Inventories to keep check on aluminium prices

Aluminium producers, particularly the bigger ones, continue to demonstrate a remarkable production discipline that began as the world started experiencing a savage economic downturn. A restraint of the present kind was not seen in earlier downturns. What is even more gratifying is that the industry is not betraying any haste in restarting relatively high cost smelters that were wisely rested in response to a collapsing aluminium market since the final quarter of 2008. At one point in 2009, as much as 5.5-million-tonne smelter capacity was idled.

Thanks to our production, more or less in line with the size of domestic market plus exports, the Indian aluminium industry, though not mauled in the same way as its counterparts in the US, Europe and also China, saw its profits taking a major hit in the final quarter of 2008-09 and during 2009-10. This is to be seen against the backdrop of aluminium prices collapsing from a high of $3,300 a tonne at the crest of 2008 commodity boom to almost $1,300 a tonne in January 2009.

Since then, aluminium prices have rallied, in conjunction with major western economies coming out of recession with forecasts of global gross domestic product likely to rise 3.4 per cent this year compared with a 1 per cent fall in 2009. At one point this year, the white metal was done at $2,400 a tonne. The London Metal Exchange (LME) three month price now is slightly above $2,350 a tonne. Progress in aluminium prices is cautious and halting unlike copper, nickel and tin. But since aluminium has underperformed vis-a-vis other nonferrous metals, investors may be seeing an opportunity in this commodity.

No doubt aluminium's underperformance has got much to do with the mountains of inventory with the LME, Shanghai Futures Exchange, Nymex and IAI stocks, together with surplus production in 2009 that is expected to be repeated this year as well. LME alone has stocks of 4.59 million tonnes and if inventories at other centres are considered, then the total comes to around 7.5 million tonnes. Such an inventory and surplus production are not allowing aluminium to reap the benefits of demand revival, particularly from the automobile and construction sectors, the two major victims of the recession. Surprisingly, the packaging sector got off lightly when demand collapse was the order of the day.

The world aluminium industry, which saw production retreating to 36.9 million tonnes last year from 39.83 million tonnes in 2008 will have to carry forward the restructuring process. This involves scrapping of ageing high-cost capacity and building of smelters in places where power costs are low with vigour to get out of the woods. Experts say world production will bounce back to close to the 2008 level, thanks to China likely to lift aluminium output to 15.5 million tonnes from 12.8 million tonnes last year. As China is likely to use 16.5 million tonnes of the metal this year, it will fill the gap between local supply and consumption by emptying a portion of the inventory and imports. Compared to China, not to speak of the developed economies, the aluminium intensity of the Indian economy remains low as the annual use of 1.3 million tonnes will bear it out.

Market specialists say the fundamentals may be stacked in the favour of aluminium but the big inventory overhang, though largely tied up in investment, will limit any major advances in prices. Improvement in the metal demand apart, global auto sales rising up to 3 per cent this year (against major reverses in 2009), likelihood of energy costs rising and some sparkling performances by other base metals are positives for aluminium. But, the market has to live with the concern that central banks may raise interest rates to control inflation. That will add to the cost of maintaining the aluminium inventory. Once the inflection point is reached, stocks will gradually start coming into the market and that will not be good for prices.

In the meantime, giving a push to restructuring, European and American aluminium groups are shutting smelters in high-energy-cost western countries. But, they are simultaneously building bigger units in West Asia with abundant gas, the source of cheap electricity. European Aluminium Association says half of the continent's capacity may be wound up by 2010-end and two-thirds capacity will go by 2013.

A Deutsche Bank report says that the cost of energy for some smelters in Europe is as high as $950 for a tonne of aluminium. There is no way such smelters can be run. As Norsk Hydro is closing a high-cost smelter in Germany, it has started commissioning a 5,85,000-tonne smelter in Qatar in a 50:50 joint venture with Qatar Petroleum. Similarly, Alcoa, which is pulling down at least four idled smelters, is building a $10.8-billion aluminium complex in Saudi Arabia.