Don’t Doubt China’s Determination to End Air Pollution

The LME aluminium price fell in June to its lowest level since mid-March as the market reacted to rising supplies and exports from China, as well as to lower output costs and higher inventories. The price decline (which this author predicted in a previous market analysis) came after speculative net long positions in aluminium were reduced for three consecutive weeks, putting further pressure on the LME price in June. However, aluminium and other base metals prices managed to recover by end of the month with Al price finishing the month at US$ 1897/t thanks to better than expected improvements in the China Manufacturing Purchasing Managers Index (PMI),  which climbed to 51.7 on June 30th. Together with a weaker US dollar, the mood of the industry improved markedly during the last two trading days of June.

“China is producing and exporting more aluminium. Rising stocks do not signal a tight market,” said Julius Baer analyst Carsten Menke. “Production costs have come down because coal prices are lower.” China’s aluminium exports have risen again in recent months. In May the country exported 460,000 tonnes of unwrought aluminium and aluminium products, up from April’s 430,000 tonnes.

For its part, the International Aluminium Institute (IAI) reported that the global aluminium production had grown by 3.5% year-on-year to 5.15 million tonnes in May. This was mostly due to China, where 5.6% more aluminium was produced. May also saw production expanded outside China, albeit only moderately. On a daily basis, global aluminium production fell slightly short of May levels, so the price response to the data was subdued.

Bank of America – Merrill Lynch stated that until uncertainty about China’s pollution crackdown policy is resolved through the second half of the year, there is a high risk that aluminium prices (and premiums) may give back some of the recent gains. BofAML ascribed this as the main reason for maintaining its third-quarter price forecast of US$ 1,700/t (77c/lb).

Constellium projects aluminium demand from aerospace will grow by an average 2 % over the next five years, about half of what it has seen historically. That compares with the 10-20 % annual growth rate it anticipates from the car sector in the coming years.

UBS Bank, whose analysts have just returned from China, is warning that aluminium bulls may be getting ahead of themselves, and says that illegal producers might be given amnesty for confessing and that their excess production may offset any supply-side restrictions. Investors hoping the incoming regulatory constraints on the aluminum market will result in a “coal-like” resurgence in the aluminium price are in for a rude shock, says UBS. As a reminder, when China ordered coal miners to run for 276 days (rather than 330), the industry obeyed, supply shrank, prices surged, and imports picked up.

“Some people we spoke to saw the whole self-reporting process as part of an amnesty project…That could lead to illegal capacity getting formalised and that would be less of a bullish picture for the aluminium price… We are a lot less bullish on the aluminium price after this trip.”

Analysts at Citigroup Global Markets Asia estimate that 3.1 million tonnes, or 8 % of total operating capacity in China, is without proper approvals, hence they expect more production cuts in the coming months.

In recent weeks, the falling aluminium price was accompanied by falling premiums. The trade appears to have lost momentum in the U.S. as the Midwest premium has slipped from its first-quarter highs above 10 cents-per-lb (US$ 220 per tonne) to a current 8.5 cents (US$ 187 /t), basis the CME’s premium contract. In Europe, premiums eased to US$ 75-80/t in Rotterdam, duty unpaid, down from US$ 100 -105 /tonne in the first quarter. Duty paid should stand around US$ 110-115/t in the last week of June.

The average aluminium cash LME price in the first half of the year was US$ 1880 /tonne. While it is not excluded that the aluminium price will fall below US$ 1800/t during the next two months, this analyst also expects it to surpass US$ 2000 /t by the end of the year. Why? China’s looming production cuts.

“Make our skies blue again”

As a reminder, earlier this year China’s environmental authority proposed to cut operational aluminium capacity by 30%, alumina by 50% and carbon by 50% in two municipalities and 26 cities across the four provinces of Shandong, Shanxi, Henan and Hebei during winter months. Based on the cuts over three months, the measures would reduce China’s total annual aluminium output by around 1.1 million tonnes directly, but due to alumina, coal, anode production cuts and lower power supplies, the final figure may come out two, even three times higher. The proposal involves the suspension of alumina production in three provinces (Henan, Shandong and Shanxi), which would affect about 50 % of running capacity, operations which account for about 28 Mt of the annual production, or 40 % of the nation’s total.

