Oversupply stresses prices

The commodity cycle has hit the bottom, writes Kunal Bose. Prices of minerals, intermediate items like alumina derived from bauxite and metals are traded at multi-year low prices. The phenomenon has more than one explanation. The embers of 2008 financial crisis are still there. Greece’s financial crisis unless resolved quickly, as some central bank chiefs, including India’s Raghuram Rajan, fear could suck the world into a ‘Great Depression.’ Three-month aluminium with major applications in transport, construction, packaging, electrical and home appliances is trading on London Metal Exchange at below $1,725 a tonne and premium charged on immediate cash delivery in every market has collapsed.

For example, the US Midwest premium is showing some signs of stabilizing at around 8.50 cents a pound after four months of steady fall. Market participants are, however, uncertain about the immediate future course of premium. Look back at 2015 mid- January, US Midwest premium at 19 cents a pound was nearly a quarter of the exchange traded metal price of 80 cents a pound. Broadly, premium at any given point is decided by interest rates (speculation about future rates too), supply and demand scene and warehouse charges. What certainly now is having a bearing on premium is the LME reform saying warehouses with queues longer than 50 days will be obliged to deliver more metal than they bring in.

Common knowledge is much of the metal in LME registered warehouses and outside is on account of financing deals. Financiers benefiting from zero or near zero interest rate and low rent for warehouse space will sell aluminium forward immediately on acquiring the metal for a small profit taking advantage of steep contango, meaning future prices are higher than spot prices. Near-term aluminium price outlook remains discouraging what with China, which accounts for well over half global production of aluminium, producing metal at an annualized rate of over 30mt (million tonnes) in 2015. The rest of the world is too pushing a higher amount of metal year on year, thanks primarily to smelters in the Middle East and India. But their production growth rate here is moderate compared to China.

The problem is consumption rise is not keeping pace with supply. This is because demand growth in Europe is staying around 1% with Russian demand slipping by over 5%. Demand growth is negative in central and South America. The US is back in business with aluminium demand growing 3.70%. Like in production, consumption in Asia, thanks mainly to China continues to grow at a healthy rate though not as strongly as in the past. By policy design, China is moving away from high debt financed growth restricting annual advance of gross domestic product to just over 7%. This is leaving China with growing surpluses of aluminium like in steel which are pushed in the world market raising dumping concerns in the US, Europe and India.

Prices of intermediate chemical product alumina fed into smelter are basically derived in normal times from LME metal rates. In the further upstream bauxite selling price has a linkage to alumina refinery functioning. For both bauxite and alumina, Chinese imports remain an important determinant of prices. Before taking a look at their current and likely future prices, it will be in order to refer to the forecast of an extra global requirement of 95mt to 105mt of bauxite by 2020. This is based on the assumption that world aluminium demand will rise to 70mt in the next five years from 53mt in 2014.

Any numbers of infrastructure and construction projects across the globe have been put on the back burner because of difficult economic situation. Most of these and many new projects requiring large uses of aluminium will be launched coinciding with improvement in economic environment. 

Aluminium makers are confident that the white metal will find increasingly large application in cars as many countries following the example of the US, European Union and Japan are enacting laws restricting emissions by all kinds of vehicles. The answer to the challenge to improve vehicle fuel efficiency is weight reduction for which the preferred metal is aluminium. The good thing is that rolled products makers like Novelis are working closely with automobile companies, which is leading to increasingly wide application of aluminium in car bodies and engines.

Assuming aluminium demand will climb to 70mt by 2020, the challenge will be to know from where the incremental bauxite will be mined and also the places where additional alumina refining capacity will be built. There are many bauxite reserves in different parts of the world, as well as resources to be confirmed as reserves good for mining. What, however, remains a major challenge in opening of mines in abundantly bauxite rich nations like Guinea is costs and infrastructure deficit like road and rail linkage to ports. Opening a bauxite mine or a refinery will also have to pass the increasingly strict environment muster linked principally to ensure red mud disposal does not pollute streams and rivers.

Recall the celebrated case of Vedanta Group’s failure to open a bauxite mine in a nearly 100mt deposit in eastern India’s coastal state Orissa’s Niyamgiri Hills, mainly in the face of unrelenting opposition from indigenous Khonda tribe people. Fears of pollution of river water resulting from bauxite mining also had a role in derailing the project. Proper rehabilitation of people to be dispossessed from land in proposed mine areas is now a major precondition for bauxite project launches in India and elsewhere. NGOs are globally active on this front. Activists under the banner ‘Foil Vedanta’ held several globally eye-catching demonstrations in London first at Indian High Commission and then at the company annual general meeting during 2012/13 to stop the mining giant in its track at Niyamgiri.

