Author Archives: Stuart Burns

For those on the other side of the pond, the debacle that is Brexit must feel rather like a distant joke, particularly the defeat this week of Prime Minister Theresa May’s Brexit plan by not just Parliament, but a large number of her own party.

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There may be many of a more nationalist or independent disposition outside the U.K., who have cheered on Britain’s original decision to leave the E.U.

And then there may be those who have supply chains embedded in the U.K. — or, indeed, in continental Europe — who worry about the disruption a “hard” exit from the E.U. would entail. (A hard Brexit is generally taken to mean an exit without a deal in place that safeguards the existing terms of trade between the U.K. and E.U.)

Readers will not be surprised to hear voters in the U.K. are similarly split.

Some want separation from the E.U. at any price — those are hard line “Brexiters,” many of whom come from more rural and northern parts of the country. A proportion of referendum voters were Remainers, who never wanted to leave the E.U. and willingly accepted both the financial cost and the imposition of European rules as an acceptable price for the economic and security benefits of being part of, if not a united Europe, at least an integrated single European market.

Ranged in between — and without a referendum, we will never know quite know how many this includes — are a variety of opinions from Leavers, who have since seen what leaving really means and changed their minds, to those who would be willing to try a partial separation of the sort May negotiated with Brussels (but has been soundly thrown out by Parliament this week).

The scale of the government’s defeat on her plan should not be understated.

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Andrey Kuzmin/Adobe Stack

They call it the law of unintended consequences and, broadly speaking, it was intended by the American sociologist Robert K. Merton to mean unintended consequences are outcomes that are not the ones foreseen and intended by a purposeful action — particularly actions of a government.

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Well, I don’t for one minute expect President Donald Trump gave much thought to the consequences for the rest of the world of his decision last year to slap 25% import tariffs on steel products from the rest of the world.

His focus was largely on a domestic audience and if he gave thought at all for the international consequences, it was probably the impact on China. Although steel imports into the U.S. from China were not as large as from suppliers like Russia, Ukraine, Brazil and Canada, the cumulative impact of deterring those suppliers from the U.S. market has been an increase in metal looking for a home in Europe.

The E.U. imposed a number of policies in response to the perceived threat of increased steel imports. One was to demand that most steel (and aluminum) imports into the E.U. apply for a form of licence, called Prior Surveillance. The measure is not designed to control imports as much as to monitor the precise origin, down to the level of manufacturer, probably with the intention of applying quotas or anti-dumping action at the manufacturer level at some stage in the near future.

But in the meantime, the E.U. feels it needs more of a blanket approach. As such, the European Commission has announced it will prolong until July 16, 2021, a 25% tariff on more than 20 types of steel ranging from stainless hot-rolled and cold-rolled sheets to rebars and railway material when the shipments exceed the average over the past three years.

According to the Gulf Times, 26 types of steel will be covered by the E.U.’s definitive measures, compared with 23 product categories under the provisional system and 28 within the scope of the original probe representing some 40% of the E.U.’s annual iron and steel imports.

The E.U.’s decision has not been met with universal approval. The decision was immensely popular among steel producers who pushed for the measures; however, consumers like the automotive sector called the move unhelpful and a cause of “regret,” according to S&P Global.

The European Automobile Manufacturers’ Association (ACEA) was quoted as saying “ACEA questions the need for such trade protectionist measures. In the automotive sector, access to EU steel production is extremely tight and imports remain necessary to fill supply-chain gaps.”

ACEA points out any increase in imports is down to increased consumption, not increased market penetration by overseas mills, saying “Motor vehicle manufacturing has increased by 5 million units per year since 2014, and some increase in steel imports has been necessary to meet this higher demand.”

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It would seem U.S. carmakers and the wider steel-consuming industry are not alone in facing higher prices going into 2019.

As GDP growth slows — recent data shows it is certainly slowing in Europe and China — manufacturers’ factory gate prices will come under pressure as this translates into lower sales. Heightened raw material inputs will therefore squeeze margins in the year ahead.

