CRU: China Decarbonization--Real Effects on Aluminum and Steel?

The Macro-economic Perspective

China generates 28% of global CO² emissions. Its energy-related emissions are 15% of the world’s total, and 57% of that energy is derived from coal. It will be tough for China to break its addiction to coal. A key enabler will be China’s willingness to stun production growth in steel, cement and aluminum. That process has actually been ongoing for five years.

2016: The Crackdown on Illegal Capacity and Emerging Operating Rights’ Market

The National Development and Reform Commission (NDRC ) began to assert control over capacity growth in aluminum during 2016-2017. After years of turning a blind eye to unbridled expansion, the NDRC acted aggressively. First they forced over 3 million tons of illegal operating capacity to shut down. Hongqiao, China’s largest producer, was forced to suspend 2.8 million tons of production until they could acquire operating rights under a new NDRC-regulated system.

This system of operating rights was genius in its design. It allowed the market to discover a clearing price at which existing holders of legal operating rights could transfer rights to those seeking to operate new smelters. It borrows from the concept of opening a bar in any American city. You either buy a new license from the local jurisdiction or you find an existing bar-owner willing to sell his/her license to you .

In the case of China, the NDRC would not issue new operating rights, instead forcing Hongqiao to find existing smelters willing to sell their rights to legitimize part of that 2.8 million tons of illegal capacity.

This system worked, allowing the market to set the value based upon a multiple of earnings for smelters. These rights traded as high as $500 per ton and successfully created an old-for-new capacity swapping system.

2021: Production Cap Becomes More Likely

China began to talk about a 45 million ton production ceiling on primary aluminum as early as 2017. This was met with polite indifference then. Now, it is a different story for several reasons:

• The operating rights system is curbing capacity.
• Beijing has taken dead aim at the coal-based smelters in Inner Mongolia, requiring 450,000 tons per year of capacity to close and stripping away preferential tariffs for power.
• Hongqiao and CHALCO have joined forces in a joint call for the industry to reduce emissions, lower energy consumption, focus on production of low carbon metal, and strongly endorsing the 45-million-ton cap.
• The NDRC has convened meetings with steel and aluminum to find out how both sectors will reduce their carbon intensity. This has placed aluminum smelters in the western provinces/regions (Xinjiang, Inner Mongolia, Gansu, Ningxia) under real pressure to reduce emissions intensity of GDP as they do not enjoy the same level of services growth as the eastern provinces

Let’s put this cap into perspective. China is producing at an annualized rate of about 40 million tons. In 2021, we expect them to add 2.9 million tons of production. At current growth rates, that means the production cap will be reached in 2022.

2022: What Happens When the Cap is Reached?

China seems very earnest about curbing its carbon and this cap may “stick.” At the same time, China’s appetite for aluminum is still growing fast, up 6.8% during 2021. How do they compensate for the cap? Here’s our thinking:

• A massive increase in recycled aluminum use. China is relatively immature in terms of using recycled content. We estimate only 21% of demand is met from recycled material versus upwards of 75% in the world ex China. This increase in demand will be met through a combination of higher imports and substantial improvements in domestic collection infrastructure.
• Imports of primary metal from Russia. The Russian Siberian smelters are ideally positioned to supply low carbon metal to China.
• Select imports of primary metal from new, offshore smelter investments in Indonesia, other SE Asia origins, Iran and Tajikistan

No one should underestimate China’s willingness to decarbonize. The tangible evidence is there.

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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