Author Archives: Stuart Burns

The London Metal Exchange (LME) launched three new contracts this week — LME Aluminium Premiums, LME Steel Rebar and LME Steel Scrap, the first new contracts to be offered by the Exchange in more than five years.

You can now hedge aluminum physical delivery premiums using an LME contract. Source: iStock.

You can now hedge aluminum physical delivery premiums using an LME contract. Source: iStock.

The two steel contracts are cash-settled against physical Turkish scrap and rebar price indexes as opposed to the current steel billet contracts that are settled by physical delivery and have largely proved to be  a failure since launch.

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Why, we might ask, would these new contracts prove anymore successful? Well acknowledging the failure with billet, the LME has worked assiduously to garner industry support both in the shaping and specification of the new contracts. Goldman Sachs, for example, is on the LME’s steel committee and major trading firms like Stemcor have publicly stated they intend to be actively involved from day one, although they still add the caveat “subject to market conditions and liquidity.”

Liquidity was always a major issue for the billet contract. It never secured anywhere near enough interest from the trade to generate sufficient volume and, hence, a fair market price.

Rebar and Scrap

The steel scrap and rebar contracts will be traded on LME Select in small lots of just 10 metric tons making them more accessible for smaller market players, while, at the same time, the LME is offering discounts for volume trades to encourage liquidity. Read more

In honor of Throwback Tuesday, we are revisiting MetalMiner’s Top 50 posts with an eye toward illuminating what’s happening in metals today. #TBT This post, originally published Feb. 26, 2009, about the production of primary aluminum, is as relevant to the LME’s new aluminum contracts as it was to explaining aluminum’s price drop at the time.

Since the aluminum price on the LME dropped below $1500/ton, it has been repeatedly stated that some 60-70% of aluminum smelters are losing money.

What goes into producing aluminum? Source: Adobe Stock/Pavel Losevsky

What goes into producing aluminum? Source: Adobe Stock/Pavel Losevsky.

Electricity alone is generally accepted as representing about a third of the cost of aluminum ingot, although at what sales price that metric is judged is open to debate. We thought it would be interesting to explore what the true costs of production are for a ton of primary aluminum and thereby test to what extent the smelters’ claims that they are losing money are correct.

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As with the steel industry, many of the industry’s woes may have as much to do with low plant capacity utilization as they do with low sales prices.

How Much Does it Cost to Produce One Ton of Aluminum?

Although the newest smelters can be closer to 12,500 kWh per ton, let’s say most smelters are consuming electricity at 14,500-15,000 kWh/ton of ingot produced. With the LME at $1,300/metric ton, that means electricity should be costing a typical smelter $0.029/kWh.

Needless to say, smelters are rather coy about their power cost contracts so it’s hard to verify how prevalent this number is though many smelters are on variable power cost contracts with their electricity suppliers such that the power generators are paid a fixed percentage of the world ingot price. If we take that as one-third, then it’s not only smelters that are losing money – many power generators must be, too.

When US national average industrial and commercial electricity consumers are paying $0.0706/kWh and $0.1013/kWh, respectively, according to the Energy Information Administration, to be selling power to smelters at $0.029/kWh represents a huge subsidy. In reality, power costs to the smaller US smelters are probably higher than this and explains why many have been cut back or idled, but interestingly the same source gives specific power costs for the Pacific Northwest of only two-thirds the national average, suggesting that many NW smelters may indeed still be getting power at ingot-price-related levels.

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We wrote recently about the probability that coal assets would become increasingly uneconomic if climate change related legislation such as emission caps and carbon taxes heaped costs on the industry that have, so far, been avoided.

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Well, an article in the Financial Times gives a glimpse of the future as envisaged by Amber Rudd, the UK government’s energy secretary. Speaking to the BBC hours before a speech on UK energy policy, Ms. Rudd announced a major review of the subsidies the UK pays for electricity produced from natural gas in an effort to encourage the replacement of the UK’s coal-fired power stations with combined-cycle, gas-powered technology ostensibly with a view to reduce carbon emissions

Coal vs. Natural Gas

Rudd would say later in her speech that she wants all coal power stations to shut down by 2025. The UK currently produces 21% of its electricity from coal-burning power stations, but those stations produce some 75% of the electricity industry’s CO2 emissions. However, a third of these power stations are expected to close by 2016, so that they meet EU air quality legislation.

