The shiny side of Alcoa's results

Almost lost in the tide of disappointment that followed the release of Alcoa’s first quarter earnings earlier this week was the news that China plans to put on hold all planned new aluminium smelters in an attempt to tackle over-capacity and manage its energy consumption.

The disappointment in the Alcoa result was a lower-than-expected quarter-on-quarter five per cent increase in revenue, even though the group’s bottom line number – a profit from continuing operations of $US317 million was better than anticipated.

Of greater longer term significance, however, both demand and prices for aluminium and alumina are continuing to increase, with prices realised for the primary metal up 7 per cent between the December and March quarters and alumina prices up 15 per cent.

Moreover, prices, particularly for alumina (where 20 per cent of third party shipments are now set at spot or indexed to the previous month’s prices) are steadily moving away from longer term contract pricing.

China’s plan, which could affect $US11 billion of planned investment in new capacity, could be helpful to the fundamentals of the industry. China is already modestly short of domestic supply of aluminium and more materially short alumina and bauxite. Its existing industry is high cost and energy and emissions-intensive and China has been shutting down some of its existing capacity to try to meet energy savings targets.

Yet demand for the metal continues to rise. Alcoa is forecasting global growth in demand for aluminium of 13 per cent this year, with demand in China and India both growing at about 15 per cent. Alcoa’s peer, Rusal, is slightly more conservative. Late last month it forecast 12 per cent growth in China’s aluminium consumption this year.

With LME aluminium inventories at relatively low levels (Rusal says they represent about 28 days consumption) and China apparently removing some of the supply-side overhang, the fundamentals for a metal that has lagged the boom in other commodities are improving.

That is good news not only for Alcoa and Rusal but Rio Tinto, where the massive bulking up of its exposure to aluminium with the ill-fated acquisition of Alcan has remained a blot on its otherwise rapidly improving performance.

The efficiency of the big aluminium groups and the strong proportion of hydro-generated power within their smelting portfolios (which also provides some shelter from soaring energy costs) also augers well. With China falling behind its own emission targets it is less likely to be tolerant of coal-fired smelters operating at the top of the industry cost curve.

The shift towards market-related pricing – Alcoa says will take until at least 2015 to move its entire portfolio from contract to market-related pricing – is particularly pronounced in alumina, largely because China and other developing economies don’t have the integrated operations of the major producers and therefore have large and growing net short positions in alumina and bauxite.

Demand and prices for aluminium, alumina and bauxite are very sensitive to levels of global economic activity. The International Monetary Fund’s latest forecasts, issued last week, see global growth developing some momentum this year, but were qualified by the uncertainty over the impact of high oil and commodity prices.

If that growth does emerge and is maintained in 2012, as the IMF expects, however, the industry, savagely restructured during the financial crisis, might be able to finally put its recovery phase behind it and join the resources boom.