CRU: Aluminum Volatility with a Capital “V”

Supply-side Price Concerns Get a Reality Check but Remain Dangerous

Market euphoria over supply-side constraints ran into the effect of China’s “command economy” at work. Power shortages in China have been well-documented, driven by high demand and coal shortages. The official start of the Winter Heating Season is also about to start Nov. 1 (when the heating systems are literally turned on, a legacy of the old Soviet-style model!) This will increase coal demand for steam generation.

Not surprisingly, coal prices were skyrocketing in China. The Zhengzhou thermal coal futures touched 1,829 renminbi/ton ($286/ton) on Oct. 18. 

Let’s put that into perspective. The price one year ago about was 575 renminbi/ton and the five-year trailing average price for Zhengzhou has been around 650 renminbi/ton. Beijing announced that it would simultaneously: 1) cap coal prices around 528 renminbi/ton and 2) take steps to increase coal production to relieve shortages. Given the fact that most coal production in China is operated by State-Owned Enterprises (SOE), the government CAN make this happen and in a hurry.

These actions by Beijing led to Zhengzhou futures prices crashing their permissive daily limit down for four consecutive days. While physical coal supply has not yet responded to a point where aluminum smelter production is out of danger, the psychological effect has been pronounced.

CRU believes that there is still about 3.5 million tons of Chinese production in a temporary curtailed state awaiting relief on power supply.

We are not “out of the woods” yet.  Two other factors remain dangerous:

1) The winter heating season could also lead to involuntary curtailments to preserve air quality. This will be especially acute since Beijing is holding the 2022 Winter Olympic Games in February and they will expect pristine air quality.

2) The dual control monitor remains in place putting smelters under scrutiny for both total energy consumption and their efficiency per ton of output. This has taken a big bite of production in the past three months.

European Curtailment Risks in Face of High Prices

The story in Europe is all about spot power prices, as encapsulated in Germany. Spot prices have reached nearly 130 euros/megawatt hour. This compares to trailing two-year prices ranging from lows of 17 euros to 49 euros. That price action set in motion a great deal of speculation that some high-cost capacity in Eastern Europe might be forced offline. Thus far, we have seen only some attrition in Slovakia, but nothing else.

Talks with leading players suggest that if prices hold here, they can survive for a while at these elevated prices. Some agile operators may eventually consider arbitrating the power price versus aluminum, where they sell back power to the hot spot price and modulate production. So far, no confirmation.

Demand Destruction Concerns Rising

The emphasis on supply-side constraints is starting to be displaced by fears that demand is being impacted in multiple ways:

1) Serious liquidity concerns among major Chinese real estate developers like Evergrande could badly impact aluminum construction demand, which represents about 30% of Chinese demand or nearly 12 million tons.

2) EU automotive demand is really being hurt by the on-going chip shortage. Thus far, conventional wisdom has been that the chip shortage will only defer not destroy demand. However, registrations in August were down 18% year on year after July registrations fell 24% year on year. These are the worse year-on-year declines since 2013.

3) Supply chain bottlenecks may turn off durable goods demand. Consumers are already getting frustrated by higher prices and lack of inventory. In some cases, they are just “sucking it up.” In other cases, they are exiting the market and saying, “I really don’t need that product after all.” Housing starts in the U.S. fell 1.6% in September. Durable goods orders fell 0.4%, last seen in April 2021. We may also be seeing that long-awaited rotation of consumer spending from “hard goods” to “soft goods” such as travel, dining, and entertainment, which of course don’t consume metal.

Are Aluminum Prices a “Buy” Now?

The rally to $3,300 was probably overdone. Now the pullback to current levels may be equally overdone. Supply-side fundamentals remain problematic, and inventories are very low. CRU projects aluminum inventories to hit a record low by 2024 at 32 days of implied consumption. We expect 2021 to produce a primary aluminum deficit of 1.6 million tons and to grow to 2.4 million tons for 2022. That must be reckoned with by the market.

We still need an incentive price for producers to both attempt restarts of idled capacity and consider new capital investment. Even starting today, we are looking at 2024 before we could see delivery of new greenfield capacity. Price signals now must give that encouragement to build or else we will see even more volatility in the future as the gravity of the deficits sinks in.

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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