Aluminum and the Self-Supporting Price Mechanism

A Reuters report last week advised that aluminum smelters were expecting increased power supplies this week as the authorities turned power supplies back on to a number of base metal producers. China’s monthly production of primary aluminum already rose 3.1% to 1.21 million tons in October, up for the first time in five months and the only base metal to see a monthly gain. Spot aluminum prices in China have risen over the last two months as they have done elsewhere in the world. They now stand at some 16,640 yuan per ton according to the report and a major smelter is quoted as saying with the cost of production around 15,500 to 16,000 yuan per ton, smelters are keen to restart production.

Klaus Kleinfeld, chairman and chief executive of Alcoa, is rather hoping they won’t. At the US producer’s Investor Day last week, he is reported as predicting China will curtail another 600,000 tons of aluminum smelting capacity before the end of 2010, on top of 700,000 tons Alcoa believe have already been shut down in an effort to meet national energy efficiency and emissions targets. Stating that the global aluminum market is now in balance and with demand growth resuming on a trend of 6.5% compound for the next ten years, Alcoa is clearly not expecting Chinese capacity to upset the party. In fact, Mr. Kleinfeld went on to say that not only was he expecting in excess of one million tons of capacity to be idled, but he did not expect it to all come back on stream next year, although it was not clear why.

If the previous report is correct and smelters are profitable at prices in excess of 16,000 per ton, why would they not restart idled production once power is made available? Only two developments are likely to get in their way: the first if power prices were increased further – raising the bar on the 15,500-16,000 per ton cost of production, and the other would be if global aluminum market prices fall as they briefly did, for example, at the end of October to $2300 per ton （15,250 yuan per ton） which would put them below the cost of production by the above measure.

A sudden flight to safety at the end of last week, fueled by fears of credit tightening in China and debt problems in Europe, specifically Ireland, led to a sell-off in metal prices as the dollar strengthened. If this is the start of a trend or merely a correction to a month of gradually strengthening prices remains to be seen; many analysts are expecting aluminum prices to be over $2500 next quarter, some suggest over $2600. If that is the case, the probability is much of the idled production will come back on stream just as soon as the power is made available. Conversely, lower prices due to currency and debt fears could have a limited downside if it results in Chinese smelters staying on the sidelines and potentially pushing the global market marginally into deficit.

–Stuart Burns