Coal cars may not be lining up in the UK soon. Source: Adobe Stock/Carolyn Franks

Coal cars may be a thing of the past in the UK soon. Source: Adobe Stock/Carolyn Franks.

Coal creates roughly twice as much carbon dioxide as gas when it is burned for power. According to another FT article this week, research presented by the American Petroleum Institute shows that in the 25 US states with the highest rate of carbon dioxide emissions from their power generation, switching completely out of coal-fired generation and into gas would more than meet their targets for reductions set under the EPA Clean Power Plan.

For once, where the UK leads the US may follow if the current administration can build a head of steam behind emission reductions following next month’s summit in Paris. We say “may” with caution though. The US coal lobby is infinitely more powerful than the UK coal mining industry and, with an export market dwindling fast, can expect to put up a fierce resistance to the suggestion coal-fired power generation should be abandoned en masse.

Auctions and Emissions

In the UK, Rudd at least recognizes it is not sufficient to heap emission limits on power generation and expect the industry to sort itself out, switching from coal to other options. A recent auction for peak power provision ended up set to hand hundreds of millions of pounds in subsidies to highly polluting diesel generators, which are cheap to build and can undercut the prices offered even by gas plants.

The auction process could be rebalanced to take emissions into account, but that would not, in itself, encourage the industry to invest in new gas plants. For that, the market needs a guaranteed price which only the government can provide, much as it did for a recent new nuclear power plant project. Investors just aren’t willing to make 25-30 year commitments in such a volatile wholesale electricity market as the UK.

No guesses who will end up paying the price of the governments drive to be the “greenest government” ever, as usually consumers will foot the bill for subsidies, but at least with natural gas they have plants capable of meeting base and intermittent peak load in a relatively less polluting manner and, unlike renewables, with total reliability of supply.

Aluminum producers are in a race to the bottom, desperately trying to reduce their production costs so they can maintain output and, by extension, continue to flood the market with metal that it doesn’t need.

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As UC Rusal’s third quarter earnings plunged 11% and it announced plans to cut a further 200,000 metric tons of capacity, US smelters have been closing capacity like the metal is going out of style, as we reported earlier this month.

Pile of aluminum bricks waiting for transport. Source: iStock.

Pile of aluminum bricks waiting for transport. Source: iStock.

But, if you think business is bad for western smelters, out in Asia it is almost worse. Japan is the worlds largest seaborne aluminum market, importing metal rather than using high-priced domestic power to smelt the metal at home.

Japanese Premiums Plummet

As such, the Japanese physical delivery premium has long been a benchmark for the supply-demand balance of the physical market. As in Europe and North America, physical delivery premiums in Asia have collapsed this year, with Q4 premiums just being fixed at $90 per metric ton, according to Thomson Reuters‘ Andy Home, recently.

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There is much debate about how much further copper prices have to fall. The LME Copper price dropped to $4,590 per metric ton on Tuesday and has recovered only slightly since. It is now at its lowest level in six years and, according to ThomsonReuters, some analysts are suggesting it could fall to $4,000 per mt, that is apparently Glencore’s worst-case scenario and the number they are cutting their cloth to live with as part of their ambitious debt reduction program.

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Not all producers are willing to join Glencore and make cuts. Bloomberg reports Codelco is saying it won’t cut copper production as prices slump. Speaking at the Metal Bulletin conference in Shanghai, Codelco’s CEO is quoted by the paper as saying he would rather rein in costs than curb output; noting that “if we suspend production then it’s difficult to restart.”

