Norsk Hydro Under Pressure From Automotive Companies – Fixed Prices For Long Term Supply Agreements?

A Reuters article this week covers an interesting development in the downstream aluminum market as it reports on discussions Norsk Hydro, Europe’s third largest aluminum producer, is having with automotive clients. According to the automotive OEM’s the long term trend of increasing aluminum use would accelerate if OEM’s could secure firm pricing for a number of years, giving them the confidence to design in greater use of key aluminum components. Consumers say they are under market and regulatory pressure to improve fuel economy and reduce emissions per mile but are hesitant to achieve those improvements by weight reduction by substituting aluminum for steel if that also exposes them to greater cost volatility. Ironically this comes as steel producers such as Thyssen have been complaining that the loss of the annual iron ore and coking coal pricing mechanism will hamper their attempts to provide long-term fixed prices to major consumers such as automotive OEM’s.

Some may think that aluminum producers should be in an ideal position to control costs. Many of them have long term power cost contracts, traditionally at fixed prices, and their raw material costs in the form of alumina are often at a fixed 13.5% of the finished metal price. But in reality they have little or no control over the ingot price and although their margin is largely protected, their ex factory gate sales price is totally at the mercy of the futures markets. As world aluminum prices rise, so do alumina costs and increasingly so do power costs as many producers negotiate in an uplift if metal prices break above certain thresholds. That doesn’t leave any room for producers to absorb losses on a fixed sales price. To fix sales prices, they have to hedge.

There are of course existing market hedging mechanisms to allow aluminum producers to hedge sales prices. The LME for example allows producers to fix prices forward, if not the actual cost of processing primary metal into finished coil or extrusion. To what extent they use these or over the counter swaps is unclear but the producers response to the expiry of sheet contracts with the can industry in the US this year suggests some do it more than others. Novelis complained that previous can stock contracts coming up for renewal last year had cost them dear because they were at fixed prices and presumably not hedged. According to a Bloomberg article, Alcoa said in April it purposely curtailed can-sheet volumes (to the tune of  75,000 tons in the first quarter) because of concerns over profitability. Alcoa Chief Executive Officer Klaus Kleinfeld said at that time the company decided to let a money-losing 10-year contract expire to focus on more profitable business. Novelis, on the other hand, has increased the amount of can stock business it is doing saying it finds such sales profitable, although he avoided saying how profitable. A recent article in MetalMiner late last month threw some light onto what may have been happening explaining that there has been a shift in power from consumer to producer allowing the producers to price for ingot, conversion premium and have agreed to pass-throughs with the consumer. Why Novelis could live with such a shift but Alcoa could not may come down to the acceptability of certain levels of margin than the willingness to hedge or not.

Traditionally we have found producers unwillingness to provide fixed prices is not because they cannot hedge their risk but because clients only honor such contracts in times of rising prices. If prices fall consumers will take a variety of steps from simply trying to renegotiate, to diversifying their spend with more spot buys at prevailing market prices, to sometimes walking away altogether. Novelis though do seem to be making the long term supply deal their specialty. In addition to their appetite for the can stock market they are steadily increasing the volume of metal they are supplying to the automotive market, recently announcing a major supply agreement with BMW for all aluminum one piece doors for the 5 Series. BMW would presumably not have taken such a commitment without security on costs. It is not a step that can be readily unwound if aluminum prices double.

So if anyone has further details of the extent to which producers are hedging or even just controlling prices of fixed price semis contracts we would be interested to hear, on or off the record.

–Stuart Burns

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