Chinese heat bends aluminium out of shape

Alcoa's decision to cut capacity further is the product of structural changes, fuelled by increased competition and falling demand in China, that are not going to go away.

Aluminium is the metal that missed the commodities boom and caught the bust. Alcoa’s announcement overnight that it was considering mothballing or cutting another 11 per cent of its global smelting capacity is further evidence of the industry’s struggle to come to terms with the structural changes in the sector.

Alcoa, which produces about 10 per cent of the world’s raw aluminium, already has about 568,000 tonnes of capacity idled, so if the latest review does lead to the removal of another 460,000 tonnes, nearly a quarter of its capacity will have been withdrawn from the market. It is also considering cuts to its alumina production, which could have implications for its local alumina joint venture partner, Alumina.

The announcement of the review and its likely conclusions contrast with the more optimistic view Alcoa had of the outlook for demand for the metal and for its pricing at the start of this year. It foresaw an acceleration in demand driven by a rebound in China’s growth rate – a rate which has since faltered.

Alcoa cited "persistent weaknesses" in aluminium prices for the latest review, saying prices had fallen more than 33 per cent from their 2011 peak. In fact, since their pre-crisis peak in 2008, they have slumped nearly 50 per cent and Alcoa’s share price by about 80 per cent.

Alcoa, of course, isn’t alone. The giant Russian producer, United Company Rusal, plans to cut 300,000 tonnes, or 7 per cent, of its aluminium production this year and permanently withdraw most of that capacity by 2015.

Rio Tinto has written off nearly $US30 billion of the value of its aluminium business, most of it relating to the disastrous acquisition of Alcan in 2007. Rio Tinto is still contemplating the fate – probably a spin-off of its Pacific Aluminium vehicle – of its higher cost Australasian aluminium assets.

In the lead-up to the financial crisis, demand for aluminium had been growing quite strongly – at a rate of about 8 per cent a year – on the back of surging demand from China. The crisis punctured the price but didn’t produce quite the structural response the big Western producers like Alcoa, Rusal and Rio Tinto, and to a lesser extent BHP Billiton, had anticipated.

The steep fall in the price should have pushed higher-cost production out of the market but didn’t. Chinese producers in particular, as well as smelters in the Middle East, continued to increase their output. Chinese production has roughly doubled since the middle of the last decade, to about 20 million tonnes, or nearly 45 per cent of the global production of the metal.

The increase in Chinese production in the face of tumbling prices could be seen as sub-economic behaviour effectively underpinned by subsidies of various kinds, and to some degree probably is. But lower energy costs, increased hydro-based generation and, increasingly, larger and more modern smelters located close to their own domestic bauxite resources have shifted the Chinese industry down the cost curve.

The fact that the Chinese are less fixated with the carbon intensity of their production than Western producers is also a factor in the shifting balance of power within the sector.

The reality for the big producers outside China and the Middle East is that their only rational response to the over-supply of metal is to reduce supply.

Rusal’s Oleg Derispaska has said he believes the industry needs to take about 1.5 million tonnes out of production over the next couple of years.

From the pre-crisis period global production has risen about a third and has out-stripped demand for the best part of a decade.

With China’s production still rising, that may not be sufficient to produce a better balance between supply and demand and firmer prices. There may have to be more restructurings, more writedowns and more closures of capacity if the industry is to be put on a more sustainable footing.

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