China needs a great amount of alumina for its smelters which appear to be geared to make over 30mt of aluminium this year compared with 27.5mt in 2014. Two of the first steps that
Xi Jinping took on assuming office of President of the Republic of China in March 2013 were to combat pollution and end graft which often is the cause for environment damaging industrial plants to stay in operation. China’s ministry of environmental protection (MEP) recently came down hard on Sammenxia Yixiang Aluminium Company for its failure to pass environmental protection inspections for a 300,000-tonne alumina project. Not only has a fine been imposed on the company, MEP has made it clear that resumption of alumina refining at the plant will depend on its installing environmental protection equipment and convincing the authorities of environment friendly practices.

Over the years, China has made phenomenal progress in alumina capacity development and production of metallurgical- grade alumina. According to research and consultancy group CRU, China’s alumina production advanced to 51.6mt in 2014 from 47.12mt in the previous year. In the same period, consumption was up from 48.801mt to 55.402mt. But China is required to make imports to take care of local alumina supply and demand deficit. Even while last year’s deficit was 3.84mt, China considered it wise to import an extra 1.44mt. This was prompted by fear that Indonesian bauxite ore export ban from January 2014 might impact Chinese alumina production. Not an unfounded concern since Indonesia traditionally had an overwhelming share of Chinese bauxite imports. But as is Chinese wont anticipating the challenges of Indonesian ban, it

resorted to heavy imports of bauxite “stockpiling more than 60 weeks’ worth of imported mineral. The stockpile will come good to bridge expected supply shortfall between 2014 and 2016,” says a report. Ahead of the ban, Chinese bauxite imports, including from Indonesia soared to 72mt in 2013 from 43mt in 2012. Supplies drying up from Indonesia and massive stockpiling in the past 16 months saw Chinese imports down to 36.531mt in 2014.

A Mumbai-based trade official says “China negotiated the Indonesian export ban by showing uncommon alacrity in broadening base of import sourcing countries to nine in 2014 from four in 2011. Malaysia’s ascendency as a major exporter of bauxite has come as a big relief for refineries in China.” Last year China imported 3.217mt of bauxite from Malaysia. Now analysts are foreseeing the possibility of Malaysia where mining and port handling capacity is steadily ramped up despatching over 10mt of bauxite to China. Malaysian exports to China rising to 1.5mt in March and then in April to 2.065mt from a monthly average of 675,000 tonnes in recent quarters give credence to supply taking a major leap to the world’s biggest market this year. CRU says in a report, surge in Malaysian supply will be “tempering any potential growth on China CIF [cost, insurance, freight] bauxite prices.” Infrastructure at Kuantan port in Malaysia allows export of about 2mt a month. The other port Kemaman is too handling bauxite cargo in growing quantities.

While China will remain a big importer of bauxite to feed its refineries, its own production is forecast to rise 11.7% to 90.3mt this year with contributions coming from both mines part of integrated bauxite-alumina operation and third party mines at Shanxi and Guizhou. At the same time for long-term raw material supply security, hawkeyed China will remain engaged in spotting bauxite reserves anywhere in the world, including countries where infrastructure building like road, rail and port remains a precondition for mineral evacuation to ports for export. To give one example, Hongqiao Group of China is hopeful of closing a mining and port investment deal in Guinea that has potential to create a 10mt annual bauxite export.

Australasia for which China is a major market is likely to step up supply by 5.4% to 84.4mt. Asian countries excluding China will find supply rising 16.7% to 40.7mt, thanks principally to impressive Malaysian progress in opening new mines and expanding ones in operation. Whether it is iron ore or bauxite, Indian authorities do not favour export of high grades of mineral. But then India exported nearly 5.2mt of low grade ore to China in 2014. Based on export of over 2mt to China in the first quarter, supply from India in 2015 could be more than 8mt. African supply should rise 17.1% to 24.8mt this year. Improvements in supply from multiple sources will keep bauxite prices in check.