Goldman Sachs is Still Bearish

Goldman Sachs is quoted as saying the bear cycle in copper has years to run, predicting rising global surpluses through 2019. The growth in China’s demand will slow to 3% a year from 11% in 2013 as the government shifts the focus from investment spending to consumer demand and services as the main driver of the economy. Read more

In honor of Throwback Thursday, we are revisiting MetalMiner’s top 50 posts, including this one about one of the first vehicles designed specifically for emerging markets, the Renault Kwid. It’s become one of our most clicked and commented on since its publication last July. Happy #TBT!

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Priced at Rs 300,000 ($4,700) is it certainly pitched price-wise at the emerging markets and at first glance should prove popular in its first market, India, but also in other emerging markets in time such as Indonesia, Vietnam and others.

Emerging Auto Markets

The attractions are clear, all have massive populations, low per-capita car ownership markets with huge medium-to-long term potential. A Financial Times article explains that Renault had to start from the ground up in designing the Kwid to achieve such a low price.

They based the whole design team in Chennai, the city known as the Detroit of India – a first for a western car maker – using mostly Indian designers and sourcing Indian parts. The concept they say is frugal, innovation and required a completely new clean sheet approach.

Illustrating the problem, the FT quotes Navi Radjou, a management theorist in saying “companies don’t like to learn new things, to be blunt. They try to exploit their existing knowledge, not to rethink what they do from scratch.”

Why Automakers Miss

Western businesses see developing economies mostly as new markets where they can sell more of what they already produce. Those that try to come up with something new tend only to tweak existing offerings, which rarely works. GM and Volkswagen may well be cases in point, having poured millions into the market with limited success.

Even Indian firms get it wrong. Tata Motors‘ Nano was certainly cheap when it was introduced in 2009, but it flopped. Spurned, the article says, by rudimentary features and a poor safety record.

Screen Shot 2015-06-03 at 12.38.16

The Renault-Nissan Kwid, a crossover SUV that breaks the $5,000 barrier.

Renault’s design team has focused on what emerging market buyers place priority on, roomy interiors to accommodate large families, heavy duty air-conditioning to cope with summer temperatures and fancy navigation and media systems.

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Part of the reason China’s economy has slowed is as a result of deliberate policy actions taken by Beijing to steer it from investment-led, export-orientated manufacturing toward a model based much more on domestic consumption.

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The result has not been great for resource companies or economies around the world, but it will, in the long run, be a more sustainable model for China, and indeed for the world. China’s super-cycle was unsustainable in the medium- to longer-term, the sooner it was curtailed the lower the long-term fallout was likely to be.

But there is another reason investment growth has slowed, not just in China but in virtually all emerging markets and that is because the US and other mature economies have on the whole reined in quantitative easing.

An article in the Financial Times states that as the Federal Reserve has purchased US treasuries, driving up bond prices and driving down yields, banks and pension funds have taken low-cost loans from recipients of those treasury sales — the banks — and invested them in higher-yielding assets, mostly corporate emerging market debt.

Emerging Markets

By some measures, the article says $7 trillion of quantitative easing dollars have flowed into emerging markets since the Fed began buying bonds in 2008, and that is before adding in QE from the UK, Japan and, more latterly, the European Central Bank. The FT quotes Andrew Hunt of Andrew Hunt Economics when it seeks to explain where those funds have gone and the impact all that loose money has had on emerging market debt levels, and I quote in part as follows.

Source: Financial Times

Source: Financial Times

How QE Money Gets To Emerging Markets

There are two main routes by which QE money reached emerging markets. One involved the Fed buying US treasury bonds, as outlined above, which results in savers going in search of higher yields — such as in mutual funds buying corporate and emerging market debt. Read more

In the run up to the Paris Climate Change summit next month, there has been talk of stranded assets among fossil fuel producers. Coal, of course, is the front runner for a number of reasons, but principally because it is the most polluting major fuel under currently usable technology and, as such, the most “at risk” against carbon taxes or tougher environmental emissions legislation

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A recent IMF report states that the fossil fuel industry has been and continues to be subsidized to such a degree that simply ending what it estimates to be the industry’s current subsidies would cut carbon emissions by 20%. The IMF isn’t some academic institution whose conclusions can be easily dismissed, governments and the media listen to what the fund says and its policies touch us all in different ways, so when it speaks so clearly — particularly when it puts it’s weight behind a movement that is gaining momentum in the run up to December’s summit — it has an impact.

