Some Aluminum Production Dips Below Costs; Output Cuts Likely If Condition Persists

 

 

Like other base metals, aluminum has tumbled from its highs earlier in the year on worries about the strength of the global economy and thus potential industrial demand, particularly as the European sovereign-debt crisis continues. Three-months aluminum fell as far as $2,054.75 a metric ton on the London Metal Exchange Monday, the lowest level in 14 months and down 27% from the May peak of $2,803 a ton.

 

 

“As a result, increasing numbers of aluminum smelters are becoming unprofitable and are temporarily shutting down production,” Commerzbank said in a daily research note.

 

 

In particular, this potential exists for higher-cost operations in China, Europe and North America, analysts said.

 

 

Estimates vary on just how much production globally is losing money. Robin Bhar, senior metals analyst with Credit Agricole CIB, estimated 15% to 20% of global output is unprofitable. Jorge Vazquez, managing director of Harbor Intelligence, suspects it’s around 40%.

 

 

“If the situation is sustained for a few more months into early next year, I suspect we’ll see some closures,” Bhar said.

 

 

Widespread closures do not occur overnight or even within a few weeks of a price tumble, he said. Producers do not want to take such steps until they are sure weak prices will persist for a lengthy period of time, since it is expensive to close down plants. “It costs a lot of money to put plants on care and maintenance,” Bhar said.

 

 

Still, Vazquez pointed out, there are already some signs of reduced output. For instance, Rio Tinto Alcan said it plans to close its U.K.-based Lynemouth smelter.  Norsk Hydro also said it would delay the planned restart of idled capacity at its Sunndal smelter in Norway.

 

 

“We believe that if these prices remain where they are and we get to the second half of December, we are going to probably hear of numerous smelter closures, specifically in China, West Europe and the U.S.,” Vazquez said.

 

 

Ultimately, cuts in production should help the market find a bottom since this means less supply. “Prices will find a floor where it is perceived that it’s simply unsustainable for prices to hold those levels,” Bhar said.

 

 

The market is being driven lower in large part by sentiment more-so than current supply/demand fundamentals as traders fret over the strength of future demand. “It’s driven more and more by sentiment and despair and positioning. Because fundamentals can never move as fast as prices do,” Bhar said.

 

 

Vazquez described the market as in “panic” mode. “Right now, for example, funds are holding the biggest (net) short position ever,” he said.

 

 

Whenever the economic fears affecting a range of markets settle down, demand likely will pick up again, Vazquez said. And then, prices may not only go to the upper end of where they should be, based on supply/demand fundamentals, but may exceed this. “The name of the game is volatility. There are deviations to the downside and deviations to the upside,” he said.

 

 

Chinese Production Declines Due To Energy Availability, Economics

 

 

The lower prices that producers are receiving for aluminum is already affecting output in China, analysts said. Commerzbank cited data showing that production in the country declined in October by 5.7% month-on-month to 1.49 million metric tons.

 

 

“If prices remain low, further production shutdowns are likely,” Commerzbank said. “It is estimated that the marginal costs of production in China are $2,300 per ton.”

 

 

Vazquez said that a combination of economics and energy-supply issues is impacting Chinese production, which he said accounts for some 43% of global aluminum production. He estimates the average cost of production in China at $2,640 a ton.

 

 

China has trouble generating enough energy capacity for all users at certain times of the year when demand picks up due to what he termed “extreme” weather conditions. This also occurs when water levels are low, meaning less hydroelectric power. Also, a “mismatch” between coal and electricity prices means that many energy producers are losing money, Vazquez said.

 

 

“The bottom line is the energy supply is structurally in a deficit position, which increases as we approach extreme weather, either summer or winter…As a result, energy supply is curtailed to high-energy consumption industries such as aluminum,” Vazquez said.

 

 

The situation is then compounded when aluminum production ceases to be profitable at a time of low prices.

 

 

Some smelters in the U.S. and Western Europe are also no longer profitable, Vazquez said. Excluding China, Harbor estimates that the average cost of production around the world is $1,950.

 

 

“That means 50% of the capacity outside China has production costs above $1,950 and the other half has production costs below $1,950,” Vazquez said. “So if we now are trading at $2,070, that means at least 25% of production outside of China is under water.”