Do Aluminum Smelter Shutdowns Impact Physical Delivery Premiums?

Soaring power costs in Europe wrecked havoc on the aluminum industry. In fact, several aluminum smelter sites have partially or temporarily shuttered this year. As most people know, power costs surged starting last year due to increasing oil and natural gas prices. However, Russia’s invasion of Ukraine turbo-charged this escalation. With Ukraine being a key transit territory, and Russian being the world’s dominant supplier of natural gas, this poses numerous problems.

Aluminum Smelter
Source: Adobe Stock/Bonzodog.

Aluminum Smelter Locations in the US Following Suit

Of course, rising energy costs are not a regional issue. Although the impact was not immediate, the global nature of the fossil fuels market raised costs in the United States. As a result, rising power costs in the US are impacting the viability of aluminum smelting.
Late last month, Century Aluminum Company, the US’ largest producer of primary aluminum, announced it would temporarily idle its smelter in Hawesville, Kentucky. The firms said they were closing the facility for 9-12 months, or until energy prices fall to more sustainable levels.
Hawesville has a reputation for being North America’s largest producer of military-grade Aluminum. In an already-constrained supply market, this loss will have a great impact. Like smelters in Europe, Century got caught between a falling LME/CME price and high energy prices. Typically, high energy prices would support higher aluminum prices, but this year’s market proved critically oversupplied. That’s why exchange prices have dropped despite persistently high power costs.

It’s not just Century feeling the pain. Last week, Alcoa Corporation announced it would begin curtailing one of three operating smelting lines at its Warrick facility in Indiana. The company cited “operational challenges” as the primary reason for the move. The company also assured customers that each of the three remaining lines have a capacity of about 54,000 tons per year. This leaves only 161,000 tons in operation.
The move will come as a blow to the adjacent Kaiser rolling mill, which takes metal directly from Warrick site. That said, it remains unclear how much this will effect Kaiser in the future.

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Source: Adobe Stock/Pavel Losevsky

Investor Positioning in Industrial Metals Flips to “Short”

Despite the global market enjoying a modest surplus, exchange inventories remain very low, and the market for physical metal remains tight. Indeed, the MW physical delivery premium had been falling from its March high – both for the LME and for the MW Premium. However, this graph from MetalMiner insights clearly shows that physical delivery premiums picked up late last month on the news of the US smelter closure.

Source: MetalMiner Insights
Indeed, over the last few weeks, investor positioning across industrial metals flipped from long to short. For example, the net long on the CME copper contract hit 42,000 contracts at the start of April. Currently, the net short stands at 25,402 contracts, its most bearish positioning since April 2020. The same is true for Zinc despite there being virtually no stock in US exchanges and record lows throughout Europe.
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More Aluminum Smelter Closures Could Spell Big Problems

At the moment, investors in the futures markets remain focused on the recessionary impact of high energy prices and rising Fed rates. Meanwhile, the physical delivery premium reflects the reality of metal supply on the ground – not just for Aluminum but for Zinc as well.
The worry is that consumers could be caught between the apparent disconnect of a weakening LME price and a rising physical delivery premium. This is especially concerning as the MW premium responds to the tightening regional ingot market in the US.

So far, physical delivery premiums are yet to reach the levels seen in March of this year. However, they have ticked up nearly 10%. And while the summer season is normally pretty quiet, increasing volatility seems more likely. This outcome is all but assured if any further smelter closures (even temporary ones) occur. In that case, investors will move to disrupt the nature of the supply market amid the reality of regional shortages.

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