Power is aluminium's single biggest cost component

Has not the New Year brought with it a sense of Nirvana for aluminium makers at home? A nasty tumble last year caused by a punishing recession brought spot aluminium prices down to $1,250 a tonne in February leading to random closure of high cost smelters around the world, including China. The white metal has recovered a lot of ground since and it is now quoted at around $2,229 a tonne at the LME.

The Economist succinctly tells us that an aluminium group smelts or sinks depending on where it finds itself on the metal’s cost curve. What, however, also remains to be said is that more than technology in employment in a particular smelter and its productivity quotient, the power bill finally decides where it will be resting on the cost curve.

Smelters here owned by Hindalco and Nalco not only have adequate captive power but their electricity complexes are where coal is mined. This advantage is further reinforced by their adequate access to high grade bauxite, the mineral from which the smelter feedstock alumina is made. We have seen how edgy Nalco becomes whenever it is required to import coal or buy power from the grid. There have been many occasions that Nalco has been denied coal supply from the dedicated mine of Mahanadi Coalfields Limited.

Power is aluminium’s single biggest cost component. It is in order to keep the smelting cost down or more precisely to ensure that the energy bill ideally remains within 30 per cent of metal production cost that Vedanta is locating its 500,000-tonnes smelter to be commissioned in two phases at Jaharsuguda in Orissa. The integrated aluminium venture will have a 1,250 Mw captive power complex and the site happens to be next to rich coal blocks.

This advantage on the power front allowed our smelters to sail through during the recent trough. One will, however, be mistaken if one thinks that it is already time for celebrations. A commodities specialist with Bank of America Merrill Lunch says aluminium still has “horrible fundamentals.” His principal concern is prices might well come under pressure with the gradual coming on stream of capacity shut earlier.

Moreover, it was not very long ago that the metal commanded a price of $3,300 a tonne. Let’s first look at China, the principal driver of aluminium demand and production. China which last year made approximately 13.62 million tonnes of aluminium out of an estimated world production of 37.57 million tonnes had to lay off as much as 3.7 million tonnes capacity. The country was obliged to do so as it made no sense to run the energy guzzling smelters when chips were down for the metal.

In step with improving metal prices and its own economy regaining the bounce, China has restarted all but 400,000 tonnes of the 3.7 million tonnes of laid off capacity. The country to be left with some surplus in 2010 as a result may need to import less aluminium. What, however, remains a cause of concern for environmentalists is that taking advantage of price improvements, Chinese regional satraps have allowed relighting of a number of polluting smelters which Beijing wants dismantled. If anything, China faces the same problem with getting rid of unwanted steel capacity. Outside China however, producers want to be sure that the recent improvement in demand for aluminium is sustainable before the capacity rested earlier is brought back on-line. China itself is now a point of concern for aluminium producers globally, including India. The Chinese move to raise reserve requirements of banks to rein in inflation and stop formation of asset bubble has put commodity sector per se under pressure. One reason why we are seeing few smelter restart outside China.

Instead, we are told about Alcoa temporarily idling production at two Italian smelters of a combined capacity of 195,000 tonnes following European Commission ruling that the company must return what it received as state power subsidy since 2006. Meanwhile, Rio Tinto closed the Anglesey Aluminium smelter in the UK on expiry of power supply contract. It is precisely for the rising cost of power that the European Aluminium Association is fearful about the fate of two-thirds of the continent’s smelters.

The first trigger for price rise came in the second quarter of 2009 when Chinese stockpiling began and now the market is getting support from the perception that the global recovery is for real. No doubt commodities are once again been seen as asset class and a hedge. A danger is, however, lurking in LME stocks of over 4.6 million tonnes of which some 70 per cent is tied up in financing deals. Speculators bought aluminium at low prices last year and sold futures at premiums. Contango charges are more than covered. Will not the market take a tumble when such stocks are released?