Aluminum

The 3-Month LME aluminum price soars. Source: Fastmarkets.com.

Aluminum prices hit $1,900 per metric ton this week. Aluminum has surged 13% so far this year.

China Proposes Supply Cuts to Fight Pollution

We already predicted at the beginning of January that China’s supply would be the most important price driver to watch this year.

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In February, a Chinese government document proposed that about a third of aluminum capacity in the provinces of Shandong, Henan, Hebei and Shanxi be shut down over the winter months. If implemented, they would be some of the most radical steps so far to tackle air quality in the country of 1 billion’s most polluted cities. Read more

We warned last month that the mostly small losses the prices our MetalMiner IndX experienced were caused by investors taking profits.

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Our suspicions were confirmed when almost all of our sub-indexes had big price rebounds this month. The Automotive MMI jumped 12.2% Raw Steels 8% and Aluminum 6%. Even our Stainless Steel MMI only dropped 1.7% and has taken off since February 1 as nickel supply is even more in question now with both the Philippines and Indonesia’s raw ore exports in question.

The bull market is on for the entire industrial metals complex. Last month’s pause was necessary for markets to digest gains but the strong positive sentiment for both manufacturing and construction shows no signs of ebbing in the U.S. and Chinese markets.

One of the biggest social challenges facing the authorities in Beijing is that of environmental pollution. It’s not just the western media that is fixated by measures of particulate matter and images of impenetrable smog in Beijing, the general population has been moved to outright demonstration and the impact on the health of those living in the affected areas is an extremely serious issue causing widespread discontent. Beijing knows it must come to grips with this problem. Drastic action is required, and recent reports suggest the authorities are finally considering just that.

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According to CRU Group, the Chinese Ministry of environmental protection is consulting industry groups such as the China Nonferrous Industry Association about a proposal to shut down 30% of the aluminum smelting capacity and 50% of alumina refining capacity during the big winter heating period from November to March in an effort to reduce coal-fired power consumption. Rumous of this proposal contributed to recent rises in aluminum prices even though the impact would not be felt before the end of 2017 and there is still considerable debate on how viable such a policy would-be.

Shutdown Plan

The provinces in question are Shandong, Shanxi, Hebei and Henan, home to a significant portion of China’s aluminum smelting and alumina refining capacity. According to an article by Aluminum Insider, Shandong produces 11 million metric tons of aluminum per year, Henan turns out 3.8 mmt, Shanxi is good for 1 mmt, while Hebei puts out 100,000 mt a year. Those four provinces account for 37% of the country’s total output of aluminum. Shandong refines 23.5 mmt of alumina per year, Henan produces 12.6 mmt, and Shanxi produces 20 mmt each year, combining to produce around 78% of the country’s total alumina output. Read more

China is a top producer of aluminum, and its ongoing battle against pollution could lead to production cuts and, subsequently, skyrocketing aluminum prices.

According to a recent report from Reuters, the aluminum price rally could also potentially be offset by the oversupply situation. Any kind of extreme market fluctuation would be dependent on the Chinese government following through on the shutdown of aluminum-rich provinces during the winter months.

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“When the government in the past tried to implement measures to control production it wasn’t very successful,” Edgardo Gelsomino, research director at consultancy Wood Mackenzie, said. “The only time production cuts really happened in China was when the economics of the smelters didn’t work.”

Aluminum Prices Begin Year on a Strong Note

Our own Raul de Frutos wrote recently on exactly how much US aluminum prices and premiums can rise in 2017. Well, they started off the year strong. “While robust demand has supported aluminum prices, investors’ eyes have recently turned to the supply side of the equation. In December, China’s share of global aluminum output was more than 56%. The giant producer’s share of supply is now facing some serious risks,” de Frutos wrote.

He concluded: “In addition to higher aluminum prices due to supply cuts, we could see higher aluminum premiums due to the ongoing trade tensions, just as we saw the spread between domestic and international steel prices widen.”

How will aluminum and base metals fare in 2017? You can find a more in-depth copper price forecast and outlook in our brand new Monthly Metal Buying Outlook report. For a short- and long-term buying strategy with specific price thresholds:

In January, aluminum prices broke through the $1,800 per metric ton level. That was an important development signaling that bulls are taking over. Just a month ago we pointed out that prices had upside potential.

We believe the key this year will be on the supply side and not as much on the demand side. These are some factors that could limit growth in aluminum output this year:

Pollution in China

A recent Chinese government document proposed that about a third of aluminum capacity in the provinces of Shandong, Henan, Hebei and Shanxi should be shut over the winter months. That sparked excitement among aluminum investors. These provinces account for over 20% of global aluminum output.

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In addition, late last month the country passed a law that will allow it to impose environmental protection taxes from January 2018, following an outbreak of hazardous smog in northern China where many industrial producers are located.

The takeaway is that China is taking air pollution seriously. Given that coal burning is the biggest contributor to air pollution in China, industrial metals supply could shrink this year, particularly steel and aluminum. Environmental closures are looking increasingly likely in China this year. What’s still up in the air is how much energy-efficient capacity will replace shutdowns in dirty capacity.

