Do Trends in the Aluminum Industry Carry Over to All Metals?

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The recent power problems in China, largely caused by bad weather reported in our recent article, comes at the same time as widespread power problems in South Africa have affected Ferro-Chrome, coal and precious metal mining.

So much for mining companies, but what of the manufacturers? It is estimated that the Chinese power problems have idled up to 10% of the country’s steel production and several aluminum pot-lines. Power failures are particularly damaging to aluminum smelters because the molten aluminum rapidly solidifies in the cell, taking months to get the cell operating again at a very high cost. So if power is likely to be disrupted, smelters usually voluntarily take pots out of operation to reduce the demands on the grid and ensure reliable supply for those cells left in operation. That is what is happening at Southern Africa’s three smelters, Bayside 190kt, Hillside 709kt and Mozambique’s Mozal 564kt following warnings from South Africa’s power generator Eskom that due to heavy rains they can’t guarantee power supply for the next 4 weeks. We have heard that due to under investment there will be intermittent cuts for the next 4 to 7 years! In addition, expansion plans at Mozal and Hillside and the proposed new Coega smelter of 700kt are all in doubt according to Standard Bank, Leon Westgate, Base Metals Flashnote, 29 Jan 2008.

Will this have an impact on US aluminum prices in the short to medium term? No, once the current speculative fund inspired lift we are seeing to the futures markets wanes it is unlikely to have any impact. New capacity coming on stream elsewhere will pick up the shortfall and demand is falling in the US as both housing and manufacturing face an uncertain year ahead. But it does illustrate a problem that all the metals manufacturers face in the longer term. Energy costs are high and show no signs of coming down. With oil at near record levels and reserves being added more slowly than production is being increased, it is unlikely oil (or gas) costs will reduce significantly in the years ahead.

Coal, the darling of the industrial revolution, is the source of immense environmental damage both in the mining, burning and production of greenhouse gasses, but even so demand is undiminished from the developing world and prices for power coal continue to move ever higher. Even low cost aluminum producers like Rusal, with the advantage of hydro power and relaxed environmental regulations are making depressing warnings about the year ahead, saying costs are up even though sales prospects are down. It raises the question, how much longer can many of the smelters in high power cost markets continue to operate? As power contracts expire and/or are renegotiated, the viability of existing aluminum, zinc and a number of other metals which rely on electrolytic or high temperature power hungry production processes must be called into question. In the long run this will place a floor under production costs. Hence prices will remain high – even if demand falls off producers will have to idle production or otherwise they will plunge into losses. The process will be most severely felt by western metals manufacturers operating older plants in high power cost locations.

Each commodity will have its own demand-supply balance so watch these pages for our thoughts on strategies for each as time goes by. But for those able to predict demand in the longer term it may make sense to fix a proportion of spend during the low points we believe the metals markets will see this year because the long term trend is likely to be higher.

–Stuart Burns

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