China realized early that, in the interest of profitable working of its aluminium industry, it should reduce dependence on imports of intermediate product alumina. During 2014, China produced 51.604mt of alumina while consumption by its smelters was about 55.50mt. Chinese alumina imports last year were 5.276mt.

Based on first quarter inflow of foreign origin bauxite amounting to 933,000 tonnes, China is likely to end up importing less than 4mt in 2015. CRU says alumina prices will remain under pressure on three counts: first, availability of surplus alumina in both the Pacific and the Atlantic; second, low aluminium prices working against the intermediate product; and third,“disappointing” Chinese demand.  
 
Primary aluminium at a crossroads in Brazil, as output falls, and imports rise  
 

With the cost of importing increasing amounts of primary aluminium now close to what exports of bauxite and alumina earn, executives say the industry is “at a crossroads”, writes Patrick Knight.

Having the world’s second-largest reserves of bauxite and being the third-largest manufacturer of alumina as well, it might be assumed that Brazil would also be a top producer of primary aluminium. This was the case 25 years ago.

But with the cost of electricity soaring, output has started to fall in the past few years, and Brazil is now a net importer of primary aluminium.

In the 1960s and 1970s, the military led regimes which ran the country for 20 years, encouraged the state-owned Vale mining company to build smelters both in the Amazon region, where much of the highest quality bauxite is found, and in Rio de Janeiro state.

International giants such as Alcan, Alcoa, and Billiton were also attracted to Brazil, where they built their own smelters, or were partners in projects with Vale. Brazil’s largest private company, Votorantim, then a leader in cement and other non- ferrous metals, also joined the industry. Votorantim’s mills close to Sao Paulo city were supplied with bauxite from its reserves in neighbouring Minas Gerais state.

To help the industry get established, the government also financed the building of the 4,000MWs Tucurui power station in the Amazon region, the largest power plant solely in Brazil and close to where the bauxite is found. Specially attractive rates were made available to the aluminium smelters. But the soldiers left power 30 years ago, and since then the situation has changed entirely. After peaking a decade ago, Brazil’s output of primary aluminium remained static for several years, but it has begun to shrink in the past few years.

The now privatized Vale has sold all its assets in the aluminium complex, and virtually all the other players have closed smelters, totally, or partly. The slow down in production has occurred despite the fact that demand for aluminium, used by the motor industry, for construction and packaging purposes, as well as by the fast growing oil and transmission industries, has continued to grow at an average of 5% a year. Demand has doubled to 1.5mt (million tonnes) in the past decade alone.

There are two main reasons for the change. In Brazil itself, successive governments have come to take the view that there is no good reason why aluminium smelters should pay much less for the electricity it uses than any other industry. This happened at a time when insufficient new low-cost hydroelectricity generating capacity was being added to meet fast-growing demand, and more expensive thermal power had to be used instead.

Demand has been spurred partly because of the increased purchasing power of up to 30 millions of consumers who have seen their incomes rise sharply in the past 20 years. Many more consumer durables of all types have been bought, notably air conditioning units which use large amounts of electricity. Periods of dry weather have also become more intense and frequent in recent years. Building large new, relatively low-cost hydro-electric power stations, which for decades generated more than 80% of the electricity used in Brazil, has not kept up with demand. The result has been that the country has been forced to depend increasingly on much higher-cost natural gas, coal, or even plants using fuel oil or diesel plants. This has pushed up the price of electricity for all consumers.

Another reason for the industry’s difficulties which has not been confined to Brazil, has been the surge in output of aluminium in China, which now makes ten times as much as Brazil. China’s huge output has helped push down the world price of aluminium to the point that numerous plants in several producing countries, notably those operated by the small number of international companies which dominate the industry, have been forced to cut supply, in the so far unsuccessful attempt to bring supply into line with demand.

Another factor in the decline in importance of aluminium in Brazil, is that the previously state-owned Vale company, was privatized 15 years ago.

Until recently, the only company to continue rowing against the tide in Brazil was the Votorantim giant, with sufficient capacity at its Sao Paulo complex of mills to make half a million tonnes of primary aluminium a year. Votorantim had continued to increase production each year, and exported about 20% of output.

But even Votorantim has now fallen into line and last year, the company was using only two thirds of its smelting capacity. To protect themselves against fluctuations in the price of electricity — which even when electricity prices were relative low, formed a third of the total cost of smelting aluminium, but more recently, has formed more than half — all the companies built some hydro-electric power stations of their own.