ThomasNet ran a piece this week on China’s latest blockbuster in the electric vehicle (EV) market: the Ora R1 hatchback from domestic automaker Great Wall.

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I say “blockbuster” not because it’s a rival to Tesla or a similar high-end brand — quite the opposite.

At under $9,000 (after massive subsidies available at the state and federal level in China), the Ora R1 could be a blockbuster in terms of sales.

With a projected range of 194 miles between charges and four doors, the article suggests the vehicle is firmly aimed at the less well-off commuter. In that context, it could have massive appeal for the authorities fighting smog and other forms of air pollution in China’s crowded cities.

The Ora R1 runs on just 47 horsepower with a top speed of about 62 mph, according to the report, which also quotes experts who say it should be capable of powering commuters for about a week per charge (based on real-world driving patterns).

Sounds like a winner, doesn’t it?

Maybe it will be, but for us it has echoes of Tata’s Nano “people’s car,” designed to lure consumers off their cheap motorcycles and into their set of four wheels.

Poor quality, reliability and growing losses forced Tata out of the sector. It was not helped, it should be added, by a PR disaster when the Nano displayed a tendency to burst into flames, frequently recorded on social media.

The Ora is packaging the R1 with a three-year, 120,000-kilometer (74,500 mile) warranty for the entire car, and an eight-year, 150,000-kilometer (93,200 mile) warranty for “core components,” suggesting reliability shouldn’t be a worry – providing the manufacturer honors its commitments.

Source: Great Wall Motors

Whether the Ora R1 will fare any better than the Nano remains to be seen. At prices between U.S. $8,680 to U.S. $11,293, the price is heavily subsidized and should retail at twice that level.

Even so, a $20,000 price in unsubsidized markets would pitch the Ora well under current small car contenders, such as the Nissan Leaf.

But success or failure hinges even more on quality and reliability in this sector than it did for the Nano in India, where consumers’ expectations were not high. EVs outside of China have so far been relatively high-end products with classy interiors and many modern innovations.

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A first road test for the R1 has yet to be released by the Western press. It has to be said, in the visual sense the car looks as bad as the old East German Trabant — but if it drives well, achieves its range projections and holds up from a reliability perspective, owners may yet ignore its ugly duckling looks and flock to what could prove to be a disrupter for the lower end of the EV market.

“No” is the simple answer, according to the Financial Times in an article this week.

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So, does it matter?

Not from a purely economic point of view, no.

Sure, it has huge implications for the Brits, and for any company buying from or selling into those troubled isles – not least of which the Irish, for whom it could be even more painful than for the U.K. itself. The U.K. being such a large trading partner for them, the imposition of tariffs and/or other forms of barriers would have profound implications for trade between Northern Ireland and the Republic of Ireland.

But in terms of a hard Brexit’s implications for Brazil, Singapore, Australia, etc., they would barely notice from the point of view of impact on GDP.

But the ramifications go further than just economic fallout.

The European Union was started as an economic cooperation, but its original aims were always much more.

As the Financial Times states, at the heart of the E.U.’s mission is an ambition to unite the countries of Europe in such a way as to prevent a recurrence of the disastrous wars and social upheavals of the 20th century. Beyond that, the aim is to advance Europe’s commercial, diplomatic and security interests around the world, help to set global regulatory standards and act as an anchor of a rules-based international order.

Europe has been a leader, or least a close follower to the U.S., in globalization and developing a rules-based global trading system. Whatever some backward-looking, misty-eyed, colonial-era-aspiring politicians may say, Brexit is a rejection of ever greater European and global integration.

The British public, which voted for Brexit, largely rejected globalization and yearned for a rose-tinted view of Britain’s past (which probably never really existed except in our imagination).

Britain is not alone in expressing such views.

Indeed, a significant plank of President Donald Trump’s appeal is similarly isolationist, as is the new administration’s in Brazil. No other country in Europe has voiced the same desire to leave the E.U., but Britain’s decision has caused a fundamental rethink on the speed and direction of European integration, despite French President Emmanuel Macron’s continued enthusiasm for the European super-state. Voices of dissent are rising and more widespread.

