Will aluminum heed the lesson from last demand shock?

The increase was testament to producers’ ability to keep operating over the worst of the coronavirus outbreak in China.

Unfortunately, the same cannot be said of the country’s aluminum processing sector, which transforms raw metal into semi-manufactured products (“semis”) and which is only now limping back to normality.

The disconnect is becoming evident in surging stocks held in Shanghai Futures Exchange (ShFE) warehouses.

With end-use demand collapsed in key sectors such as automotive, the dissonance with rising smelter production becomes ever more striking.

Where China is today, the rest of the world will be tomorrow as the virus spreads.

The global aluminum industry has a terrible record of responding to demand shocks. It is still living with some of the inventory accumulated in the wake of the Global Financial Crisis a decade ago.

Will this time be any different? The early-year figures from China don’t offer much cause for optimism.

China supply bulge

ShFE stocks have mushroomed from 185,127 tonnes at the end of December to 519,542 tonnes.

That may be just the tip of the iceberg with more metal trapped at smelters by logistical bottle-necks.

A plea by China’s National Nonferrous Metals Industry Association for the government to step in and buy up unsold inventory in the guise of “strategic” stockpiling is a sure sign of sector stress.

So too is an eight-month suspension of ShFE fees for delivering metal to exchange warehouses, a step intended to “ease the financial pressure on market participants,” according to the exchange.

Total reported aluminum ingot inventory in China grew by 17% from 1.24 million tonnes on Feb. 21 to 1.45 million tonnes on March 6, according to Doug Hilderhoff, principal analyst for North American aluminium at research house CRU. (“Market View”, Aluminum Association, March 6, 2020)

“Stocks are expected to further increase throughout March but may peak in April when aluminum semis plants have fully restarted and have worked off inventory at the plants,” Hilderhoff said.

That, however, may amount to no more than pushing the supply bulge down the value chain if end-use demand in China hasn’t recovered by then.

China has historically exported domestic market surplus in the form of semi-manufactured products, which unlike primary metal aren’t subject to an export tax.

Exports of semis slid by 1.5% last year and slumped by 23% in January and February as China’s stringent quarantine measures compounded normal seasonal new year slowdown.

However, this might be the calm before the export storm if China’s growing surplus overwhelms end-use demand before Beijing can engineer a manufacturing stimulus.

Western contagion

It’s noticeable that the Shanghai aluminum price has fallen by 12% since the start of January, while that in London is down by “only” 6% at a current $1,652 per tonne.

The Chinese market is pricing in its current domestic supply surge. The non-Chinese market isn’t there yet.

But it may not have long to wait as the economic chill of mass quarantines spreads around the rest of the world.

The canary in the coal mine for aluminum producers is the rapid collapse of automotive production, a core end-use sector and one with complex, international supply chains.

Carmakers including Fiat Chrysler, Peugeot and Volkswagen cut production at European plants on Monday in the face of quarantine measures and imploding demand for new cars.

The last even remotely comparable shock was that of 2008-2009, when the automotive sector was a key transmitter of credit crisis to manufacturing crunch.

Western aluminum producers cut production by too little too late to prevent a surge in unsold metal stocks. The simultaneous collapse in credit markets saw that metal flood into London Metal Exchange (LME) warehouses.

Registered LME aluminium stocks rose from 1.17 million tonnes in August 2008 to 4.61 million in August 2009. The legacy has been long-lasting, not just in terms of the aluminium price but also in terms of the LME’s warehouse function, which has been distorted by the weight of all that metal ever since.

Under pressure

It’s true that the aluminum smelting process doesn’t make it easy to switch off a plant. It takes time and can cost a lot of money, particularly if long-term power deals have to be renegotiated.

However, Western producers should heed the warning of the last crisis. If run-rates aren’t curtailed voluntarily, the price will end up forcing involuntary closures.

The prolonged period of low pricing over the first part of the last decade left a long trail of smelter casualties, many of them permanent.

This particular demand crisis couldn’t have happened at a worse time for global producers.

Last year was a particularly weak one for global aluminum demand, which is estimated by Russian producer Rusal to have eked out minimal growth of just 0.1%.

The price was already under pressure and producers were struggling even before the coronavirus.

Alcoa announced in October last year a review of 1.5 million tonnes of smelting capacity. Magnitude 7 Metals, which brought the bankrupt New Madrid smelter in Missouri back into operation in 2018, is “in prayer mode”, according to chief executive Charles Reali.

The remaining seven operating U.S. smelters are high on the potential hit list if the international price starts following the Shanghai price lower.

That poses an interesting question of a U.S. Administration that has sought to preserve its domestic smelters by import tariffs.

One possibility, discussed by Citi analysts in a recent note, is for a hike in the tariff from 10% to 25%, matching that already levied on steel imports.

That would mechanically feed through to an 80% increase in Midwest U.S. aluminum premiums to around 25 cents/lb, Citi argues.

Even such a regional divergence, however, could only provide partial protection against a downturn in the global price from what are already margin-compression levels for producers.

The only way to avoid the mistakes of crisis past is coordinated global production cuts.

Don’t hold your breath.

(By Andy Home; Editing by Jane Merriman)