Bauxite's blistering pace

The bauxite door has opened again as the iron ore door closes.

Summary: A surge in ore demand from aluminium smelters has bolstered the price of bauxite, at the same time as excess supply has dampened the price of iron ore. Aluminium prices remain fairly depressed, but the ore needed to make it is definitely gaining ground – and that is adding to the coffers of Rio Tinto, one of the largest bauxite miners in the world.
Key take-out: While bauxite production will eventually catch up with demand, and ore prices will fall back, for now miners such as Rio are making hay while the aluminium smelter operators are shining.
Key beneficiaries: General investors. Category: Commodities.

Bauxite, the ore of aluminium, is not supposed to cost more than iron ore. But unless the current trend is reversed, a remarkable transformation could occur thanks to the price of iron ore falling and the price of bauxite rising.

The gap between the bulk ores is still large but the trend is significant, with the price of iron ore falling by 28% from $US135 a tonne at the start of the year to around $US97/t today and said to be heading for $US80/t, while bauxite has risen by 30% from $US50/t to $US65/t.

Looked at over a longer time period the trend is even more interesting, with iron ore down by almost 50% since its price peak of $US185/t in early 2011, and bauxite up by 105% since trading at $US32/t in early 2009.

For Australia’s big diversified miners, Rio Tinto and BHP Billiton, the shift in prices is a mix of good and bad news, not unlike a case of one door closing and another opening – with Rio Tinto the clear winner in that competition between the two arch-rivals.

A handful of smaller stocks, such as Bauxite Resources and Australian Bauxite, want to join the industry, not that it will be easy thanks to geological and chemical differences between bauxite deposits and the fact that bauxite is part of the even more complex and energy-intensive aluminium industry.

There is also a risk that the current spike in the bauxite price could fade just as quickly as it has arrived, thanks to it being largely the result of Indonesia’s ban on the export of unprocessed ore, the same government decree which has pushed the nickel price higher.

But there are long-term supply and demand trends adding to the price pressures that are driving bauxite up and iron ore down.

The problem confronting iron ore exporters is easy to understand, because their commodity has entered a period where supply exceeds demand, with the inevitable consequence being a lower ore price.

Bauxite, from a long-term perspective, is being driven by a combination of factors that include a worldwide boom in building aluminium smelters, particularly in the Middle East to make use of surplus gas-powered electricity, without the smelter owners ensuring sufficient future supplies of bauxite.

Excess smelter capacity has killed the aluminium price, and almost killed Rio in 2009 when it paid $US40 billion for Canadian-based Alcan, a world leader in aluminium production thanks to an abundant supply of low-cost hydro-electricity in Canada.

Despite a price recovery to around $US1.20 a pound in 2011, the aluminium price has been stuck at US80c/lb for the past two years.

The depressed price for aluminium is in contrast to the rising price of its ore, bauxite, and provides a useful indication of how the two commodities have separated because of the smelter-building.

Reaction to the bauxite and aluminium price changes can best be seen in the shuffle underway in Rio’s aluminium division, where the export of raw bauxite has become a more profitable business than its two-stage processing conversion, first by refining to alumina and then by smelting to aluminium.

Rio is also a beneficiary of it controlling the world’s bauxite resources that assay close to 50% aluminium. Bauxite mined in WA – home to Australia’s biggest collection of alumina refineries (three belonging to Alcoa and ASX-listed Alumina and one to BHP Billiton) – assays closer to 33% aluminium, but has the advantage of requiring lower temperatures for processing.

In north Queensland, Rio is expanding bauxite production at its Weipa mines, and is considering the development of a big new mine called South of Embley.

Across the Gulf of Carpentaria, Rio is in the final stages of mothballing one of Australia’s oldest alumina refineries at Gove because of rising energy prices.

The push to lift bauxite production for sale to third parties, particularly in China and the Middle East, was apparent in Rio’s March quarter report, which revealed a 5% increase in bauxite production but no increase in aluminium production.

In the management notes attached to the quarterly report Rio acknowledged record first quarter bauxite production and shipments to feed its Yarwun alumina refinery near Gladstone and for sale to third parties.

Deutsche Bank, in one of the first research reports to pick up the emerging trend to boost bauxite production, described what’s happening as “heading upstream”, a short-hand way of saying Rio would focus on mining in preference to refining because the profit margins are higher.

Not said in that report, produced earlier this month, is that bauxite mining is benefiting from increased use of the same automated systems which can be seen at work in the company’s iron ore mines, including driverless trucks and computer-controlled drilling.

“Rio Tinto is heading more upstream and will not be spending further capital in the near term on smelter projects after the completion of the Kitimat (Canada) refurbishment project,” Deutsche Bank said in the report headed “The aluminium division resurfaces”.

“Third party bauxite sales will increase from 20 million tonnes a year (currently around 50% of production) to 25 million tonnes in 2015 with the closure of the Gove refinery.

“The company has the option of increasing third party exports over the long run to over 30 million tonnes with the development of the attractive South of Embley project near Weipa, however we believe this project will not be approved until 2015.”

Bauxite exports will never rival iron ore as a profit contributor for Rio, but it is significant that the company is reverting to its roots as a bauxite miner in preference to processing thanks to the higher profit margins currently available.

Will they be available for long?

Perhaps not, because while Australia is the world’s biggest producer of bauxite, it does not have the biggest reserves. That title belongs to the West African country of Guinea where Rio already has a small investment in bauxite mining and is planning a much bigger investment in iron ore at the proposed $US20 billion Simandou mine.

Other investors, especially those with heavy aluminium-manufacturing capacity, are rushing to plug the hole in their bauxite supplies.

Last year, two Middle East emirates, Dubai and Abu Dhabi, announced a $US5 billion investment in Guinea to mine bauxite, convert it into alumina in that country, and then ship the refined material to the Middle East for smelting into aluminium.

Eventually, bauxite production will catch up with demand. In the meantime an almost forgotten part of Australia’s mining industry is enjoying a mini-boom.