Lights Out for Rio Tinto Alcan Plant: What Plant Starts and Shutdowns Say About Energy Policy – Part Two

The first part of this story appears here.

Century Aluminum, Rio Tinto Alcan and Alcoa all find themselves in a similar position with regard to shedding higher-cost smelting capacity.  This piece discusses Alcoa’s move to cut approximately 12 percent of its higher cost smelting capacity. We caught up with Jorge Vazquez of Harbor Aluminum to get his take on some of the more subtle (or not-so-subtle) aspects of these capacity curtailments.

MetalMiner: What is your take on the reason behind these closures and threat of future closures? Do you think any of this is due to actual contracting aluminum demand?

Harbor: Demand is not contracting. It didn’t contract last year and it isn’t contracting this year. The industry had 7 percent growth last year and 7-8 percent this year. These closures relate to both price and cost. On one side of the equation – aluminum prices remain really low (compared to key metrics) and on the other hand, we continue to face 7-10 percent inflation in the industry (e.g. production costs). The combination of these factors has really put pressure on capacity utilization. Fourth quarter earnings results show Alcoa has lost money. Century is losing money, UC Rusal and Rio Tinto Alcan have all lost money. It has been a tough fourth quarter. We expect the same situation for the first quarter and the situation could get worse. Earnings season begins in two weeks. We expect more curtailment announcements because of profitability.

MM: We always appreciate the various lenses you use to analyze the market. How do you think about the aluminum market in context of production costs by global market?

Harbor: There are essentially a couple of ways to analyze the market: a global view, China and the ROW (rest of the world). The Shanghai Futures Exchange plays inside the China market and the rest of the world looks at the LME. Here we see two big drivers, both related to the cost of production.

Most of the smelters in the rest of the world rely upon long-term energy contracts. These contracts, most of them anyway, reflect energy prices of the past. As these contracts expire, the starting point of negotiations for new contracts appears much higher than the past. The combination of re-pricing of energy products plus an extra burden of a CO2 tax which starts in 2013 and 2014 (and also in Australia) have impacted all producers with global operations such as Alcoa, Hydro and Rio Tinto, among others. It makes no sense to continue to invest in a smelter with an unfavorable cost position.  Producers should invest only where energy prices remain not much of an issue. The bottom line to us – the Middle East represents the only viable place to add production capability. That’s why you don’t see any expansions going on anywhere. And why you don’t see curtailments in the States. Cheap natural gas and no CO2 emission legislation have helped.

Europe and now Australia remain the most challenged with both higher energy prices and a CO2 tax. Brazil will follow suit because of higher energy prices, though they lack the CO2 tax. The current spot price is four times higher than the long-term contracts. Brazil has been curtailing output since 2009.

We’ll post a follow-up piece to this series examining the steel market shortly.

(Editor’s Note: Meet Jorge Vazquez in person at Harbor’s China Aluminum Conference on April 23 or at Harbor’s 5th Aluminum Outlook Summit)