CRU: Russian Export Tax Injects More Volatility in Aluminum

This appears to be a case of the Russian government making an opportunistic “raid” on one of its most lucrative export industries. Their timing is good: First, UC Rusal, Russia’s only primary aluminum producer, is the leading exporter of primary aluminum in the world. Second, aluminum prices are on recent highs.

Taxing its large aluminum exports is a good way to shore up the Russian Federal Treasury while other Russian commodity prices, notably energy, have not fully rebounded from the effects of the COVID-19 pandemic.

Let’s put some hard numbers on this. UC Rusal produces about 4 million tons of primary aluminum per year and exports about 3 million. It has a major presence in Europe, Asia and to a lesser degree into the USA.

Anytime a new business tax is introduced, it’s not welcome news. However, this move really penalizes Rusal.

Rusal has worked hard to recover from the damage to its credibility caused by the 2018 U.S. sanctions against Russia. It has:

• Aggressively re-shaped its corporate profile under EN Group’s 56% stake in the company and Lord Barker of Battle’s highly visible leadership

• Rejuvenated its North American commercial leadership with key additions from competitors

• Actively promoted its low carbon intensity image, announcing plans to split into two companies in 2022, with its low carbon assets placed into a new company named AL+

• Continued to raise its share of higher-value casthouse products with particular emphasis on capturing new high-volume sales of billet and slab into Mexico while maintain commanding market shares in the EU and Asia

This tax injects uncertainty about the surety and cost of supply from Russia. The political tensions between the Biden administration and Putin-led Russia are escalating. The recent slew of Russian-origin ransomware attacks raises speculation about whether Biden will impose new sanctions on Russia.

None of this is constructive to Rusal’s well-designed efforts to regain market confidence and share. Buyers are nervous about putting their supply chain in harm’s way with purchases from the Russians.

What Does This Mean for Short-Term Prices?

This tax is set at 15% of the export value but no less than $254 per metric ton or about 11.5 cents per pound. The market is now handicapping how much of this cost can and will be pushed to the market. So far, the market has voted clearly…it is afraid of the tax and believes it is going to inflate prices. LME prices jumped nearly $100/ton from early June to $2,560/metric ton. Physical premiums in Europe rose $35/ton, and Europe seems to be most acutely in the “crosshairs,” as it has a greater dependency on Russian metal than either North America or Asia.

There have been concerns that Rusal might suspend some of its exports until the tax expires in December.

Here is the reality of what could happen:

• UC Rusal has pre-sold much of its commodity grade P1020 melting ingot to Glencore under a long-term (six years) contract. P1020 is the benchmark for the U.S. Rotterdam duty unpaid market and CIF Japan price. As part of this transaction, Glencore has advanced money to the Russians for future exports. They will expect their metal AND they will get it. Exports of ingot will NOT be slowing. Most of this metal is sold on pre-established regional premiums and it will be difficult for Rusal  to push the tax through to Glencore.

Notwithstanding the fact that Glencore has fixed premium purchases and they are NOT liable for the tax, they will undoubtedly seek to capitalize on Rusal’s higher tax burden by arguing that replacement costs ARE higher, and they will mark up their selling premiums.

• Rusal doesn’t like the tax, but they are still very profitable at current LME prices even if they had to absorb most of it. This argues for NO cut in production nor attempts to wait out the tax by holding back exports.

• There is no indication that the Russian government has made a hard and fast decision to lift the tax at the end of December. If revenues from energy exports are not higher, it is quite possible the tax could remain in effect in 2022. No one should be banking on this tax being temporary.

• Rusal sells about 50% of its exports in the form of value-added product (VAP) from their casthouses. These VAP contracts are done on yearly deals and the buyers will expect their metal. If the Russian’s were to delay or suspend shipments, it would be extremely harmful to their efforts to secure 2022 contracts as they move into the critical “mating season” during September-November. VAP upcharges are typically negotiated quarterly and the Russians ARE likely to enjoy success pushing some of the tax through in higher VAP pricing. Russia commands a major share of European billet and rolling slab demand.

What Does This Mean for Medium-Term Prices?

Like the 2018 Russian sanctions, this new tax is a shock to the supply chain and will be financially disruptive. However, early calls for this to double the physical premiums in the U.S. are very premature. The supply WILL come to market, it’s simply a matter of the clearing price against the upside risk of the $254/ton tax threshold that the government has set.

The Russians are very important to the aluminum market, but they are not the only game in town. As we discovered in 2018 when sanctions effectively shut down the Russian export machine, buyers are resourceful and WILL find alternative supply.

First, there is still 1.56 million metric tons of LME high grade aluminum sitting in warehouses. Much of this is in Asia and it’s not ideally positioned to serve Europe or the U.S. However, traders were already starting to move these stocks to those markets in response to historically high physical premiums. The Russian tax announcement will only accelerate this movement .

Second, the market will drain other stocks to compensate. These include Japanese port stocks, consignment inventories that traders have already placed into fabricators plants, and other unreported stocks held by banks/traders. It’s unrealistic to expect much help from other producers, as their stocks were already very lean. There are also no government stockpiles to be released (unlike China where the Strategic Reserve Bureau is releasing 50,000 tons/month for the balance of 2021 to alleviate tightness there).

Third, major primary metal buyers were already reacting to strong premiums by rotating more demand to scrap. This is a familiar pattern. Anytime primary prices have gone up over the past 35-40 years, buyers become more inventive with scrap. Scrap discounts to primary are starting to increase again after COVID-19 related supply constraints are easing…there’s more scrap being generated as industrial production gets back to pre-COVID-19 run rates.

Most knowledgeable traders believe physical prices will run 3-4 cents/pound or $65-90/ton, meaning 25-35% of the tax will be passed through to the market. The underlying LME has already delivered about $100/ton. In aggregate, total price “might” capture as much as 75% of the tax. However, arguably the LME price was moving higher well before the Russian tax news, and one has to reserve judgement as to how durable this recent spike in price could be. A lot of that relates to a cooling of recovery-led demand for aluminum.

There are some signs that demand is leveling off in Asia. The U.S. consumer emphasis on durable goods spending may be peaking. A rotation of spending back to experiential spending (travel, entertainment, dining) is in full swing. Anyone been in an airport in the past month? This will take the edge off metal-intensive demand.

The longer the market has to ponder its options, we believe cooler heads will prevail. Supply chain managers are already re-tooling to compensate for possibly more expensive Russian supply. Don’t bank on a doubling of physical premiums quite yet. The cure for high prices is high prices and aluminum buyers are masters at finding alternatives.

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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