Is Rio Tinto Changing Its Aluminium Strategy – Again?

After agreeing last December to sell the Dunkerque smelter in France  many have seen the move as Rio Tinto’s desire to continue to divest its non-core parts of the aluminium segment – much like BHP Billiton did – such as Pacific Aluminium division’s assets in Australia and New Zeeland, and the ISAL smelter in Iceland.  Moreover, Rio Tinto has been considering the full or partial listing of Pacific Aluminium the Australian Securities Exchange (ASX), as a method for divesting itself of the division, according to a report in the Australian Financial Review.

Amid this media speculation, Rio Tinto’s CEO came out in early February with something quite surprising that poured cold water on rumours regarding the fate of Pacific Aluminium. The world’s second largest miner now believes Chinese reforms could mean aluminium markets have reached “a turning point”. Rio Tinto’s CEO Jean-Sebastien Jacques said that Rio is primed to invest in aluminium growth projects as China’s sweeping restructuring of its capacity takes shape. “I have no doubt that medium and long term, China will re-engineer and restructure the aluminium business to be much more balanced in terms of supply and demand. Demand is not an issue; the only question is about supply and all the signals for the long term are moving in the right direction. This could be a turning point for the aluminium industry, for which we are uniquely positioned with our 2.3 million tonnes/year hydro-powered Canadian smelters, “added Jean-Sebastien Jacques.

Mr. Jacques says China could provide a further boost for Rio’s fortunes and the mining industry in general because of the budding the electric vehicle revolution, as well as Beijing’s big-spending Belt and Road initiative.

The statements came only some ten days after this author wrote in these pages about Rio Tinto, explaining that it was not the right move for Rio to sell part of its aluminium segment, by drawing parallels to its fateful acquisition of Alcan in 2007. Jacques’ about-face is more than obvious.

However, when asked whether Chinese reforms were changing the outlook for Rio’s Australian smelters, Mr Jacques said: “All our assets are for sale at any point in time, it is only a question of value … If somebody comes and offers the right value for Pacific Aluminium, we will look at it,” he said.

There are three new major developments that could decide the future of Rio Tinto’s aluminium business, above all else Pacific Aluminium. Other than the aforementioned developments in China, there are ongoing efforts to solve the electricity supply problem in Australia, as well as a pending implementation of aluminium import tariffs in USA – and it’s unclear whether Canada will be exempted.

Let’s take it step by step and look at what Jacques’ remarks in more detail.

First off, what is the right value for Pacific Aluminium? Estimates of the portfolio’s value range from US$1.9 billion by Credit Suisse to US$3.9 billion by Macquarie Group. In such circumstances it is not likely someone would offer the top price, but at the same time, it is unlikely Rio Tinto would accept the lower price.

Pacific Aluminium’s assets at present include Australian smelters at Bell Bay, Boyne Island, and Tomago, and New Zealand’s Tiwai Point smelter, Queensland’s Gladstone Power Station, plus the QAL and Yarwun refineries.

Australia’s energy bills – going down?

Australia has been experiencing electricity supply blackouts during peak demand times in summers over the last several years, which has been reflected in rising electricity costs and has forced some aluminium smelters to reduce production last year. The situation improved markedly this year thanks to the 100 MW Tesla battery, installed last November. The Hornsdale Power Reserve (as the project is known) has dispatched power dozens of times since then, including injecting 100 megawatts of power in a split second when a unit at the biggest coal-fired power station in neighbouring Victoria tripped in December.

This is a huge relief for the Pacific Aluminium smelters and may be of key importance for their future, regardless whether they will remain under Rio Tinto’s umbrella or will continue as a separate company or under new ownership. In any case, the less uncertainty, the higher the value these assets will have. Especially when the current energy contracts roll off, the smelters will be in a better position to renegotiate long-term, competitive electricity supply contracts.

The China factor 

Thirdly, Jacques is especially interested in the developments happening in China. Despite its efforts to confront air pollution and reduce the production of aluminium during the winter months, China continues to add new capacity. According to the latest official figures, China produced some 3 million tonnes of primary aluminium in January, down 1.7% year/year, but almost 10% higher month/month. Over 4 million tonnes of new smelting capacity will be ready to start production by the end of the year, not to mention the partial restarts of curtailed production. However, a big part of new and restarted capacity will replace old capacity that had to be closed. Rising production costs may also prevent some smelting capacity to restart production, meaning production growth in 2018 may turn out much lower than previously thought.