Trade Barriers

The fight against imports is getting more serious and this is something that could support not only aluminum prices but also midwest premiums, which rose to $0.09/pound in January. Recently, the U.S. launched a formal complaint against the Chinese government with the World Trade Organization over subsidies it says Beijing provides to the country’s vast aluminum industry.

In addition, U.S. customs officials seized $25 million worth of aluminum linked to a Chinese billionaire accused of stockpiling the metal across the world. The move is the most potent action yet by federal authorities probing whether U.S. companies connected to Chinese magnate Liu Zhongtian illegally avoided nearly 400% tariffs by routing the metal through other countries.

The same combination of domestic environmental and foreign trade imperatives already forced China to get serious about steel capacity closures. Is it possible that we see a similar outcome in aluminum? Quite likely.

Rising Raw Material Costs

Many analysts argue that cutbacks in China won’t happen because aluminum prices are well above last year’s levels, when prices were trading at $1,450/mt. However, it’s important to note that production costs are well above last year’s levels, too. The increase in production costs will limit additional restarts this year.

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Chinese coal production dropped 10% last year. Thermal coal prices doubled and hard coking coal prices quadrupled. China also proposed to close 50% of alumina refining capacity in Shandong, Shanxi, Hebei and Henan from November to March. Alumina prices already rose by more than 50% in 2016. Further shutdowns are likely to support prices of the raw material this year.

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Our Automotive MMI took off in February, surging 12.2% along with strong gains in steel prices and all of the base metals in the automotive index saw gains in the first full month of 2017.

Hot-dipped galvanized steel was a particularly strong performer along with the catalyst metals, palladium and platinum. The tough talk about U.S. automotive production that President Donald Trump started during the campaign has only ramped up since his inauguration. Automakers could have to significantly alter their purchasing and supply chains if a border tax is enacted.

House Republican leaders have proposed what they call a “border-adjusted tax,” which would place a levy on vehicles imported into the U.S. and fully exempt those exported. Though Trump initially deemed the idea too complicated, White House Press Secretary Sean Spicer recently said it was under consideration and could help pay for a wall along the Mexico border.

An overhaul of the U.S. tax system could hand an advantage to Ford Motor Company, Honda America and General Motors, which rely the least on imported vehicles among the major automakers. The shake-up, if it is a border-adjusted tax, would clearly undermine Toyota America, which relies on shipments of RAV4 sport utility vehicles from Canada and Lexus luxury models from Japan, and deliver an even more damaging blow to companies with zero domestic production, including Mazda Motor Corp.

“The border adjustment piece of this is very intriguing for us,” Ford Chief Executive Officer Mark Fields told analysts after posting a $10.4 billion pretax profit for 2016. “The reason for that is we are the largest producer of vehicles here in the U.S. We’re a top exporter.”

About 79% of Ford’s domestic vehicle sales were built at home last year, according to researcher LMC Automotive, second only to the much smaller electric-car maker Tesla Motors. Honda ranks just behind Tesla and Ford, with 68% of its U.S. sales coming from domestic plants, followed by GM with 65%.

If the first weeks of the Trump administration are any indication, though, initial action on a tax plan could happen quickly via executive order and the lengthy process of legislation could be a post-executive order action plan.

January is typically the weakest month of the year for U.S. auto sales, and last month appeared to be no exception. Sales fell 2% to 1.1 million, according to Autodata Corp. Supply chain executives are clearly more worried about supply chains and a possible import tax this month than end-product sales.

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U.S. construction spending unexpectedly fell in December as investment in private projects rose marginally and public outlays tumbled, which could have an impact on the economic growth estimate for the fourth quarter.

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The Commerce Department said on Wednesday that construction spending slipped 0.2% to $1.18 trillion. Construction spending in November increased by an unrevised 0.9%.

Economists polled by Reuters had forecast construction spending gaining 0.2% in December.

Construction spending still increased 4.5% in 2016, but the rate of increase was less than half of its 10.6% surge in 2015. The government reported last week that GDP increased at a 1.9% annualized rate in the fourth quarter after accelerating at a 3.5% pace in the July-September period.

Our Construction MMI increased nearly 3% in February, as prices of both steel and aluminum products increased and buoyed the index. 73% Of construction firms said they expect to expand their payroll this year, according to survey results released Tuesday by the Associated General Contractors of America and Sage Construction and Real Estate.

Increased prices and general optimism about the infrastructure plans of the incoming Trump administration are contributing the overall bullish environment for construction metals. The steel sector, in particular, is suddenly a hot investment sector. Michael Tomera, head of PricewaterhouseCoopers‘ U.S. steel analysis arm, recently told me in an interview that, “There are momentum drivers here. If you look at liquidity, market conditions, infrastructure development in the U.S. with the new infrastructure and trade plans, all of those are good indicators for the metals industries and growth going from 2016 into 2017.”

