The last twelve months have seen an incredible comeback in the aluminium market. Thanks to sweeping fundamental changes in the way aluminium is produced and consumed, the metal has rocketed from lows of $1,700 to five-year highs, before settling around the $2,000 mark. But what caused such a remarkable turnaround, and will the forces that pulled aluminium back continue to strengthen the market in the coming year?
In 2017, the health of the global aluminium market was determined predominately by the smelters of the People’s Republic of China. As anyone who has even casually followed the aluminium market in 2017 well knows, capacity cuts carried out by Beijing over the past year have overshadowed the global market’s every move. Capacity cuts in the Middle Kingdom came from two initiatives – the culling of illegal aluminium capacity, and seasonal cuts made in an effort at smog reduction.
According to market experts, two factors should be taken into account when looking at the cuts enacted by Beijing. First, production numbers published by official sources have historically differed, often radically, from numbers published by independent, non-government numbers. However, according to most outside estimates, the production trend is following a downward trajectory. Current estimates show that from a high of 38.5 million in July, production in October dropped to 35.6 million tons per annum, and is expected to drop even further to 33-34 million tons per annum in the fourth quarter of 2017.
The second factor that calls for attention is the weak margins Chinese producers have endured. Although global aluminium prices have risen by around 23 percent through the end of November, the cost of inputs has risen as well, squeezing the profitability out of many of China’s aluminium producers. This fact has taken its toll on producers both within and without the 2+26 cities region, stamping out the majority of supply growth. As a result, inventories are likely to recede at aluminium warehouses across China.
At present, the lion’s share of aluminium smelters in China is not profitable. According to SMM, the average Chinese aluminium smelter is losing around CNY2,000 on each metric ton of smelted primary aluminium, which means that between 70 and 80 percent of the country’s installed capacity is losing money. Even though alumina prices have recovered slightly in the past several weeks, it still accounts for 23 percent of the Shanghai Futures Exchange price and 47 percent of the total cash cost of Chinese aluminium.
Of the inputs that have proven to be a limiting factor, alumina is perhaps the most critical. A scarce supply of bauxite ore, robust demand from aluminium smelters, cuts at Chinese plants, and intentional stockpiling at certain Chinese refineries conspired to push the price to a high of US$484 per metric ton in October. Prices have eased somewhat on account of 2+26 smelter cuts, but the price remains relatively high. Despite the increased availability of bauxite resources, cuts at China’s alumina refineries, which have been deeper in cases than those carried out at aluminium smelters, are likely to keep the market tight and prices high well into the coming year. At minimum, alumina prices are expected to remain at US$400/metric ton or better through to the end of winter cuts on March 15.
The cost and availability of thermal coal is also a limiting factor in China’s aluminium output. Supply over the past year has been problematic thanks to weather disruptions in Columbia, India, and Indonesia, and labor and transport concerns have hampered production in Australia. China’s domestic supply has faced a new and complicating issue in the form of increased influence on coal prices and production by central planners in Beijing. Market planners have striven to keep coal prices in a range between CNY550 and CNY750 per metric ton since early 2016. However laudable the goal may be, the execution has left much to be desired. As coal prices approached too closely to either limit, planners in Beijing have instituted the number of allowed run days or have forced disruptions to mine production under the auspices of safety inspections. Unfortunately for coal miners, such moves have largely been over-corrections in practice due to lags in implementation domestically and production ramp-ups abroad. All things considered, experts foresee a modest relaxation in coal prices in the next year. However, how great a factor this may play in boosting capacity restarts in 2018 remains up for debate.
In addition to a tightening of existing capacity, Chinese smelters have seen a reduction in new capacity as well. At present Beijing is only allowing smelters with explicit government permission or those who have purchased capacity from other smelters to augment their present output. By the end of 2017, 4 million metric tons of new capacity across 25 expansion projects is projected to come online, with Chalco accounting for 1.2 million metric tons per annum of that total. In the coming year an additional 3.2 million metric tons per annum in 18 projects is slated to be brought to bear, with around two-thirds of that capacity belonging to state-run firms. Expansion projects are expected to fall off significantly in 2019 and beyond, dragging down production growth as well. But since global aluminium demand is expected to grow by over 5% in 2018, prices will likely grow.
Overall, market watchers have largely taken Beijing at its word even if their numbers don’t always add up. What is most likely, they say, is that illegal capacity once shuttered will remain that way, and seasonal cuts will the rule going forward. That being the case, the expected production cuts are likely to fall within a range of 3.5 million and 4 million metric tons each year for the coming three years. Illegal-capacity cuts expected over the next three years in Shandong are expected to total 1.734 million metric tons per annum each year, followed by Xinjiang with 1 million metric tons per annum, and Inner Mongolia with 250 thousand metric tons per annum. Pollution-driven winter supply cuts each year for the next three years should total 198 thousand metric tons per annum at smelters in Shandong, 286 thousand metric tons per annum in Henan, and 38 thousand metric tons per annum at plants in Shanxi.
A significant external pressure on the Chinese aluminium sector comes in the form of duty regulations announced by the European Union. Such regulations pave the way for increased import duties upon Chinese aluminium, which is already facing a raft of duties from the United States government, with even more likely as ongoing investigations come to a close in 2018. These regulations also rest atop newly-announced duties to be levied on imports into Europe of rolled products and aluminium foil originating from China. Exporters from China spent the majority of 2017 taking their lumps from the governments of major trade partners objecting to what they consider to be unfair subsidies and trade practices and, as this year comes to a close, the likelihood of the momentum of this backlash tapering off any time soon seems exceedingly unlikely.
Despite a slight weakening in global aluminium prices, most experts believe the market’s fundamentals are solid. As the recent decline of aluminium at the LME is viewed by market watchers as merely a ripple due to SHME prices, the broad consensus among analysts is that the low prices of aluminium in China represent smelters operating deeply in the red, and that the invisible hand will inevitably correct for this aberration going forward. Broadly, the consensus places aluminium prices in 2018 within a range of US$2,033 and US$2,087 per metric ton of primary aluminium. With prices setting at US$1,700 per metric ton at the beginning of 2017, the metal’s recovery is impressive to say the least. And, as conditions in all corners of the globe are poised to remain favorable, there’s little reason to think that aluminium’s recovery won’t continue on through the new year.