Aluminum - Is There Light at the End of this Tunnel?

Aluminum price moves have lagged the other metals like copper and zinc both on the upside since 2002 and now during the period of global recovery, but have risen sharply during July.

 

Positive recent market events - restocking, rising scrap prices, regional shortages of available metal - have analysts forecasting the market moving from oversupply this year to a moderate deficit in 2010 setting the stage for a return to more normal market conditions and prices north of $1.00 per pound in 2010.

 Given the recent aluminum price action moving decisively from the low $.70’s to $.87 per pound over the last half of July and early August, it begs the question of whether there is finally the beginning of a turn in this very important metal market, and what can we expect going forward into 2010 and beyond.

 

What we have seen recently has been a 16% shutdown in global smelter capacity (6.4 Million tons), a flattening in LME inventory growth at a level of 4.55 Million tons, a 51% drop in U.S. metal service inventories from October 2008 peaks, a reported upturn in restocking at distributors, and China restarting 1.3 Million tons of capacity while the Shanghai Futures Exchange price spread over LME sits at $360/ton. China has shown discipline in not flooding world markets with metal in this downturn, and there is now evidence of an actual short term shortage of available metal in China evidenced by this price spread and widening premiums for metal from traders in Japan going into China. Expected imports from the West into China are projected to be 900,000 tons this year. Aluminum scrap prices have been edging up, depending on grade, by over 10% due to sharply reduced rates of auto scrapping. So far we do not know what will be the disposition of the approximately 600,000 tons of strategic reserves purchased by the Chinese Government in early 2009, but these could be held for years before coming back into the market.

 

For 2009 a global surplus of 1.2 Million tons of primary aluminum is expected, but China’s market is expected to be in balance, as reported by Alcoa in its Q2 earnings conference call. The alumina market is also expected to be in balance. Overall demand is forecast to decline by 7% this year but a number of analysts and producers expect it to rebound by at least +7% in 2010 paced by auto and aerospace demand, with a potential deficit of 400,000 to 1 Million tons. Average global consumption growth has averaged about 4% historically, which requires 1.5 Million tons of capacity be added annually. If there are few further smelter curtailments, it will take at least two years to work off the LME inventories to more normal historic levels. But the disposition of LME stocks all depends on who owns those stocks and what may be the motivation to sell them, so there is not a simple correlation with supply and demand. Witness the rising LME price and physical premiums around the world this year, at the same time as LME inventory levels have been increasing.

 

In terms of cost structure, at the price lows seen earlier this year, over 75% of the industry was operating below its cost of production, which was clearly unsustainable. However, the aluminum cost curve was lowered in early 2009 by approximately $650/ton due to significantly reduced energy and key materials input costs. Alcoa, for example, has announced it has already taken out $1 Billion in procurement costs on its way to $2 Billion by 2010 from reductions in caustic soda, pitch, coke, and fuel oil. Expect the secular trend of curtailing production to continue over time at the higher cost U.S. and European smelters in favor of expanding capacity where there is low cost hydro power like Iceland, Greenland, Russia, and Kyrgyzstan or low cost gas as in the Middle East.

 

The proportion of scrap to primary metal is steadily rising in the product input mix as recycling technologies are improving, producers are getting more creative in segregating internal and purchased alloy scrap in order to capture that cost delta, and consumers demand greater recycled content in finished products. India, for example, has lowered its import duties on scrap to zero in order to stimulate the use of more recycled metal versus primary to support the growth in demand.

 

In major end use markets, analysts are predicting a recovery in demand to 2007-08 levels by 2011. In Transportation markets, Aerospace is the bright spot as order backlogs remain high despite order cancellations, with a rebound expected in 2010 and moving above 2008 levels in 2011. Auto vehicle usage is forecast to rise in 2010/11 but still be substantially below 2008 demand. Truck/Trailer demand will remain low. Beverage Can Stock demand will remain steady with growth in beer offsetting declines in soft drinks. In Construction, Residential housing is expected to grow in 2010 but Commercial Building will continue to decline in this period so that overall Construction demand will rebound but will still remain below 2007-08 levels in 2011.

 

Aluminum prices have risen quite dramatically in just the past month. As we look to the end of 2009, further price gains to the $.90 to $.95 per pound level are expected and some analysts are forecasting a further rise to the $1.25 level in 2010 as the market moves into deficit. The long run forecast price is estimated by analysts to be $2,200 to $2,400 per ton or $1.00 to $1.09 per pound, the price required to support a 10% return on capital for a new first quartile smelter investment, so expect to see prices moving toward this level over the coming couple of years.

This author consults with leading institutions through GLG