CRU Aluminum: Is the Market Mispricing the Fundamentals?

Fear factor over demand is dominating price discovery

Here are a few of those fear factors.

• Rising energy prices across the globe

• Higher interest rates in the US

• China in lockdown, stunting GDP growth

• Eurozone acutely stresesd by the war in Ukraine

• Equity markets selling off aggressively, fueling concerns about recession

You can see why disciples of technical trading are suggesting that aluminum is on a path to sub-$2,500 per ton.

Last week, I talked about how the automotive market might be a counterpoint to this wave of bearishness. This week, I want to revisit the broader fundamentals in aluminum, which seem to have been overwhelmed by this race to the bottom.

Supply fundamentals remain challenging

Let’s revisit the supply side of the primary market.

Chinese primary production is rising faster than we expected. It is now increasing by 3.5% thanks to increasing power availability in Yunnan and Guangxi. But coal prices are also climbing in China. And recall that in 2021, coal shortages led to power shortages as well as to power rationing among aluminum smelters in these same areas. Stay tuned for updates on that front.

European primary production is still a shambles, with over 800,000 metric tons of idled capacity due to insanely high power prices. Prices in parts of the Eurozone remain elevated well beyond levels at which it would make economic sense to restart capacity. The LME price decline from $3,500 per ton to $2,715 per ton compresses cash flows for even more of the remaining operating capacity. We might see even more smelter curtailments in Europe.

Outside of Europe, the prospect of restarts is already “baked “into the market. Rio Tinto’s smelter in Kitimat, British Columbia, will be back to full capacity by the end of 2022. The same is true for Alumar, the Alcoa/South 32 joint venture in Brazil. These two smelters combined bring another 880,000 tons of production back into the market. These restarts will be welcome to the US and European markets, respectively, where major deficit conditions persist.

Other restarts in the US – Intalco (Washington), New Madrid (Missouri) and Warrick (Indiana) – are not likely. There is a great deal of attention given to Blue Wolf Capital Partners’ efforts to buy Intalco from Alcoa. There is an agreement in principle. BUT they are still trying to secure power from the Bonneville Power Administration (BPA) and the open market. BPA says Blue Wolf can not avail themselves of the industrial rates that original signatories to the BPA deals of 50+ years ago got. And even those rates are in the range of $40-50/MWh, which is not a bargain.

New Madrid faces substantial capital costs to rebuild its carbon plant to allow its 3^rd line of 80,000 tons/year to reopen. ARG International, its owners, don’t seem inclined to spend that money, especially with the LME down.

Last but not least, we still have no clarity around how Russian producers are compensating for the loss of 3 million tons of alumina ex Australia and Ukraine. Reports now are that the Chinese ARE stepping in to supply them. Preliminary reports show 200,000 tons of exports to Russia in April. However, that would still leave Russian smelters short about 50,000 tons/month, and it is far from assured that China can maintain that export run rate given Beijing’s zero-tolerance policy on Covid. It’s hard to bet on the Chinese supply chain being stable.

CRU still thinks some curtailments could occur in Russia. We have 280,000 tons/year factored in now, and this could rise to 500,000 tons/year. Some extreme views see Russian producers cutting up to 1,000,000 tons.

Self-sanctioning of Russia could cut supply

Politicians are still weighing their options for increasing pressure on Russia via sanctions. The private sector is not waiting for them to legislate action. Many companies with robust ESG standards can’t afford to stand by and continue business as usual. It would be disingenuous for them to justify continued purchases of Russia-origin metal while the war in Ukraine rages on. Some have made public statements about suspending commercial dealings with Russia. Others are quietly pursuing alternative supply options. This will not be easy.

As we have described before, Russia exports about 3 million to 3.2 million tons of primary metal/year. Approximately 1.5 million tons of that total goes to Europe. European buyers will be scouring the planet looking for supply ex Brazil, Canada, India, and the Middle East to compensate. LME stocks will be fully depleted, and the so-called “hidden stocks” will be all but drained. We will scrape bottom in this process. Buyers of P1020 or re-melt ingot should find supply. It will be much more problematic for buyers of value-added, alloy shapes such as billet, rolling slab and wire rod. These products will command increased upcharges, and incremental supply would have to come from India and even China, assuming the Chinese government decides these products are exempt from “primary” export duties.

On balance, it will be a tough supply situation.

Will weakening demand compensate for the tight supply?

CRU has lowered its expectations for primary aluminum demand in 2022. Our forecast for World ex China was reduced from a 4.1% growth rate to 2.7%. That knocks down demand by 200,000 tons/year. In China, we see a 0.4% growth rate compared to 0.8% previously.

These reductions in demand, combined with higher Chinese output as well as restarts in Canada and Brazil, will trim the 2022 net deficit from 1.6 million tons to 1 million tons. I can’t stress this enough: It is still a deficit, and that is lost in the current angst over the risks of recession.

Physical premiums expressed over LME HAVE eased in the past two weeks but remain very elevated. Most savvy traders are not in panic mode, suggesting that the supply fundamentals still must be accounted for. We agree with them. The pullback in LME prices may be a healthy correction, allowing buyers substantial relief on absolute prices while they wrestle with the overall effects of inflation. CRU still believes that LME prices can stage a reasonable rebound once the fundamentals get the attention they deserve. That means $3,000 per ton LME prices still are in the cards. Stay tuned.

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