China has been for long remained at the receiving end of global criticism for unrestrained exports of steel and aluminium and causing environmental injuries, writes Kunal Bose. The latter because of the country allowing the functioning of power guzzling ageing steel mills, aluminium smelters and alumina refineries in unrestrained ways. This is causing price distorting global surpluses. In both aluminium and steel, the world’s second-largest economy has half the share of world production. But unlike aluminium smelters in Canada, Europe and the Middle East using hydro or gas-based energy, the ones in China are fed with coal-fired electricity and, therefore, the industry there leave a big carbon footprint to the annoyance of the rest of the world.

Beijing is, however, no longer inured to world criticism of its industrial actions. The country’s president Xi Jinping inspires confidence as a reformer. Among his topmost priorities are elimination of corruption and ridding principal industries such as steel, aluminium and coal of polluting capacity in phases. Capacity elimination was attempted by the central government in the past too ahead of Xi coming to occupy the president’s office. But all that was largely frustrated because of machinations of bureaucrats and party officials at provinces.

In pushing through the crusade, Xi has the advantage that his writ runs firmly over both the communist party and the government. To the pleasant surprise of the rest of the world, China’s steel capacity elimination in 2016 was ahead of target. It now looks entirely possible that the targeted 150mt (million tonne) scrapping of undesirable steel capacity by 2020 will be achieved. Encouraging progress in decommissioning of coal capacity is also being made.

But what about aluminium, on which China is up for a major scrap with the US Administration? The Chinese government appears serious about forcing smelters to cut production during the winter beginning November and running up to March end. If pushed through, the move will potentially cut aluminium output by up to 1.5mt Aluminium prices got a leg up in the wake of China saying the smelters in four provinces surrounding Beijing would be required to slash production by as much as 30% during the winter heating season to support a campaign to fight smog and pollution.

At a recent industry conference in London, Lu Dongliang, a senior vice president at Chalco, China’s largest producer of aluminium, said the government was also earnest about coming down heavily on illegal smelters that could affect capacity ranging from 3mt to 8mt. It is, however, left to conjecture how much production will actually get killed by the proposed campaign. Giving an insight into possible aluminium industry restructuring following the government crackdown, Lu said there could well be a shift in smelting capacity from heavily populated areas to western China. “We already have some enterprises thinking of shifting capacity to western China where costs will be lower. But to what extent this happens remains to be seen,” said Lu.

But as hopefully production gets a cut during the winter and some capacity permanently eliminated, new capacity in excess of 3mt is said to be in the pipeline in China. Lu said Chinese aluminium capacity would climb to 45mt by 2020. He also said the use of aluminium would rise 7–10% in 2017 and 2018. According to a London-based analyst, even after all the talks about production discipline Chinese aluminium output in 2017 is heading for a rise of 7.9% to 34.4mt. Demand improvement in China will reduce surplus aluminium that brings pressure on the country to export, allegedly by breaching trade rules of the World Trade Organization. Excluding China the world remains either in balance or deficit in the metal. Whatever Beijing may be saying, worries remain about reduced capacity in China. But operators more often than not have the tendency to hang on to signals appearing positive. Vivian Lloyd, analyst at investment banker Macquarie says:“We have always been biased towards China capacity cuts story, but near term there’s loads of aluminium hanging around. There has been a big rise in Chinese exports.” What then naturally follows is falls in premiums to be paid on physical delivery. Premiums seen as an accurate measure of primary aluminium metal supply at a particular point vary from market to market. In a way, premiums reflect the competition between suppliers to get maximum prices and buyers the opposite.

The last five years have seen aluminium makers in Europe and North America dismantling smelters in attempts to cut surplus and boost prices. Industry leaders such as Rusal of Russia, Alcoa of the US and the Norwegian Norsk Hydro have all participated in cutting of capacity. That and also rising protests by smelting groups in the US, European Union and India about China’s predatory export pricing and skulduggery involved in faking primary aluminium as semis have built up pressure on Beijing to finally start talking seriously about production discipline. CEO of India’s Vedanta Aluminium Abhijit Pati says: “Even while the country’s aluminium use is growing nicely, imports mainly originating in China and the Middle East are meeting over half the local demand for the metal. As a result, a good portion of the Indian smelting capacity has remained idle.”

The export focus of Chinese smelters has shifted to semis (at least to make aluminium appear like that) as there is a 15% tax on primary aluminium. Beijing offers a 13% rebate on exports such as flat rolled products and tubes and pipes. Foils receive a 15% rebate. Like it has started doing in the case of steel where China has half the share of global overcapacity of around 700mt, the country should ideally encourage consolidation of smelter capacity as production cuts are announced to be made. Baowu Steel Group that in the closing days of last year emerged as the world’s second largest steelmaker after ArcelorMittal following the merger of Baosteel and Wuhan Iron & Steel is undertaking multiple market-based reforms, including eliminating uneconomic and polluting capacity. The merged entity has also announced to be in the forefront of steel technology innovation.