The true casualty of a hard Brexit, apart from the obvious damage to the U.K. economy, will be the European dream of ever-closer unity.

Historians may well look back on 2019 as the year that dream hit a wall and a return to economic pragmatism prevailed among European policymakers, as opposed to the ever-closer union favored by Brussels.

Some would argue that is no bad thing. There is much wrong with the E.U., particularly its unaccountability and arrogant imposition of policies seen by many as favoring the few over the many.

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Be that as it may, as the shockwaves of a hard, no deal Brexit reverberate around Europe, it may be more than just the Brits who come to regret that referendum on June 26, 2016.

Few would have predicted this five years ago, but India is facing a real dilemma.

It is exacerbated by the country’s predilection for subsidies and set against the backdrop of a chronic power generation landscape.

As any regular traveler to India will know, while power outages are not as common as they once were, they remain an almost daily occurrence in many areas. According to the FT, quoting figures from the New Delhi-based Energy and Resources Institute, per-capita electricity consumption by the country’s 1.3 billion people is just 38% of the global average, while tens of millions of households still lack grid connections — so demand growth is high and set to continue for decades to come.

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Not surprisingly, the government has made the push for reliable, universally available electricity a long-running key policy priority; a policy based largely on coal-fired coal plants that was roundly condemned by both environmental organizations and many Western governments.

India’s Coal Paradox

Coal is the only fossil fuel India has in abundance, with extensive deposits situated in the northeast of the country, although power plants in the west and south often import coal from Indonesia rather than haul product across the country on a rickety rail network. Oil and gas have never been favored because they are largely imported.

As for those subsidies mentioned earlier, the Gujarat state government has just awarded two major coal plants run by Adani — Tata Power and Essar Power — increased power rates to help stem heavy losses the plants are incurring due to uneconomic imported coal supply costs.

Over the past couple years (and estimated into the future), India’s thermal power capacity additions have given way to solar and wind. Source: FT.

Part of the problem for coal-fired plants has always been competitively priced coal supplies; even though the country has abundant supplies, it suffers from an appalling logistics infrastructure. Today, only plants sited very near to the deposits in northeastern India remain viable. Most of the rest are in trouble, with Credit Suisse estimating half of them as being ‘stressed’ – i.e. interest payment exceeding profits – putting some $35 billion of investments at risk, the FT reports.

Various sources’ share of India’s total electricity capacity. Source: FT.

Renewable Energy Power Price Collapse Plays Its Part

The second — and, in many ways, more profound — dynamic at work is the collapse of renewable energy power prices.

According to the FT, Japan’s SoftBank, as part of a consortium in 2017 agreed to sell power from a northern Indian solar park for Rs2.44 per unit, well below the cost of coal power, which typically costs well over Rs3. Last year, state-run NTPC — by far the biggest thermal power producer in India — has canceled several plans for large coal projects, including one for a giant 4GW plant in southern Andhra Pradesh state, while Adani Power invested more than $600 million in a solar plant in sunny southern Tamil Nadu. Coal is no longer seen as economically viable in India — not from an environmental point of view, but purely based on the cost of production.

Not surprisingly, in recent meetings, state thermal power station equipment manufacturers were bemoaning (off the record) the dire state of the market, with little on offer except repair and maintenance.

After he was elected in 2014, Prime Minister Narendra Modi and his government set an ambitious target of increasing India’s renewable energy capacity by 2022 to 175GW, equivalent to 40% of the country’s total power capacity. This was a target seen as more for external consumption than a genuine strategy; but last year, despite the backlog of coal-fired plants still in the works, more solar power capacity was brought on stream than coal, suggesting the 40% target may yet be achieved, particularly if better storage solutions can be achieved to smooth out the variability of renewable power supply.