Several became up to 70% self sufficient. It might have been thought that this state of affairs, which partly shielded the smelters from the soaring price of electricity, would allow these companies to continue making and selling aluminium.

But with the world aluminium price continuing relatively low and with the electricity price soaring in Brazil because of the 

chronic shortage of power, selling their electricity to the grid or end users, rather than using it themselves, has proved more attractive.

While the price of electricity remains so high in Brazil, something which seems likely to continue for many years, the aluminium companies seem unlikely to re-start their idle smelting capacity, let alone add any new capacity.

Two successive years of severe drought in Brazil’s south east and also north east regions, have brought the country to within an ace of
being forced to introduce electricity rationing, which was forced a decade ago. The dry weather has forced de facto water rationing in many towns and cities, prejudicing much of industry. The dry conditions are continuing, and some worry that they have been at least in part caused by the de-forestry activities in the Amazon region, so could persist for many years, of not for ever.

The past few years have seen demand increase by an average of about 5% a year, with per capita consumption increasing from less than 5kg a decade ago, to 7.5kg last year. This is still far below the average in more developed countries.

Several years of prosperity, and easier access to credit has seen the number of motor vehicles made rise by more than 50%, to exceed three millions a year. The motor industry one of whose executive is now the executive director of Abal, the aluminium industry’s trade association, uses about a quarter of all the 1.5mt of aluminium used in Brazil each year. The construction industry, the second-most-important user along with packaging, has also grown steadily, as an increase in credit, coupled with rising incomes of a large proportion of Brazil’s 200 million population, spurred increases in home building. Aluminium is now used to make a third of all window and door frames, as well as numerous other fittings previously made from wood or steel.

Although the world economic slowdown has fed through into a slow down in all these industries in Brazil, demand for aluminium is expected to continue to grow to the point where Brazil will be obliged to import up to 3mt of primary aluminium a year, in a few years’ time.

Industry leaders says the smelting industry is at a cross roads. It will soon be too late to re-start the idle smelting capacity.

But while the government continues to turn its back on the primary smelting industry, demand for both bauxite and alumina from Brazil, continues to grow strongly .The result is that coupled with increased revenues from the sale of electricity, strong earnings from the sale of bauxite and alumina means the financial state of all companies in the industry remains extremely strong. Although the leading producer Votorantim, in common with Alcoa, is cutting output of aluminium,Votorantim is to build a large new alumina manufacturing plant in the Amazon region, which when complete will add 3mt to Brazil’s current 11mt alumina-making capacity. Alumina made by Votorantim in the 

Amazon will cost less to produce, and should also be cheaper to transport to Votorantim’s mills in Sao Paulo, than that from the now elderly, and relatively high-cost mines in Minas Gerais state. Bauxite from Minas travels to Votorantim’s mills by rail, with a train carrying the mineral passing through the congested centre of Sao Paulo city every afternoon. Alcoa continues to invest at its multi billion dollar Juruti bauxite mine on the main Amazon river.

The export of bauxite and alumina together now earn Brazil a hefty $2.5 billion dollars or so each year. But with imports of primary aluminium now rising steadily, the cost of imports will soon exceed industry export earnings by a growing amount. This will present governments with a dilemma, and perhaps force officials to re-think the countries policy for primary aluminium. After running a healthy trade surplus for 15 years, the trade balance has moved into the red, and the growing import of aluminium, is one of the reasons.

A further complicating factor in the equation for aluminium, has been the fluctuations of the Brazilian currency against stronger currencies such as the US dollar in which the price of aluminium as well as bauxite and alumina, are set.

Brazil’s currency was overvalued for many years. With interest rates set high to attract foreign investors, the country became a haven for ‘hot’ money. The strong currency resulted in imports, including of primary aluminium, cheaper than they would otherwise have been. But the strong real also made Brazil’s exports, including those of bauxite and alumina, more expensive than those from competitors.

This situation has now changed, so imported goods have become more expensive, while Brazil’s exports have become more competitive.

Because it could not be denied that insufficient primary aluminium was now being made in Brazil to meet demand, which meant that what was available was sold for very high prices, the users of aluminium, notably in the motor and construction industries, persuaded the government to scrap a 6% import duty on aluminium last year.

But the soaring costs of imports may encourage the government to look again at what the long term future of primary aluminium in Brazil should be.