What Baosteel before merger was to Chinese steel industry, Aluminium Corporation of China, commonly known as Chinalco is to aluminium industry of the country. Chinalco and China’s second-largest aluminium entity China Hongqiao will have to be in the forefront of capacity consolidation that invariably leads to ejecting uneconomic capacity, overall production efficiency

improvement and cost saving. Aluminium has been among the best-performing industrial metals this year with its prices climbing from a low of $1,450 in late 2015 to close to $1,900 a tonne. Price improvements of the present kind allowing profitable smelter operation does not, however, create ideal condition for mergers and capacity consolidation. If anything, taking advantage of good prices, high cost ‘swing’ smelters tend to return to production. That once again sets in motion supply surge posing a risk to prices. In China where the government writ runs over business, the fate of consolidation will depend entirely on Beijing’s stance.

In the meantime, driven by the virtues of consolidation and ownership in downstream value added extruded products, Norsk is buying the 50% of Sapa that it does not already own in a cash deal that gives the latter an enterprise value $3.2bn. Sapa, an equal ownership joint venture between Norsk and the Norwegian consumer goods supplier Orkla, is seen as global leader in aluminium extrusions, which find major application in automobile and construction. Norsk says the merger to be completed in the current half of 2017 will yield synergistic benefits of $42m a year. In a comment on the merger, Norsk chief executive Svein Richard Brandtzaeg says:“[Whole ownership of] Sapa will enable us to assume global leadership, establish a platform for growth, and provide responsible operations and sustainable solutions for the future low-carbon economy.”

In the first quarter of 2017, Sapa had operating margins of 5.5%. But Norsk believes margins of Sapa operations for the year will be double that. Lex in the Financial Times says: “Norsk will need to spin a better tale on cost savings to justify buying Sapa at this point in economic cycle.” But mergers are attempted for deriving value over short, medium and long-term through economic cycles and substantial synergistic benefits. Take Indian aluminium group Hindalco’s $6bn buy of Novelis, the Canadian group specializing in value-added products finding application in automobile to packaging to construction and metal recycling, in 2007. Businesses of both Hindalco and Novelis have taken some major leaps since.

Great times are awaiting aluminium application in automobile as electric and hybrid cars are to cut a big profile in the automobile industry. Moreover, as governments in developed and emerging economies enforce increasingly demanding emission norms, vehicle weight reduction will lead to growing replacement of steel by much lighter aluminium. From luxury carmakers such as Mercedes,Audi and Land Rover Jaguar to mass market vehicles like Ford 150 pickup truck, aluminium is ruling the roost. Aluminium’s popularity with original equipment manufacturers for automakers rests on the tripod of light weight leading to better fuel economy for vehicles, good formability and high strength.

But isn’t a cloud hanging over aluminium and also steel as the US repeats the threat to invoke section 232 of a national security law passed in 1962 at the height of Cold War? The invocation can be made only when imports of goods are seen to be compromising national security. In this particular instance, the threat appears to be one way of pandering to the ‘America first’ groups of Donald Trump support base. Against the US trade sabre rattling is to be considered representations to WTO Goods Council by China and the European Union that section 232 tariffs would not find justification on national security grounds.

The thesis of commerce secretary Wilbur Ross is based on the premise that under pressure from imports, particularly from China but also from Russia and the EU, the American smelting industry has been reduced to a single entity Century Aluminium that is capable of making aerospace grade high quality aluminium alloy required for making combat aircraft. As his argument goes, the domestic producer is perhaps able to meet peacetime needs for aluminium alloys required in producing armour plating for military vehicles, naval vessels and combat aircraft. But the US will be vulnerable to shortages in the event of conflicts.

At a White House briefing, Ross said: “At the very same time that our military is in need of more and more of the very high quality aluminium, we’re producing less and less of everything, and only have the one producer of aerospace-quality aluminium.” The wide ranging investigation of imports by the US Administration will cover to what extent the country’s domestic aluminium industry is in a state to meet the defence requirements in conflict times and the effects of job, skills and investment loss on national security.

No doubt like in the US, aluminium producers in India and Europe have borne the brunt of low priced imports from China where bloated capacity has led to supply excesses over a long time. Reacting to the US trade salvoes, a senior Chinese industry official said:“Aluminium products imported from China are general products with civilian uses such as packing, roofing, road signs and consumer durables. None of these products has any bearing on national security.” In any case, as the official pointed out aluminium required for US national defence is less than 2% of total domestic consumption.

China is largely responsible for global aluminium overcapacity. But capacity created in recent times in the Middle East and India is also to be accounted for. Weaknesses in global economic growth impinging on demand till recently have also contributed to capacity overhang. In contrast to overbearing tone of US officials that all ills of domestic smelting industry are because of imports, three senior officials from Alcoa, Rio Tinto and Arconic Inc. have been judicious enough to recommend that a solution is to be found through engagement with China so that its surplus production stops hurting others. Unilateral trade actions will not be found conducive to solving the problems of the global aluminium industry.

Concerned about the fallout of unilateral actions by the US, more and more industry officials are suggesting that Washington should make a deal with the world’s biggest producer to find a solution to excess imports. Rio Tinto Aluminium CEO Alf Barrios observed:“I must say the recent statements from the Chinese government recognize the oversupply and offer some hope, I believe, the best outcome is a negotiated solution.”