Dirty Metal – China’s Troublesome Tether Between Coal And Aluminium

Dirty Metal – China’s Troublesome Tether Between Coal And Aluminium

The year 2019 has been a red-letter year for the aluminium sector in the People’s Republic of China. Despite trade tensions, tariffs, reciprocal tariffs, environmental crackdowns, and all manner of price fluctuations across the entire spectrum of the aluminium value chain, the Middle Kingdom churned out a record volume of aluminium per day in June, cobbling together a month that saw 2.97 million metric tons of primary aluminium roll out of potlines. June’s per-day total of 99,000 metric tons of aluminium eclipsed the previous record high of 98,400 metric tons per day, achieved only half a year ago in December.

Though prices for aluminium spiked in May to CNY14,380 per metric ton, June saw the market fall by 2 percent, coming to rest below the CNY14,000 per metric ton break-even point that separates profitability from problem production. Ramp-ups at smelters in southwest China earlier this year have taken advantage of a corresponding fall in alumina prices to expand margins and keep producers of the white metal in the black.

Aluminium semis and unwrought products continue to burst forth from China’s shores as well. The year’s second quarter saw 1.54 million metric tons of aluminium product ship from China, a rise of 7.1 percent in annual and quarterly terms and just short of all-time record shipments. In addition, year-to-date volumes of aluminium product exports reached new highs, exceeding last year’s totals by 10.4 percent.

Mirroring aluminium’s boom this year is a similar bumper crop of coal. In a bid to stock up prior to a surge in demand over the summer months, China’s coal miners broke production records in June as well, bringing 333.35 million metric tons of the fossil fuel to the surface in June, exceeding the prior month’s production by 6.7 percent and rocketing past last June’s total harvest by a robust 10.4 percent. June’s total coal output brought the year’s production to date to 1.76 billion metric tons, besting the prior year’s opening six months by 2.6 percent.

Though June easily set coal production records, it may only be a prelude to even more dizzying highs, as Beijing has requested miners in heavy coal-production provinces Shanxi, Shaanxi, and Inner Mongolia to spin up production even further as well as signing off on expanded coal-mining capacity in an effort to get a step ahead of ballooning demand.

On the surface, the ready availability of coal is good news for China’s aluminium sector. Roughly 90 percent of the power used in the electricity-intensive production of aluminium in China is derived from captive coal-burning power plants. Though the country has made significant strides in more efficient production of aluminium, production of the metal has risen to a degree significant enough to overshadow the drop in per-ton coal usage. In addition, captive coal-fired power plants are granted a legal protection from the country’s environmental regulation regime, allowing such facilities to make power enough to not only run the plant’s aluminium smelting operation, but also enabling it to sell often significant quantities of surplus power to neighboring communities, undercutting power that may be potentially more sustainably produced.

Captive markets

The economic well-being of aluminium smelters in China is closely tied to the fortunes of its captive power plants. When Shandong province debuted a new fee schedule for captive power plants, shares of the province’s powerhouse producer and world’s biggest smelter of aluminium China Hongqiao Group Limited went into free fall, dropping shares by 8.5 percent in one day and pulling trading prices to never-before-seen lows. The fee schedule led to the demise of Aluminum Corp of China’s (Chalco) Shandong Huayu smelter and its 200 thousand metric tons per annum of production earlier this year as well.

The symbiotic relationship Chinese smelters have on their captive coal-fired power plants may be beneficial for those particular producers in the short term, but the ever-strengthening death grip is exceedingly bad news for the war against global climate change. According to a report issued earlier this month by UBS, meeting the Intergovernmental Panel on Climate Change’s (IPCC) goal of avoiding the dangerous 1.5°C bump in global average temperature, all coal-fired power plants must be shuttered by 2050.

However, as UBS painstakingly documents, current projections show that the world’s economy is nowhere near on track for such an outcome, with the last coal-fired plant on Earth expected to close in 2079. And as with most aspects of carbon emissions, as China goes, so goes the world. Prompted largely by global peer-pressure, Beijing began scaling back construction of new coal-fired plants in 2016, though the rationale given at the time was that of a desire to avoid oversupply. Despite the fact that a somewhat respectable number of projects have been given the ax in the intervening years, the total number of shelved and closed capacity was paltry in comparison with the country’s total coal-fired power capacity, which is estimated at around 1,000GW.

China’s transition to renewable power has fared little better, with coal’s expected market share dropping by only 8 percent by 2030. UBS’s projections make it abundantly clear that, should China fail to adopt a “red alert” stance and pare off 100GW of new coal-fired capacity thereby limiting coal-fired capacity to its cap of 1,100GW for 2020, the fragile hope of preventing a 1.5°C increase in global average temperature is all but lost.

Meanwhile, the ex-China aluminium trade has been instrumental in moving the global economy toward a less carbon-centered focus. Finding use in applications including wind turbines and electric vehicles, making inroads in automotive, construction, and aerospace applications due to its high strength-to-weight ratio, and becoming the choice material for packaging and other “disposable” uses due to its total recyclability, aluminium has proven indispensable in tapering down our reliance on less responsible materials. China’s actions (or rather inactions) vis-à-vis coal-fired power in the production of aluminium become even more galling in comparison with aluminium’s positive contributions elsewhere on Earth. Simply put, China’s insistence upon producing one of the most important materials for battling carbon use via carbon-intensive means is a stunning perversion of aluminium’s promise.

Not all is lost, however, as Beijing has within its reach several tools at its disposal for cleaning up its aluminium game. Among the most important is that of the Emissions Trading System (ETS). Though it is still in trial mode until at least next year, China’s ETS is expected to reel in the country’s aluminium sector at some point in the future. When Chinese aluminium smelters are drawn under the ETS’s umbrella, the plan will have those operating captive coal-fired plants pay a token penalty of about US$7 per metric ton of emissions generated by those plants. While fees as drastic as Europe’s ETS are unlikely to be passed (€23/tCO2), instituting a system with teeth and doing so in the very near future may well blunt the blows China’s aluminium sector has been inflicting upon overall progress on carbon neutrality.

Secondly, as UBS points out, Chinese banks should reassess their relationships with coal-fired power overall and enact a moratorium on financing coal projects. Though largely flying under the radar, this approach is not new nor particularly controversial. Scores of financial institutions around the world have already sworn off the financing of coal-fired power, including powerhouses like BNP Paribas, ING, and Deutsche Bank. Such a move is an easy win for the Chinese financial sector, as a mere half of one percent of its debt is tied up in coal-fired power projects.

In addition to pressure internally, outside forces are in a position to exert a significant influence on the problem of coal-powered aluminium smelting capacity. Perhaps the party in the best position to influence change is the United States. Though the Trump Administration’s Section 232 tariffs have done precious little to stave off the growing coal-powered overcapacity in the Chinese aluminium sector, Washington, D.C. continues to hold significant sway in Beijing’s decisions. The two governments continue to dialog over trade issues despite growing tensions, and, if coupled with a rescission of Section 232 tariffs, an agreement regarding overcapacity may still be within reach. Curtailing China’s runaway aluminium capacity is a win on multiple fronts, as a receding in the flood of low-cost aluminium over the rest of the world’s markets is likely to go far in reviving the struggling American aluminium sector.

China’s aluminium sector is at a crossroads, with the road to responsible power production on the right standing in stark contrast to the left-hand path of carbon-belching aluminium excess. Beijing is rapidly passing up chances to do the right thing and buy in to climate-saving power production. Fulfilling the promise of a carbon-free economy through responsible aluminium production and use is still possible for China, but only if the shot-callers in Beijing choose to act now.