the world over.
As analysts at Barclays Capital point out, even assuming an individual smelter only receives part, say 50 percent, of the realized premium, that would still be enough to pull 3.4 million tons of a price-challenged 10.5 million tons of global capacity back into positive margin territory.
All of which helps explains why the LME aluminum price has been bumping along the bottom of a $1,830-1,930 range for the last month or so.
In theory it’s the sort of price level that should generate a global producer reaction.
In practice, government intervention (China) and investment demand (everywhere else) are helping cushion the impact of price.
Yet, it seems very unlikely, bar an unexpected rebound in global manufacturing activity, that the aluminum price can stage any sustained upside move without a more fundamental realignment of fundamentals.
It’s a precarious status quo but one that could be sustained for several more months yet, or, as BarCap puts it, at least until “the mounting pressure from a third consecutive quarter of poor results in the sector (leads to) more aggressive decision-making by Q4 this year.”
The producer pain, in other words, is going to continue and will likely get worse before it gets better.
— Andy Home is a Reuters columnist.
The opinions expressed are his own.