Equipment manufacturers are also investing heavily in new technologies to apply to construction site safety, inspections and other fields. Equipment manufacturer Caterpillar, Inc. has invested in San Francisco drone tech startup Airware. Rather than make its own unmanned aerial vehicles, Airware has focused its efforts around providing software and services that help large enterprises use drones throughout their operations. Airware’s cloud-based software helps companies plan flights, automate them as much as possible, then analyze all the data their drones collect.

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Drones have been used on construction sites for the last five to ten years, but the fact that a key player like Cat is investing in the technology is a sign of a maturing market. Site technology doesn’t directly affect construction metal prices but it is part of a trend in lean project delivery that has delivered better results, and better projects, for general contractors and construction managers over the last decade. In other words, the increase in construction projects in the U.S. is directly proportional to better project management.

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Aluminum prices started the year on a strong note, finally overcoming the $1,800 per metric ton price level that had acted as a ceiling for more than a year.

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While robust demand has supported aluminum prices, investors’ eyes have recently turned to the supply side of the equation. In December, China’s share of global aluminum output was more than 56%. The giant producer’s share of supply is now facing some serious risks.

For years, Chinese cities have been choking on the smog spewing from China’s industrial production sector but things have recently gotten worse. Last month, authorities asked 23 cities in northern China to issue red alerts as inspection teams scoured the country. The scale of the red alert measure shows that the Chinese government is taking air pollution seriously… at least this time.

Investors are now speculating about capacity cuts in China as the country released a new policy document with plans to close around a third of aluminum capacity in the provinces of Shandong, Henan, Hebei and Shanxi over the winter months to help reduce emissions.

The cuts, of course, might not happen. Implementation of the document is subject to feedback and it will be normal to expect reasonable complains from both affected producers and regional governments.

Aluminum Premiums Pick Up

US aluminum premiums. Source: MetalMiner IndX.

For U.S. aluminum buyers, the all-in aluminum price consists of the aluminum price plus regional aluminum premiums. The premium is a surcharge that consumers must pay on top of prevailing prices in order to take immediate delivery of the metal from warehouses.

Not only the price of aluminum has risen, but premiums also picked up last month, trading now at $0.09/pound. The U.S. has also experienced a sharp contraction in aluminum smelting capacity over the past year. This has created a case of supply shortfall within the U.S., which now depends on aluminum imports to satisfy its rising domestic demand.

The fight against imports is getting more serious and this is something that could support domestic aluminum premiums. Recently, the U.S. launched a formal complaint against the Chinese government with the World Trade Organization over subsidies it says Beijing provides to the country’s vast aluminum industry.

In addition, U.S. customs officials seized $25 million worth of aluminum linked to a Chinese billionaire accused of stockpiling the metal across the world. The move is the most potent action yet by federal authorities probing whether U.S. companies connected to Chinese magnate Liu Zhongtian illegally avoided nearly 400% tariffs by routing the metal through other countries.

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The same combination of domestic environmental and foreign trade imperatives already forced China to get serious about steel capacity closures. It is possible there could be a similar outcome in aluminum. In addition to higher aluminum prices due to supply cuts, we could see higher aluminum premiums due to the ongoing trade tensions, just as we saw the spread between domestic and international steel prices widen.

Alcoa Corp. reported higher-than-expected revenue in its first quarterly results after the metals company split into two in November, helped partly by a rise in alumina prices.

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The producer of aluminum, alumina and bauxite also said it expects a 4% growth in global aluminum demand in 2017 even as the market remains modestly oversupplied.

Amazon.com Inc. is taking to the high seas.

The online retail giant has begun handling shipment of goods by ocean to its U.S. warehouses from Chinese merchants selling on its site — taking on a role it previously left to global freight-transportation companies, the Wall Street Journal reported.

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The move marks Amazon’s latest step in a multiyear effort to build out its delivery business. The company doesn’t own or operate ships, but is openly acting as a global freight forwarder and third-party logistics provider, categories of companies that book space on ocean vessels and truck goods between ports and warehouses.

The demise of the primary aluminum smelting industry in the western world has been like a long, slow train crash. As this graph from CRU shows, the decline has been relentless, and although many reasons are cited for the closures of U.S. and European smelters, power costs and the resulting cost of production are a primary cause.

Source: CRU Group

According to North American trade group the Aluminum Association, since 2015 seven U.S.-based aluminum smelters — more than 60% of U.S. primary aluminium smelting capacity — have been curtailed or closed. Over a similar time frame as the graph shows, Chinese aluminum production has grown from 11% of global primary aluminum in the year 2000 to nearly 55% today.

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The West has been surprisingly philosophical about the loss of smelting capacity, appearing to take the view that aluminum is such an energy-intensive product that the movement of smelters to low-power cost locations has a logical inevitability about it.

Where is Aluminum Production Going?

That argument holds true for the growth in the Middle East. Production in and around the cradle of civilization has jumped from 0.9 million metric tons in 1999 to an expected 5.7 mmt this year. But it hasn’t until recently had much logic for high-power cost locations like China. Even Beijing would appear to agree that power production and prices are sufficiently precious and high-cost that exporting primary aluminum is not a logical business model even for an export-orientated economy like China’s. Read more