Manufacturers across Asia are being hit by surging aluminum prices, as smelter closures around the world and an overhang of more than 5 million tons of the metal stashed in warehouses continue to play havoc with the market.
Unlike many other commodities, traded aluminum carries an inbuilt premium, which is expected to surge nearly 50% to $370-400 per ton in the April-June quarter from $255 in the preceding three months. Analysts expect premiums to rise even further later this year.
Premiums, which come on top of the spot metal price, are the extra price paid for immediate delivery of the metal from warehouses. The spot price has fallen from more than $2,000 at the start of 2013 to about $1,760 late last month on the London Metal Exchange.
The hike in the premium — even as actual prices of the basic metal declines — is the latest surprise to hit the volatile aluminum sector, which has been tossed and turned since the global financial crisis erupted in 2008. The fact that the premium now represents about 20% of the total price of the metal, compared with 5% in 2008, underscores just how much the industry dynamics have changed.
“The market dynamics in aluminum have been crazy since physical reserves were backed up during 2009 and 2010,” said Paul Adkins, principal at Beijing-based aluminum consultancy AZ China.
The aluminum price for Asia — apart from that for China — is effectively set by negotiations between Japanese producers and such leading global producers as UC Rusal and Rio Tinto. The market for China, which will produce and consume approximately half the world’s aluminum this year, is virtually separate from the rest of the world.
A lightweight, corrosion-resistant metal, aluminum is one of the world’s most plentiful in its raw state and is used in sectors ranging from construction to automobiles to packaging.
But aluminum production requires two expensive and energy-intensive processes — refining and then smelting — to extract the metal from bauxite and other less-prevalent ores, giving it an industry nickname of “frozen electricity.”
In rough dollar terms, raw bauxite is sold at $50 per ton. It is then refined into aluminum oxide, or alumina, for about $350 per ton. After that it is smelted, the most energy-intensive of the processes. This costs producers about $2,000 per ton outside China and even more in China, where the cash cost of production is about 14,500 yuan ($2,359), Adkins said.
Total production, or supply, of aluminum and demand for the metal were reasonably well-matched last year, at 49.3 million tons. That figure is expected to rise about 5.6% this year to 52 million tons as the auto industry increases its use of the metal in car engines for environmental reasons, say analysts at investment bank UBS.
New rules on aluminum transactions, to come into force on April 1 from the London Metal Exchange, are poised to help accelerate supply, a move UBS expects will help rebalance the market.
The rules, designed to protect buyers and sellers in the same way regulations at stock markets do, will dictate how quickly metal can be extracted from warehouses — known as “load out rates.” The new rules are expected to shorten delivery times, which will mean larger volumes of aluminum will be shifted more quickly out of warehouses, according to industry representatives.
Figures from the London exchange show that there are 5.3 million tons of aluminum in warehouses. The metal is in two main locations — Detroit and the Netherlands, in addition to such places as Malaysia. The bulk of the aluminum stocks is owned by investment banks and trading houses, including Glencore Xstrata, JPMorgan Chase and Goldman Sachs.
Aluminum emerged as a physical store of value when prices plunged in 2008 from $3,317 per ton at the start the year to $1.492 in early 2009. At the same time, ultralow interest rates and general economic malaise meant that financing and warehousing costs became extremely cheap, allowing speculators to take advantage of low spot prices against higher 12-month forward prices; the difference is known as a contango.
From January 2008 to December 2009, warehouse stocks jumped from just over 1 million tons to 2.3 million tons and increased further to 4.6 million ton in January 2010, even as prices regained traction, rising to $2,267 per ton in that month. After that, aluminum stores and prices waxed and waned until 2013, when prices began sliding once more, falling close to $1,600 per ton before rebounding slightly.
Now, however, many experts, including Adkins at AZ China, believe aluminum prices have probably bottomed out. Adkins also believes, however, that the combination of the metal price and the premium will remain range-bound. In contrast, UBS analysts said they expect the price of the metal to come under further pressure.
A shakeout in the sector is already underway ahead of the new rules at the London exchange, with the closure of unprofitable refineries and smelters in Australia and South Africa and the cancelation by Rio Tinto of a $3 billion smelter in Parguay.
A further wrinkle in the market emerged in January when Indonesia delivered on its long-held promise to halt exports of raw metal ores in a bid to move up the value chain. In recent years, Indonesia has become the primary exporter of bauxite to China, but Jakarta enacted the law with the aim of developing the country’s processing capabilities.
The move has forced Chinese alumina producers, who have excess refining and smelting capacity, to build facilities in Indonesia. UC Rusal also plans to build a refinery there. But none of these facilities are ready yet, and China is thought to be pressuring Indonesia for a short-term exemption to the export ban. The situation, however, has been complicated by Indonesia’s legislative and presidential elections slated for mid-2014.
Buyers around the world can continue to expect a rocky ride in the aluminum market for at least the rest of 2014 and quite possibly even beyond that.