As part of Beijing’s supply-side reforms, over 3 million tonnes of illegal smelting capacity were closed last year. Companies with legal but outdated production are entitled to replace their capacity with more modern facilities. Any capacity shut during 2011-17 that is not replaced by the end of 2018 will not be able to count as replacement capacity, the Ministry of Industry and Information Technology (MIIT) has said.

A couple of factors will however further reduce China’s capacity in the future and lead to a more balanced local market:

  • Rising inventories of aluminium in warehouses monitored by the Shanghai Futures Exchange, which reached record highs of over 800,000 tonnes in early February, compared with around 100,000 tonnes a year ago.
  • The recently announced U.S. tariffs on aluminium products,
  • Beijing’s continued efforts to curtail air pollution.

Section 232 – U.S. tax

U.S. President Donald Trump announced last week that the United States will impose tariffs of 25 % on steel imports and 10 % on imported aluminium. He will make a final decision on aluminium by April 11.

While the decision ostensibly aims to protect the U.S. steel and aluminium industry, it has produced strong opposition from consumers of the two metals in U.S. as well as from exporters from Asia and Europe. No doubt that such a tariff will increase costs for all American consumers.

The announcement shot the Platts US aluminum Transaction premium to 16 cents/lb (US$ 353/t), delivered Midwest, net-30 terms — almost a three-year high. One US trader told Platts he is now offering material at 19 cents per pound into the Midwest for March — up from a bid/ask spread of 14/15 cents at the end of February. He said this is “assuming he goes through with 10% from all countries.” The premium, or surcharge to get immediate delivery of metal from warehouses, surged to its highest level in three years.

In the first 10 months of 2017, the U.S. imported more than 5.7 million tonnes of primary aluminium and aluminium products, a rise of 18 % over the same period in 2016, according to the U.S. Commerce Department. Though the DoC stated that Canadian aluminium is vital for the U.S. defence industry as “the U.S. and Canadian defence industrial bases are integrated,”  President Trump shot back saying that there would be no exemptions. Moreover, in a tweet, he claimed that a trade war would actually be good for America.

So lobbying by Rio Tinto and Alcoa for Canadian aluminium tax-free exports may come out fruitless. Regardless of it, even with an import tax of 10%, Rio Tinto would still reap more benefits than losses in future. Why? Because the higher all-in aluminium price (LME+premium) in U.S. will more than compensate for the costs of an import tax. Moreover, due to higher production and exports levels, coupled with lower cost, Rio Tinto’s profits may substantially increase in future – tax or no tax. Finally, a substantially lower tax on aluminium imports than on steel may even favour aluminium at the expense of steel in future applications even more, especially in automobile industry.

Rio Tinto recently announced plans to ask the Quebec government for certificates of authorization to double the production capacity of the Arvida plant, which uses AP-60 technology for the production of 60,000 tonnes/year, out of total 232,000 tonne/year, employing 1,000 workers. It would be an investment of around US$ 100 million. Canada delivered 2.46 million tonnes of primary aluminium to the US last year, accounting for 50.4% of all US imports.

Conclusion

As this article went to press, it was also announced that Norway’s Norsk Hydro made a US$ 345 million binding offer to buy Rio Tinto’s aluminium smelter ISAL in Iceland. The Icelandic plant delivers 230,000 tonnes of extrusion ingot used in the European construction and transport sectors, from a newly built casthouse. The offer also includes Rio Tinto’s 53% stake in an anode facility in the Netherlands and its 50% stake in an aluminium fluoride plant in Sweden.

Were the deal concluded, it would mean that the agreement had been negotiated earlier, before Rio Tinto came to this “turning point” strategy. It would also mean that rising electricity costs in Iceland (ISAL is currently paying around US$ 34 /MWh) are the main reason for divesting the smelter, something that Rio Tinto is obviously not ready to tolerate despite expecting more favourable market conditions in future.

Rio Tinto said that its aluminium division posted US$ 1.58 billion in earnings in 2017, the highest since the ill-fated Alcan acquisition. The bulk of those earnings came from Rio’s Canadian smelters. Operating profit (EBITDA) was US$ 3.42 billion, compared to US $ 2.34 billion in the year before.

Lower production costs in second and third quarter (compared to the previous two), stable aluminium price (even somewhat lower during the summer but compensated with rising aluminium premiums in U.S.) will guarantee further profits in 2018.

Rio Tinto’ “turning point” could just as easily mean that divestment has just finished, capacity expansion is next.

 



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