Aluminum Market Is Poised for More Gains

The global aluminum market caught a midyear updraft in prices that is expected to continue this year as critical end markets such as transportation and housing improve.

Aluminum prices have increased 38% since July, which has boosted sales levels and likely buoyed the performances of aluminum makers including Alcoa Inc.— which reports after the market closes Monday, kicking off the fourth-quarter and year-end earnings season—as well as Rio Tinto and Russia's UC Rusal.

The price increase for aluminum, which is used in a broad array of industrial products and is considered a key indicator of industrial demand, reflects stronger end markets as well as production cutbacks, mainly in China.

New housing starts and automobile and aerospace sales are showing signs of strengthening globally, analysts said, especially in the U.S., the world's second-largest consumer of aluminum. Economists say housing starts are likely to rise 17% in 2011, compared with a 7.3% gain in 2010. Car sales, which rose 11% in 2010, are expected to climb 12% in 2011.

Barclays Capital Equity Research expects 2011 aluminum consumption to grow 8.1%, compared with a 7.9% growth rate in 2010.

"The aluminum market will improve," said Edward Meir, a metals analyst with MFGlobal.

Aluminum prices are hovering around $2,400 to $2,500 a metric ton. Analysts expect the price to rise to $2,700 a metric ton in 2011. While Alcoa, UC Rusal and Rio Tinto all benefit from increasing aluminum prices, much of the companies' sales are already contracted, and it can take months for the higher prices to be figured into current sales and profits.

The industry's momentum could also be derailed by two factors. Making aluminum requires huge amounts of energy, and rising energy costs could erode aluminum profits. In addition, if producers boost production to capitalize on rising prices, more aluminum on the market would likely depress prices.

But Leo Larkin, a metals and mining analyst with Standard and Poor's, says the three top aluminum companies account for about 48% of global output, which should help keep supply in line with demand.

"With a greater degree of concentration, we think the restart of idle capacity in response to stronger market conditions should be more rational," he said. "This is likely to reduce the volatility of industry prices and profits."

A wild card is China, the world's largest aluminum consumer, which usually produces about 16 million metric tons yearly. It has shut down some of its smelters to cut pollution and energy consumption, cutting output by 1.3 million metric tons.

Market observers are unclear how long those aluminum smelters will stay off line. Much of the country's aluminum is produced at small and midsize smelters that are major employers in their regions. If those smelters stay offline for an extended period of time, pressure may mount for them to reopen.

Despite the rise in demand and prices, about four million metric tons of aluminum are sitting in warehouses world-wide, according to Mr. Meir. As much as 70% of that inventory is already tied up in futures contracts, which effectively removes it from the stock of aluminum available to today's buyers.

"Although the stock picture in aluminum looks very bearish with a lot of inventory, it is not as bleak as one would think because much of the inventory is tied up and not available to the market," he said.

For the world's aluminum makers, the forces in the aluminum market look favorable for quarterly earnings. Alcoa, which has lagged behind competitors, is expected to swing to a profit for the 2010 fourth quarter.

"It is a little bit more optimistic outlook for the company," Mr. Larkin said. "Going forward, their costs will be lower. They have trimmed their debt. Their downstream operations seem to be turning the corner, especially in Russia. Slowly but surely they are turning the freight liner around."

Rio Tinto, which produces several metals and minerals, is investing more of its profit into the expansion of its aluminum smelters. The company said last month that it would invest $758 million in the first phase of a new, more energy-efficient aluminum technology at its Canadian smelters.

Rusal said last month that it expected a stronger 2011. "Several factors point to encouraging prospects for the aluminum market: the revival of the domestic market, increased economic activity in Germany, South America and Asia, spot premiums reaching an all-time high, partly due to China becoming a net importer of aluminum," Rusal said in a written statement last month.

In a further sign that Alcoa expects aluminum demand to strengthen in 2011, the company said it will restart production at three of its previously idled smelters in New York and Washington. The resumptions, expected in the first half, will add 137,000 metric tons by year end. That still leaves about 674,000 metric tons of Alcoa's aluminum production shut down.