CRU: U.S. Aluminum Supply Chain Takes Another Hit with Strike

Some familiar themes are at the center of the labor dispute. First, the union wanted to preserve defined pension benefits for new workers and, second, they wanted to limit management’s ability to use outside contractors.

From the company’s perspective, they were seeking to reduce labor costs through more staffing flexibility and to reduce the long-term liability incurred through defined pension plans.

Rio’s response to the walkout was swift, immediately shutting 65% of the plant’s capacity or 250,000 metric tons/year. The timing of that action was surprising, given the huge cost to close and restart a primary smelter, often running to $150-200 per metric ton and taking 3-6 months to restart. Initially, we expected Rio to sharply reduce amperage to all the potlines and keep the smelter “on warm,” effectively slowing electrolysis but allowing a quick recovery of full production. The decision to take drastic action was unexpected but not unprecedented.

When the Becancour, Quebec, aluminum smelter was struck for 18 months during 2018-2019, Alcoa (75% owner) and Rio (25%) closed nearly 85% of that smelter. Alcoa took a $40-50 million charge for their share of restart costs for 345,000 tons of idled capacity. Rio bore the remaining share, so they fully understand the financial impact of closing Kitimat.

The decision to shut Kitimat was partially driven by Canadian labor laws that preclude the use of outside labor to run plants during a strike. Only management personnel and other “essential workers” are allowed to operate the plant. This severely limits management from maintaining full production for very long. Such was the case of the Becancour smelter.

Rio’s decision to move swiftly on the closure was also indicative of their determination to lower operating costs even if it meant incurring hefty restart costs. Rio spent over $4.8 billion U.S. during 2015-2016 to completely rebuild this smelter. That represented an extremely costly retrofit of over $11,000 U.S. per ton of installed capacity. A big cost overrun. They got a plant with among the lowest current operating costs in the world, but also were burdened with a very low return on sunk capital. Therefore, they were/are eager to further reduce operating expense to try and recoup their huge investment even faster.

The closure of the plant likely means that Rio is committed to a long, arduous negotiation along the lines of the Becancour experience. With current aluminum prices high and cash flows from other assets performing well, they have some “staying power.”

Another contributing factor to their tough stance is the long-term need to invest massive capital in their Quebec smelter system. These assets are underpinned by highly attractive, legacy water rights from the government. However, major investment will be required to upgrade the hydro dams and generating stations to maintain the competitive advantage. Those investments will be well above $1 billion U.S. Recent examples of this being the $252 million CAD allocated in 2020-2021 to upgrade the Isle-Maligne hydroelectric station.

Rio needs a highly efficient Kitimat smelter in the West to generate big returns and cash to support this investment.

What Does This Mean for the Short-Term Aluminum Market?

Kitimat is an important cog in the U.S. supply chain. It is the dominant supplier of P1020 ingot to remelters operating west of the Mississippi. The loss of this 250,000 tons of supply will mean West Coast P1020 prices will spike to a premium of at least 5 cents/pound over the Midwest duty paid market. Essentially, the market will now have to draw metal from either Quebec, the U.S. smelters in the lower Ohio Valley or the LME warehouses in Detroit.

This will exacerbate an already strong Midwest duty paid market, trading in the 31-32 cent/pound range above LME cash.

The smelter was also an important supplier of rolling slab for the major direct chill (DC) rolling mills such as Arconic, Constellium, Novelis and Commonwealth Aluminum. This will tighten up slab, which was already experiencing strong mill demand-pull to supplement internal casting. Every DC mill in the U.S. is running flat-out to support orders that are running 26% ahead of last year.

If Becancour taught us anything, it was that Rio has a great deal of resolve to get a labor deal that keeps them highly competitive for the long term. Market conditions now allow them the luxury of a smelter system that can generate strong earnings while they grind out an agreement with the union over the long haul.

Don’t look for a quick solution to this strike. It will have lasting repercussions on an already, very tight primary aluminum situation in the U.S.

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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