True, there is a lot of scepticism and uncertainty among analysts and industry experts whether Chinese authorities will implement proposed measures on capacity reductions to cope with air pollution during the winter months. However, this scepticism is unwarranted: China’s government cannot fail this time and has to prove to the rest of the world that it was serious when it announced mandatory production cuts.

After all, it is no longer a matter of someone’s decision, or of good will on the part of Chinese authorities. Above all, this is a matter of survival and of ensuring the health of the tens of millions of people living in the areas surrounding Beijing, where air pollution far exceeds critical levels during winter months (heating season). The high degree of industrial production in the area, and the accompanying emissions spewed into the air (PFCs, PMx, SOx etc.) are such that living conditions have become unsustainable.

Faced with this reality, Beijing has no choice but to act urgently and protect its citizens. As such, it must implement its so-called “blue skies” policy to the letter. The process is just beginning, and in following years the government is expected to deploy a wider spectrum of actions meant to prevent rising air pollution. Under these circumstances, any scepticism and uncertainty, currently dominating among analysts, can only be deemed groundless.



4 Comments

  • Paul Adkins says:

    Goran,

    I enjoy your writing and your analysis is usually excellent. But I question one angle you presented.

    I admit I am one of the skeptics you mention, but your logic for why Beijing will go through with the cuts is not sound. You state that the Chinese government has to prove to the rest of the world that they are serious, and that it is for the best for their citizens. These are noble reasons but no motivation. The Chinese government really doesn’t care what the outside world thinks. And if they were serious about looking after their citizens, why only apply the edict to 4 provinces?

    The government has form in this regard. It is very good at issuing edicts, but not so good at policing them. In 3 waves of environmental inspections over the last almost 12 months the inspectors did not close a single smelter. Only the local governments closed some small capacity to avoid going to jail.

    The affected smelters have no reason to support the cuts, and will lose millions of dollars if they do. But they aren’t the only losers – the local governments themselves will lose VAT revenue, and will be reluctant to support the cuts. Any excuse to grant an exemption will be explored. In particular Hongqiao is the most severely affected by far (800kt of the 1.1mt) and now that they have the extra $3 billion debt, they will fight to stay open.

    All the above is speculation on ny part, but the salient point is that hard-nosed analysis doesn’t rely on what should happen. In the absence of hard evidence, recent form is the next best indicator, and that’s why I am skeptical.

    Paul Adkins

  • Goran Djukanovic says:

    Thanks Paul, for expressing your view. To be honest, I didn’t think of you, didn’t know you are a sceptic on this, and didn’t read your statements recently (somehow I don’t see them on Google news).
    Actually, I do really think that Chinese government is serious this time and it will prove to the rest of the world (USA before all) they are determent. Otherwise they would risk further actions by USA and WTO to protect their interests when it is about China’s exports, both aluminium and steel.And exports will continue till ever there is a surplus in China and production growth. It can’t simply last forever, once must slow/stop. Air pollution is a nice, elegant way to make a move in that direction and reduce /limit production. And to protect the health of citizens by the way, in the same time.
    The level of industrial production in the area, and consequently emissions in the air (PFCs, PMx, SOx etc.) is such that the atmosphere can not accept it any more, it is saturated, making living conditions impossible during the winter. In other provinces it is still affordable pollution (not critical) which doesn’t mean they will be a subject of similar measures very soon.So my point is, for these two main reasons, that it is not any more matter of local interests, as before, this time Chinese government and environmental authorities will have to act. And it will be very visible.
    Because of all, I can’t agree that ‘’the recent form is next best indicator’’ and I believe this time will be different. Maybe not all as promised and announced by there will be actions and results.
    And finally, maybe the only risk for actions, only what can make Chinese authorities frightened a bit and force them to think again and change the initial initiative (‘’soften’’ a bit) cold be such rare articles as my recent articles and statements, showing that consequences for the aluminium production might be much higher than initial calculation and expectations show, if measures are implemented completely. Without it, with only sceptics out and their opinion, the success and realisation of ‘’Blue skies’’ policy would be much more certain. Especially knowing China happens to surprise, make a move opposite of expectations of majority.

    So, let’s wait for November, December and see what will happen.

    Cheers
    Goran Djukanovic

  • Bruce Miller says:

    Canada does n9t need coal to produce Al. We use brute Hydro Power. Is our Aluminum cheaper to produce?

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