Where Is The Aluminium Market Heading?

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-China's export tax key to global aluminium
-Aluminium smelter costs heading lower
-Are Australian refineries pressured?
 

By Eva Brocklehurst

Chinese producers have called for the removal of the government's 15% export tax on primary aluminium. JP Morgan flagged this export duty as one of the bearish risk factors for aluminium prices earlier this year. While dropping the tax would be inconsistent with China's overall policy push against industry overcapacity in a number of commodities, and towards exports of semi-fabricated products, this particular call could potentially gain more traction on the back of producer arguments. A surplus of primary aluminium in China has weighed on the margins and cash flow of these Chinese producers.

The broker does not incorporate any change in export tax policy into forecasts but does believe that any potential reduction in, or removal of, the tax would have significant implications for global aluminium trade and prices. Outside of China, Chinese exports would alleviate the market deficit and weigh on London Metal Exchange prices and regional premiums.

The overcapacity in the global aluminium market has Macquarie looking at how energy prices have affected the cost curve. A general decline in energy prices, particularly coal, and appreciation of the US dollar are pushing down production costs while more energy-efficient technology is also helping smelters reduce costs by consuming less power. Globally, around 54% of smelting capacity uses thermal coal, 36% uses hydro electricity and 8% natural gas, with the remainder using nuclear or oil as a power supply. In Europe and the Americas more than 80% of aluminium capacity is backed by hydro electricity but Macquarie notes European smelters curtailed production recently to protest that environmental regulation was making electricity prices prohibitive. Low cost smelters in Europe, as long-term contracts become rarer and higher power costs are being encountered, have been moving further up the cost curve.

Macquarie suspects the centre of gravity for global smelting will move towards the Persian Gulf and Asia, where plants are currently more cost efficient. In terms of the decline in coal prices, this has already had a direct impact on aluminium smelters with linked power plants. Despite Chinese aluminium production coming mainly from power generated by thermal coal, the price of energy in China is regulated by the central government and the link between coal prices and the national electricity tariff is not efficient.

Macquarie notes Chinese smelters are countering this regulation with self-generating facilities. China's aluminium production that is supported by captive power supplies now accounts for around 30% of global production. In sum, coal is the deciding factor in saving energy costs in aluminium production and Macquarie suspects, while the market is not expecting energy prices to rebound soon, the overall cost curve is exposed to downside risk.

The supply shock created by the Indonesian ban on bauxite exports is supportive of both bauxite and alumina prices in the near term but Goldman Sachs does not consider, longer term, this level of market tightness is sustainable. The broker reviews the cash margin of the Australian alumina refining industry to identify those assets likely to come under pressure. Rio Tinto ((RIO)) made the decision in 2013 to improve returns by shutting down the long-running, loss-making Gove refinery and Goldman Sachs suspects Alcoa's Kwinana refinery may consider a similar strategy if it is unable to manage its power costs. BHP Billiton's ((BHP)) Worsley remains one of Australia's most profitable refiners and the broker expects investors will gain a much cleaner exposure to this business through the in specie de-merger that is proposed for South32 next year.

Rio Tinto manages its portfolio with a long bauxite, short alumina, long aluminium strategy, in Goldman's analysis. Replacement of Gove alumina exports with direct bauxite leaves the company well placed to leverage the strong, longer term demand for quality bauxite, in the broker's view. Alumina Ltd ((AWC)), through its 40% interest in AWAC, is well placed to leverage near-term strength in the alumina price but Goldman has concerns that normalisation of alumina prices and rising Western Australian gas prices could put around 20% of Australian production at risk.
 

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