Aluminium outlook improves on rising deficit

In 2007, the height of the global commodities boom, Aditya Birla Group Chairman Kumar Mangalam Birla and Tom Albanese, chief executive of Vedanta Resources chief executive and former chief executive of Rio Tinto, made landmark purchases of aluminium assets. Ignoring the advice of his colleagues at Hindalco, Birla acquired the 2005 Alcan spin-off Novelis, the world's largest manufacturer of aluminium rolled products such as can stock and industrial sheets. He knew there would always be money in downstream value-added products, unlike primary aluminium, which is subject to major price swings.

At $6 billion, the investment looked stiff. But Birla stands vindicated, considering the post-takeover working of Novelis and its high-end aluminium rolling technologies for application in automobiles, aerospace and packaging.

For Albanese, however, the $38-billion acquisition of Alcan on expectations the demand from China and other emerging nations would sustain the demand for metals turned sour, with the 2008 global financial crisis heralding the beginning of the end of the commodities super cycle. What Albanese didn't bargain for was China's relentless drive to build aluminium smelting capacity despite its growing dependence on import of bauxite, primarily from Indonesia, and alumina from Australia. The financial crisis did not prove a deterrent to Chinese capacity growth. The outlook for aluminium, beset with excess capacity and supply, became so grim that Rio didn't find a buyer for Alcan in 2011. By June 2013, when Albanese had to quit Rio for what was principally seen as his 'aluminium misadventure', Alcan assets bought in competition with Alcoa of the US had to be written down by about $25 billion.

Albanese now has reasons to feel good-aluminium, for long the worst-performing among non-ferrous metals, is faring well. The fact that Rio's aluminium business recorded a 26 per cent annual increase in earnings before interest, tax, depreciation and amortisation in the first half of this year despite metal prices at the London Metal Exchange (LME) averaging nine per cent lower comes as deliverance for Albanese. The current LME cash price of about $2,040 a tonne, with a record high premium of about $450 a tonne (the cost to secure physical metal), is indicative of the demand for aluminium continuing to be more than production, resulting in market tightness. For instance, global production of primary aluminium in the second quarter of 2014 was 13.285 million tonnes (mt), against an estimated requirement of 13.753 mt. In the first quarter, too, demand was more than supply.

National Aluminium Company Chairman Ansuman Das says in a trend reversal, the global physical market has moved into deficit territory, principally due to a revival in demand from the automobile and aerospace sectors. Car makers are turning to aluminium as a substitute for steel for a drop in vehicle weight, leading to lower emissions, a result of increasingly strict rules in the US and European Union, says Das. The construction and packaging sectors are also turning into major demand centres for aluminium. Resting of high-cost capacity both within and outside China and the lag of up to two years to get metal released from LME warehouses have also led to tightness in the physical aluminium market.

China, which has a high number of high-cost and polluting smelters, has reportedly decommissioned about two mt of capacity. Outside China, about one-mt capacity has been rested. This month, Alcoa will permanently shut a 190,000-tonne smelter in Australia.

At what point will capacity, which swings in and out of production depending on LME prices, be back on stream? Financial services group Macquarie says an "all-in price of about $2,500 a tonne will be needed to incentivise restarts of high-cost smelters". But the breakeven point for a significant portion of rested capacity is well above $2,500 a tonne. In any case, companies will not be in a hurry to restart closed smelters. Consensus is emerging that the metal will remain in deficit beyond 2015, despite new capacity being commissioned by Emal and Maaden in West Asia and Hindalco and Vedanta here. As for a rise in aluminium prices, the 12 mt of inventory outside China, including 4.91 mt at LME registered warehouses, will be a restraining factor. Hopefully, LME warehouse reforms will lead to faster delivery of the bought metal.