For merchants, distributors and consumers of semi-finished aluminum products such as bars, sections, plates and sheets, there are at least two elements to the prices paid.
The first is the underlying primary ingot price, usually tracked by the LME or, in the US, the Midwest Ingot price. The second element is the conversion cost between the primary ingot price and the price of the bar, section, plate etc. This is traditionally made up of the cost of delivering the primary ingots to the fabricator, the cost of re-melting, casting, rolling or extruding, heat-treating, finance…and so on.
Costs naturally vary from fabricator to fabricator and from product to product. Depressed demand has kept a firm lid on conversions costs over the last 12-18 months, and mill lead times have been relatively short for most commercial or non-aerospace products reflecting the weak demand.
Consumers, at least towards the end of the value chain, have seen steadily falling prices driven primarily by falling metal prices, but also by falling conversion costs. However, pressure is building for prices to rise according to the mills, so we analyze their arguments to see to what extent they hold water — in other words, to what extent the price of aluminum semis could be in for a rise.
The mills’ first point is that the world is clearly in oversupply. HSBC in its latest quarterly report states global inventories, including both exchange and non-exchange inventories, have remained at around 7 million tons since the beginning of the year, equating to some 60 days of consumption and more than double the levels seen before the financial crisis in 2008.
The picture looks even grimmer if we account for the off-exchange inventories, which Alcoa estimates to be another 2.3 million tons outside China, and 1 million tons in China, taking the total global inventory count to more than 10 million tons.
Even so, most of this over-production continues to be soaked up by the bank and hedge fund stock, forward-sell and finance model where investors buy at spot and forward-sell at a higher price on the LME forward curve, taking a profit (after warehousing and ultra-low interest rates are taken into account.)
The model has been given a boost for those traders who also own the warehouses; they get a profit out of the forward curve and the storage costs. As a result, premiums paid in Europe and Japan for physical delivery are at or near record levels. Unfortunately for fabricators, most sales prices are made at a simple premium over the LME and are expected to include this primary metal premium.
Fabricators often fix their billet or slab premiums for a period of time, but these procurement contracts set in 2010-11 are now coming to an end, and for mills not enjoying some form of vertical integration, new contracts will reflect the higher physical premiums being charged in the spot market.
Even for vertically integrated mills, downstream operations are often run as independent profit centers and may still face increased primary metal premiums.
Point 1, then, to the mills — this definitely represents an increasing squeeze for fabricators and sooner or later will force them to raise prices.
See how the producers stand, and our aluminum price outlook for next quarter, in Part Two later today.