CRU: Aluminum Producers Discover Discipline

The London Metal Exchange’s (LME) three-month price is $2,347 per metric ton and is approaching levels last seen in 2018. Technical indicators suggest, if it can break through current resistance levels around $2,350 per metric ton, a move to $2,700 per metric ton cannot be ruled out. That would take LME prices back to their own 10-year highs. 

Isn’t the Cure for High Prices, High Prices Incentivizing More Production?

Aluminum producers worldwide are doing very well. Producers operating in the first quartile of the cost curve are making over $985 per metric ton, with the lowest-cost producers earning over $1,200 per metric ton. Even producers in the fourth quartile are earning over $500 per metric ton. Historically, these margins would inspire new projects and re-starts of idled capacity. However, production growth is more-or-less pacing consumption growth, and restarts are scarce.

In China, we expect a 7.2% rise in new production in 2021. Chinese consumption will rise 6.8%, and we forecast China will still experience a net deficit of 220,000 tons. China’s crackdown on illegal production, combined with strict adherance to the new system requiring operating rights before building new capacity, is working. Old, idled capacity operating rights have been sold or transferred to faciliate that 7.2% rise in new capacity. There really isn’t that much old capacity left to restart.

The Chinese producers have learned that “less is more.” This SHFE rally has lasted a year, with fat margins. Producers are realizing that the “check value” of operating rights is keeping production growth aligned with demand, and avoiding the historical big surpluses.

Outside China, we expect a 4% increase in 2021 aluminum production. That growth is confined to Iran (which can’t export it), Malaysia, Norway, and Russia. World ex China demand will surge 13.1% over 2020, leading to a World ex China surplus of about 650,000 tons or about nine days’ consumption. That surplus will be shrunk by exports of primary metal into China to help them balance their market. The effective surplus in the World ex China will be less than five days’ supply.

Why Aren’t World ex China Producers Cranking Up More Production?

Conventional wisdom expects Western producers to respond to the current price by restarting idled capacity. That is not happening for multiple reasons.

One, it’s very expensive to restart an idled aluminum smelter, on the order of $200-300 per ton depending upon how long the smelter has been shut. We’ve studied aluminum closures since the Global Financial Crisis and found a strong correlation between the length of curtailment and their probability of restart:

• Between 2008-2015, 8 million tons closed and only 3.1 million of that has restarted to date, leaving 61% idled
• Between 2016-2020, 3 million tons closed and 1.9 million tons restarted, leaving 37% idled

Two, many closures were driven by uncompetitive power or even an ability to get power at any price. A good example is Brazil, where the 460,000-ton Alumar smelter has been closed since 2015. Brazil is in the midst of a prolonged drought, leaving hydroelectric generation down and making their power provider, Eletronorte, reluctant to commit to long-term supply and fixed prices.

Third, it is debatable whether the LME and regional premiums will be this strong when the restarts are executed, which could take 6-12 months. The forward LME price curve is very flat and the Midwest premiums are at a discount to spot (backwardation). Most producers take a conservative approach and only begin to hedge the incremental production when the restart is complete. It is possible that producers could preemptively hedge the future production before the restart is ready, but that has traditionally been shunned and the forward discount does not incentivize that move.

Fourth, here in the U.S., Section 232 exists with uncertainty around its longevity. We have three producers operating in the U.S. with various curtailed capacity:

• Alcoa with three of five lines shut at Warrick, Ind., totaling 110,000 tons, plus a fully curtailed smelter at Ferndale, Wash., of 235,000 tons (closed Q3 2020)
• Magnitude 7 with one of three lines shut at New Madrid, Mo., totaling 80,000 tons
• Century with half of one line shut at Mount Holly, S.C., totaling 55,000 tons

All these plants enjoy the benefit of the Section 232 duty, which is boosting Midwest aluminum prices by $250 per metric ton at current LME and CIF import replacement premiums. Section 232 came in via Executive Order…it could disappear equally as fast. The Biden administration does not appear to be focusing much on this now. However, if you are one of the three producers above, will you commit capital to a restart with the risk of seeing that $250 per ton of bottom-line revenue evaporate overnight on top of the restart costs? That’s leading to the current hesitation to restart. 

Assume Restarts at Your Own Peril!

As an aluminum buyer, it is tempting to assume that producers will revert to form and open more capacity, resulting in the LME falling. The constraints above argue that U.S. producers are unlikely to restart anything. Outside the U.S., conservatism will also reign supreme. It would be unwise to assume production increases will put out the current LME price rally.

Greg Wittbecker joined CRU in January 2018 after retiring from Alcoa, where he was Vice President of Industry Analysis and Managing Director of Alcoa Beijing Trading, based in Shanghai, China. His career spans 35 years in the aluminum industry, having also held senior commercial and management roles at Cargill, Wise Metals and Koch Supply and Trading. Greg brings perspective on the entire aluminum supply chain from bauxite to aluminum finished products and will be a regular contributor to SMU going forward. He can be reached at gregory.wittbecker@crugroup.com

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