IMF Reports Costs of Coal Subsidies

The IMF claims the subsidies are largely made up of polluters not paying the costs imposed on governments by the burning of coal, oil and natural gas, according to an article covering the topic in the Guardian newspaper.

These include the harm caused to local populations by air pollution as well as to people across the globe affected by the floods, droughts and storms being driven by climate change. Leaving aside the global effects on weather, which are contentious both in their extent and effect, ending the subsidies (and therefore cutting consumption) would slash the number of premature deaths from outdoor air pollution by 50% — about 1.6 million lives a year — the report claims.

Of course it’s not as simple as that, such a massive swing from using coal for power generation and alternatives to oil for transport could not be achieved reliably in the short- or even medium-term, renewables are so variable in delivery and most power grids so inflexible they could not cope with a rapid switch but that would not stop the process, merely slow its roll out.

A High Cost

The IMF report estimates the subsidy at $5.3 trillion for 2015, making it greater than the total health spending of all the world’s governments, or put another way the subsidies represent 6.5% of global GDP.

Just over half this figure is the money governments are forced to spend treating the victims of air pollution and the income lost because of ill health and premature deaths. The article not surprisingly sights coal as the dirtiest fuel in terms of both local air pollution and climate-warming carbon emissions and says it is therefore the greatest beneficiary of the subsidies, with just over half the total. Oil, heavily used in transport, gets about a third of the subsidy and natural gas the rest.

Source The Guardian Newspaper

Source: The Guardian Newspaper

Not surprisingly, a large part of this is in Asia with the biggest single source of air pollution as coal-fired power stations and China, with its large population and heavy reliance on coal power, providing $2.3 trillion of the annual subsidies, the paper reports. Read more

While Copper slid to a new six-year low last week, there is some discussion about exactly why.

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Everyone can agree the market is oversupplied, demand has slowed in China, consumer of over 40% of the world’s copper and for Barclays believes China is partially responsible for the latest fall.

Barclay’s Note

Chinese demand is a big part of the problem. The WSJ printed, last week, comments from the bank’s most recent note to investors. “There’s over a million tons of additional supply coming online next year and the year after during a time when demand is seeming to stall,” said Dane Davis, a metals analyst with Barclays in New York.

“Not only are prices going to be lower, they will be lower for a sustained period.” Global copper output is expected to reach a record 22.89 million metric tons this year, while demand is expected at 22.4 mmt, according to Barclays, that’s some half a million tons of overcapacity. Production cutbacks by the likes of Glencore and Freeport McMoRan, however, should balance that excess but it is the extent to which this new capacity comes on stream that worries Barclays. Certainly, China’s consumer-price inflation decelerated in October, according to data released on Tuesday suggesting growth will continue to slow unless some currently unexpected stimulus measures are announced.

Source: WSJ

Source: WSJ

However, others disagree, saying the current weakness in the copper price has more to do with a bounce in the strength of the dollar. The dollar appreciated to its strongest level since April this week versus the euro and its highest in more than two months versus the yen after a Labor Department report showed US employers added 271,000 workers in October, the most this year. Good jobs data increases the likelihood of a December rise in Federal Reserve interest rates and the US Dollar responded accordingly. A stronger dollar makes all dollar-priced commodities more expensive for non-dollar economies suppressing demand and, hence, prices.

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There is more to it than just the dollar though. Although inventory on the London Metal Exchange has been falling it has been rising on the Comex and the Shanghai Futures Exchange, according to the FT. With some quarters predicting the dollar will hit parity with the Euro next year and be below 1.50 to the Pound by the end of this year, the pressure will remain on the copper price. Expect a rebound from recent lows, but it won’t arrest the trend.

The big meeting is due in December, the eyes of the world will be upon the assembled dignitaries, will they be able to reach an agreement and what impact will that have on the world? Are we talking about the 2015 United Nations COP 21 Climate Change Conference in Paris?

