High energy prices to dent aluminium makers' profit

By its very nature, aluminium will always remain a lot more expensive than steel, which it is seeking to replace in many high end applications. Very appropriately, the chief technical specialist of Jaguar Land Rover, a marquee acquisition of Tata Motors, Mark White told Reuters that on replacement question “aluminium price relative to steel is one issue, but the main issue is volatility of aluminium prices, which can’t be stressed enough.” Aluminium is replete with instances of major price swings leaving its producers either in a profit binge or forcing them to shut relatively high cost smelters.

The world has seen much of the latter in the wake of blistering recession of 2008-09 from which the aluminium industry will take time to recover. Users of the white metal are at a disadvantage if the three-month price on London Metal Exchange would move from a low of $1,400 a tonne at which nearly 80 per cent of world aluminium capacity becomes unviable in March 2009 to nearly $2,500 in April 2010 and now to $2,071. In seeking a much bigger volume of application in automobile industry, which is under dual pressure to cut emission and gas consumption, aluminium is in competition with hot dipped galvanised steel selling in Europe at $850 a tonne. White, who is overseeing the application of more and more white metal in cars in Jaguar stable, says the use of aluminium sheet by the European car makers now at 130,000 tonnes could “double or even triple in the next 5-10 years” in a stable price situation. In order to offset wide price swings in a short period and thereby create ground for greater use of aluminium, White recommends that metals producers make “long-term supply agreements of up to 10 years with car firms.”

He further says that a car maker’s contract with a smelter may be linked to a particular model or a platform taking into account an auto cycle plan of up to 10 years. The recommendation no doubt looks good on paper as it is tailored to encourage carmakers to reduce weight of vehicles now ranging from 1,200 kg to 1,400 kg and create incremental demand for aluminium. According to White, long-term supply contracts would give a boost to aluminium use in cars in a much faster way than any development of alloy or joining technologies.

And if the formula works for Europe then no doubt this is likely to come for replication in China, Japan and the US. Maybe here in India too. An industry official, however, says the proposal of White is fraught with risks for aluminium makers. Except for a handful, smelters across the globe depend on imports or local buying of the intermediate chemical alumina. This means aluminium makers have no control on the major smelter feedstock. Moreover, energy accounting for over a quarter of aluminium production cost is bound to become more and more expensive. Like we are told that up to 1.5 million tonnes of smelting capacity in China is to come offline this quarter to end September following Beijing directive to rein in energy use. China had a share of 13.642 million tonnes of the 2009 global aluminium output of 37.669 million tonnes.

Call it industry restructuring or a big cleaning up operation, Beijing is seriously pursuing the target of permanently shutting down energy guzzling plants run on old technologies and therefore, a source of pollution. Raising energy prices and scrapping some subsidies are expected to help in achieving this goal. Energy is one issue which certainly will make aluminium makers wary of entering into the kind of long-term contracts White is suggesting. This apart, smelter owners will be watching how the proposal to price alumina on a shorter term index starting next year will pan out. This will be saying goodbye to the prevalent practice of pricing alumina on a long-term basis and as a percentage of the metal price. Our own Nalco sells most of its alumina in the world market on long-term contracts.

It seems that alumina refineries are planning to do what the world’s leading iron ore producers have successfully done earlier this year. If China achieves the smelting capacity cut it is targeting and smelters in the highest cost quartile return to production stream slowly, then alumina market should develop softness. Experts, however, say that the alumina market will continue to remain “relatively balanced” because the refineries retired capacity a lot more drastically than smelters during the worst recession times.

The prevailing aluminium prices are not leaving the producers overjoyed even though industry leader Alcoa reported profits of $137 million in June quarter against a loss of $545 million in the same period of 2009. Alcoa second quarter working is ahead of market expectation. There no doubt were fears that slowing industrial demand in China and weaknesses in the western economy would delay Alcoa turnaround. But Alcoa pulled it off because of bold restructuring involving idling of a quarter of capacity and retiring thousands of hands. Some other aluminium producers too opted for identical restructuring.