Will 2017 Be the Year Aluminium Prices Reclaim Their Shine?

Will 2017 Be the Year Aluminium Prices Reclaim Their Shine?
Oleg V. Deripaska, President, RUSAL, Russian Federation speaking during the session: Energy’s Clean Transition at the Annual Meeting 2017 of the World Economic Forum in Davos, January 18, 2017 World Economic Forum / Greg Beadle

Oleg Deripaska, the president of Russian aluminium titan UC Rusal, addressed the Annual Meeting of the World Economic Forum in Davos on Wednesday. “Renewables are an excuse for some countries to use more coal”, he said, before arguing that “We need to implement a carbon price, let’s say tomorrow and maybe even escalate it a little to show a strong signal for people that it will be done properly.” Christiana Figueres, the former Secretary-General of the UN Framework Convention on Climate Change, echoed his comments, contending “there is simply no space for any new coal … we also need the early retirement of existing coal.” Total CEO and Chairman of the Board Patrick Pouyanné also chimed in, arguing “As long as we don’t have a price on CO2, there is no way that gas will overcome coal.

Indeed, although many countries have been making progress in developing renewables, the energy source’s inherently intermittent nature requires a consistent, dependable backup – just look at the damage done to Alcoa’s Portland aluminium smelter after the transmission network failed for just four hours. Since the aluminium industry is very energy intensive, moving beyond this deadlock hinges on implementing carbon pricing.

In a subsequent interview with Bloomberg TV on Thursday, Deripaska forecast that the price of aluminium to stabilize on account of steady demand and the People’s Republic of China following through on promised capacity cuts to reduce pollution. A recent Goldman Sachs is even more bearish on aluminium prices – citing domestic media, the investment bank contended that China may ax thirty percent of its smelting capacity in Henan, Shandong and Shanxi. Goldman goes on to forecast that, should Beijing follow through with the promised cuts, China’s annual production would drop by at least 2.5 million metric tons. The drop in capacity would be sufficient to move the aluminium market, which they forecast to be balanced in 2017, into a deficit of between 1.5 and 2.5 million metric tons, which is equal to between 2% and 4% of the estimated consumption for the year.

Assuming the deficit reaches 2.5 million metric tons, Goldman then projects worldwide prices will leap far above marginal costs. Cheap Chinese aluminium would go the way of the emperors – prices could rise to $1,750 per ton at present costs, and might still remain as high as $1,650 per metric ton at the end of the year.

In addition to voluntary cuts, China may face pressure from the WTO over the complaint filed by the United States alleging unfair subsidies to its aluminium industry. Should the WTO find merit in Washington’s complaint, and should China refuse to reign in even more capacity, Chinese aluminium could very well find itself on the receiving end of substantial import tariffs. This being the case, the pressure to cut capacity even further could be quite significant.

Goldman also notes the potential for supply discipline due to consolidation within China’s aluminium smelters. In 2007, the top five aluminium producers accounted for 35% of the country’s capacity. Since then, the industry has witnessed a significant increase in concentration – at present, those same five producers account for fully half of the country’s capacity (and one quarter of the globe’s supply). With consolidation to this degree, Goldman envisions a greater likelihood that producers will clamp down on supply growth when aluminium margins evaporate. They have the statistics to prove it, too: approximately 1.5 million metric tons of capacity in China was put on hold due to smaller margins. As for the current year, Goldman predicts that a portion of the 3 million metric tons scheduled to come online may be dropped if margins become slim.

A significant slice of capacity in China could be in jeopardy even without a squeeze on margins. Approximately 40% of the country’s capacity is operating at a loss at current prices. Even though over half of that capacity is state owned and difficult to close, the combination of supply-side discipline and weak margins may be enough to push that capacity over the edge. If nothing else, loss-making production will find itself upon the chopping block long before profitable capacity in most circumstances.

All things considered, the chances are strong for the aluminium market to make up the ground lost in recent years after commodity prices crashed. A squeeze in the coal market, supply-side reforms, the threat of trade sanctions, consolidation in the marketplace, weak margins – any one of these factors will likely push aluminium prices higher. As all of these conditions are either present or looming on the horizon, expect aluminium prices in 2017 to be the strongest in years.