Alumina, Excess Capacity and Price Linkage Stable

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Commodities, Non-ferrous Metals

We periodically review the aluminum market but rarely stop to consider the raw material supply side to the industry. As the intermediate stage between bauxite which is mined out of the ground as an ore and refined aluminum sits the intermediate product alumina. Supply of alumina (aluminum oxide) is mostly controlled by the major mining companies and aluminum producers, Alcoa, UC Rusal, Rio Tinto, BHP and Chalco between them control 60% of the market so you may think that they control the price to suite their downstream smelting activities. But that is not the case. Individual aluminum producers rarely have a neat balance between alumina capacity and aluminum smelting capacity so they all engage in some supply with competitors and as current practice would have it they are run as individual profit centers seeking to obtain a viable price from their buyers, even if it’s the same group company.

So it may be not too surprising that the alumina market bears some resemblance to the rest of the metals market – dogged by excess production and with alumina plants running at below capacity. As with the primary metal market, China is the 800lb gorilla at least in terms of demand. Although global production of SGA (smelter grade alumina) is forecast to fall by 7.5% this year, China has been ramping up production. Encouraged by new smelters being commissioned and existing smelter re-starts, the Chinese alumina industry has not only increased production back towards the mid 2008 peak but is forecast to grow a further 18.5% in 2010 according to HSBC. In addition, China is importing and it is believed building inventory.

Although the price of many long term contracts are fixed at a percentage of the finished aluminum price, typically around 13.5%, spot prices move with the market. The industry benchmark is generally considered to be set by Nalco of India. In addition to some 240,000 tons Nalco sells each year on long term contracts, the company sold a further 300,000 tons last year (and expects to sell 360,000 tons next year) on a spot basis, much of it to China. From a spot price of US$191.13 a ton in February, Nalco is now getting US$283.70 a ton in August reports Bloomberg. With the monthly average for August at US$1934 per ton that puts the spot at about 14.7%, marginally above the 13.5% long term contract price. The Chinese alumina producers sell on posted prices and after not changing the price since April, Chalco has twice increased its price in August and September as the market has recovered to RMB 2,550 per ton (US$373) some 20% of the SHFE price for primary aluminum.

So the industry is facing a stagnant market in the developed world but rising demand in Asia and the Middle East where new smelters have come on stream this year. Alumina refineries have been running at about 78% utilization this year so there is technically plenty of capacity. In theory, prices should maintain their nominal 13.5% linkage to the aluminum price and not present a rising cost driver to the primary aluminum price, which is itself dogged by massive inventory levels. The only caveat is bauxite, the raw material from which alumina is refined. With the drop in price and demand, bauxite mines have been idled and new projects curtailed. The recent announcement by Bloomberg underlines the precarious location of many of the world’s bauxite and alumina facilities. Guinean President Moussa Camara who took power in a coup last December is looking to regain control of the country’s massive reserves from the Russian producer UC Rusal. Guinea is the world’s largest bauxite exporter and claims Rusal acquired control of the resources unfairly. Rusal paid $19 million for the assets, while consultants had valued it at $257 million. The mine and refinery Friguia has the capacity to produce 640,000 metric tons of alumina and 1.9 million tons of bauxite a year, and was temporarily shut by government order earlier this month as the dispute escalated. At the same time, Bauxilum of Venezuela with the capacity to make over 2 million tons is reportedly down to 1.4 and falling as the firm repeatedly fails to raise enough money to renew plant and equipment amid the turmoil of Hugo Chavez’s socialist revolutionary experiment. For the time being though the world seems to have enough bauxite and sufficient refining capacity. Alumina prices are expected to remain at the 13.5% linkage to aluminum and shouldn’t pose a challenge to primary metal economics over the next two years. Just as well, the aluminum market will have enough of a problem digesting the massive primary metal inventories without rising raw material costs squeezing margins.

–Stuart Burns

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