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No, we are talking about OPEC’s summit in Vienna on December 4. In the short- to medium-term the price of oil will have a bigger impact on the citizens of the world than anything agreed to in Paris. OPEC is facing a revolt the likes of which has not been seen since the 1970’s. Many members, indeed most members are at a breaking point and Saudi Arabia has been accused of running the cartel for its own ends against the wishes of the majority.

The club is coming apart at the seems. Algeria’s former energy minister, Nordine Aït-Laoussine, is quoted in the Telegraph as saying the time has come to consider suspending his country’s OPEC membership if the cartel is unwilling to defend oil prices and merely serves as the tool of a Saudi regime pursuing its own self-interest. “Why remain in an organization that no longer serves any purpose?” he is quoted as saying.

The International Energy Agency (IEA) estimates that the oil price crash has cut OPEC revenues from $1 trillion a year to $550 billion, setting off a fiscal crisis that has far-reaching consequences, particularly in the Middle East already riven with sectarian unrest and four civil wars.

The widely accepted aim of Saud Arabia, and a small band of Gulf partners, is to drive US shale producers to the wall and thereby choke off the threat to OPEC’s dominance. If that is the case the battle is proving much harder than was probably anticipated. So far US output has only dropped by 500,000 barrels per day but still stands at 9.1 million b/d, much as it did this time last year. True, there is only so long hedging can keep some producers in business or technology can reduce costs, but the US Energy Department expects a loss of only 600,000 b/d next year, far from a collapse and by then OPEC will have foregone another half trillion dollars.

As the Telegraph points out, the infrastructure and technology in the US remain in place even if some shale producers go to the wall. If oil price move back up to $60+ new firms will come into the market and production will rise again. The US shale industry has become the new swing producer whether Saudi Arabia likes it or not.

Another less well debated target could be to check solar and wind power the paper suggests, both of which are terribly price dependent. The oil price does not directly impact electricity prices but certainly has an indirect effect by its impact on natural gas prices often linked to the oil price and hence natural gas or LNG’s ability to compete with renewables. But the move to renewable is inexorable, driven in some quarters by politicians desire to “do the right thing” and in others, such as China, by the knowledge that more of the same would result in such a widespread health risk that civil unrest could be the end result.

Source: Telegraph

Which brings us back to Paris, the two summits are not unrelated.

Attempts to limit carbon emission have already reduced oil demand. OPEC forecasts that oil demand will keep rising relentlessly, adding 21 million barrels of oil per day (b/d) to 111 million by 2040 as if nothing will change.

Yet, car producers the world over are not pouring billions into electric vehicles to be trendy, they know the internal combustion engine is, in the long term, a dead end. Paris will hasten that trend and as if in recognition the IEA says oil demand will be just 103 million b/d in 2040 even under modest carbon curbs. It would collapse to 83.4 million b/d if global leaders really grasp the nettle. Rather than try to drive other supply sources out of business, the Saudi’s would be better off maximizing their returns for as long as they can, it is after all a finite resource, both in terms of supply and in terms of demand.

Source: Telegraph

Source: Telegraph

The crunch though may be none of the above but the gradually collapsing geo-political state of the Middle East, as governments struggle to maintain budgets in the face of the oil-related revenue collapse.

Most petro economies have become used to huge government largesse, austerity in the form of salary reductions, a break on new hiring, reductions in subsidies or welfare payments could result in unrest in an area not noted for its calm debate in recent years.

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Unhappy populations right across the Middle East are more likely to turn to extremism if there are no jobs or prospects. As the paper points out Saudi Arabia, itsel,f has suffered five Isil-linked terrorist acts on it’s soil since May, several of them targeted at oil installations, probably as the terrorist organization also has an eye on raising the oil price. Isil is largely funded by oil revenues and no doubt is also facing a drop in income as a result of Saudi Arabia’s stance. Saudi Arabia is playing a high stakes game, a game that if I were the halftime coach I’d be instructing the team requires a change of tactics in the second half.