CRU: Looking Back and Ahead in Aluminum

There were 3 macroeconomic effects that rippled through the entire global economy:

• Russia’s invasion of Ukraine sent global energy prices soaring, as they “weaponized” their exports of natural gas and oil, hitting Western Europe extremely hard and driving retail prices up everywhere.
• The surge in energy amplified inflation pressures that were building during the recovery from the pandemic. The public and private sector scrambled to cope with the effects of inflation that had not been experienced in 40 years. Central banks raised interest rates to try and check this, leading to a sharp slowing of GDP growth in the World ex China. The question now is not whether we are heading into recession, but how bad will it be!
• China’s zero-tolerance Covid policy stunted its domestic economic growth. President Xi is unrelenting in his approach to dealing with Covid and it is having major negative effects on the Chinese economy. We are seeing rare public protests as discontent mounts within the population.

The aluminum market saw direct repercussions from these macroeconomic events:

• European primary aluminum producers cut over 1.1 million tons of production, equal to 16% of implied consumption. Record-breaking electricity prices forced massive curtailments in Germany, France, and Norway.
• The rapid decline in the London Metal Exchange (LME) and regional physical prices triggered a major de-stocking cycle. This has encouraged the impression that real demand was down. Buyers across the value chain cut inventories when prices began falling. This led to a sharp reduction in new orders as the de-stocking cycle kicked in. Europe is still working through the cycle, while the US is completing its purge of stocks. Real demand is holding up better than expected. US third quarter GDP +2.9%. Data from Eurostat in Europe indicates that manufacturing in September 2022 is higher year-on-year, despite the fears of natural gas-inspired risk to manufacturing.
• The supply-demand balance shifted from expectations of a record deficit to a balanced market. Forecasts of a global deficit of over 2 million tons for 2022 disappeared as China and Western European apparent demand plunged. The market will finish 2022 in a small deficit of 200,000-300,000 tons.
• Aluminum prices fell sharply from Q1 throughout the year. The strong economic rebound from pandemic-induced shutdowns was stalled by high energy prices, sharp rises in interest rates and consumer rotation away from discretionary spending. LME prices threatened $4,000 during March 2022, only to tumble all the way down to $2,300 in Q4.
• Midwest P1020 premiums mirrored the behavior of the LME, falling throughout 2022. Premiums approached $0.40 per pound in Q1 before starting a steady retreat which left them at $0.20 per pound ending the year.

How Does 2023 Shape Up?

We head into 2023 trying to handicap how global demand will bottom out, the survival of smelting in Europe, and how the Russian geopolitical situation will play out in our market.

Here is our take on these key swing factors:

• Will European smelters restart in 2023? We believe that energy prices will remain too high to allow restarts before the second half of 2023 and that additional curtailments may even occur.
• How securely are the remaining US smelters operating? Forward power prices in the US remain untenable for any of the four smelters (Hawesville, Mt Holly, New Madrid, Sebree) that potentially face buying from the day ahead markets in 2023 or 2024. Alcoa’s smelters at Massena and Warrick either have long-term deals or are self-generating.
• What will happen with Russian aluminum? Will it be banned from the market? At this point, the US and Europe do not appear ready to apply sanctions on Russia. These are geopolitical decisions that will hinge upon Russia’s behavior in Ukraine. More provocative action by Putin in his conduct of the war may provoke sanctions. Many companies are choosing to self-sanction Russian metal to adhere to their ESG standards. Over time, more and more companies will wean themselves off Russian supply, but it will a protracted process.
  • The Russians show no sign of curtailing production, which means they will price their metal to sell down to cost of production. This will create huge price disparities between those countries/companies dealing with the Russians and those who are not.
  • Those disparities will become flashpoints in international trade. Origins such as Mexico, Turkey, and Vietnam may find themselves subject to fresh antidumping actions if and when their semi-fabricated products start to enter markets at substantially lower prices.
• How bad will demand get during the recession? We believe that the destocking cycle has run its course in the US but has more room to run in Europe, where inventories are still excessive relative to current real consumption. CRU believes global demand will rise 1.5% during 2023, led by the US, China, India, and Middle East. Europe will remain very weak, dropping -2.3% from 2022.
• What is the outlook on the LME price? CRU is holding to a very conservative forecast of LME prices. We expect Q1 2023 prices to average just $2,050 before gradually rising to $2,275 by Q4 2023. Other third party sources such as the World Bank ($2,400) and Reuters (survey poll at $2,400) are most optimistic that prices will recover. It will all pivot around how soft or hard the recession hits Europe. We remain optimistic that China will exert appropriate stimulus to get its economy moving again.
• How will the Midwest premium perform? Premiums in the Midwest are still deeply discounting import replacement. We believe import replacement is now $0.25 per pound in a market trading at $0.20. That is not sustainable. Given the systemic deficit in US primary metal, premiums ought to gradually rise to replacement cost. The forward market on the Chicago Mercantile Exchange (CME) is already building in a contango for 2023, e.g., $0.22-0.23 per pound in expectation of the market re-pricing itself to import replacement.
• Will semi-fabrication aluminum conversion charges remain historically high? Despite end buyers exercising extreme caution in concluding 2023 supply deals, sellers are remaining disciplined on pricing. There seems to be belief that core demand will allow the mills to fill capacity for automotive, can sheet, aerospace, plate, and other industrial applications which are the domain of the direct chill/hot and cold roll mills. Concerns are concentrated within building and construction, where continuous castings dominate in the “common alloys” such as 3105 for painted sheet applications. Thus far, this sector is also holding the line on pricing, buoyed by the fact that imports are still somewhat constrained by the antidumping orders put into place during 2021-2022.

By Greg Wittbecker, Advisor, CRU Group, Gregory.Wittbecker@crugroup.com