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Until then, coal plants are still needed to provide base-load and increasingly intermittent power, a role they are not as well suited to as gas, but in the absence of anything else may be of such need that those subsidies keep rolling in.

The dollar has been on a tear this year, boosted by a large corporate tax cut, a hawkish Fed and the imposition of import tariffs, the Financial Times suggests.

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These policy interventions were specifically designed to help Republicans in November’s midterm election, but they are unlikely to have a lasting positive effect.

Election-motivated fiscal giveaways typically increase macroeconomic instability, while tariffs reduce rather than enhance productivity. Neither will sustain the 2018 dollar recovery in the medium term, the news source believes, nor will the effects of quantitative easing (QE) continue to support mature markets (now that the policies are being withdrawn on both sides of the Atlantic).

According to the Financial Times, since late 2010 the dollar has rallied 35% in broad terms and 50% against emerging-market currencies, while the total return to U.S. stocks is 430% and German bonds have made more than 80%.

These gains have come as both a direct and indirect result of massive QE in the U.S. and Europe, funds have flowed out of emerging markets into those that are direct beneficiaries of QE. As QE is reversed, so too will the flow of funds; QE-supported markets will suffer and, relatively speaking, emerging markets will again become more attractive, the Financial Times believes.

The issue for commodities is what impact this will have on the dollar.

Dollar strength has been one factor depressing commodity prices this year. If the dollar were to weaken relative to a wider basket of currencies, this could have an inflationary effect on prices.

How quickly dollar strength ebbs remains to be seen.

The most recent hike in Fed funds was deemed by many to be a step too far — or at least too fast. At least, the White House that would have preferred a more cautious Fed approach.

The Fed’s position is that we could see two more rate hikes in 2019, a move that would support dollar strength (providing GDP growth remained positive), but recent assessments this week suggest there may be no further rate hikes next year, paving the way for a weaker dollar sooner rather than later in 2019.

Of course, dollar strength is only one of several dynamics impacting the price of commodities, but it remains a consistently strong correlator over time. Other factors include GDP and stock market growth in emerging markets, to the extent that an end to QE boosts investment interest in emerging markets that too could be supportive of commodity prices.

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For now, prices appear under pressure, but what 2019 holds for us — once the current sell-off runs its course — remains the be seen.

Well, that was something and nothing, wasn’t it?

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The non-event of the month was the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) announcement this week of its intention to end sanctions on En+ Group plc, UC Rusal plc, and JSC EuroSibEnergo, all vehicles associated with Russian oligarch Oleg Deripaska.

Deripaska remains on the sanctions list. However, following his nominal separation from the firms, OFAC decided to end sanctions.

Deripaska is reported to have put plans in place to reduce his shareholding in holding company En+, which is currently 70% to fall to 44.95%, while a Russian bank will take title to a portion of Deripaska’s shares, according to Aluminium Insider.

The article states Deripaska will also be required under the agreement to hand over shares in En+ to charitable foundations and assign voting rights above a 35% threshold to a voting trust. Other shareholders deemed to have a familial or professional relationship will be compelled to do the same.

Once the entire plan has been executed, En+ will retain ownership of 56.88% of Rusal, with Deripaska’s stake reduced to 0.01%.

That’s good news, aluminum buyers may retort, and yes, it is in terms of finally settling a source of some disquiet that has been underlying the market since May.

But the fact that the aluminum price barely moved underlines the reality that the market had long expected this outcome — and barely reacted, accordingly.

What happens next year remains to be seen.

The whole metals complex has been at best trading sideways during the second half this year, buoyed by decent demand but depressed by worries about global growth and trade wars.

The lifting of sanctions frees up some 200,000 tons of Rusal primary metal sitting on the LME for consumption, and potentially 10 times as much sitting in off-warrant or off-market stock and finance trade storage.

The LME metal is unlikely to go anywhere fast. Currently, the LME supports rollover of maturing stock and finance trade contracts with two-year forwards at a sufficient premium to one-month forward to facilitate extension.

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As such, the market is not going to be flooded with Rusal metal that would cause a further weakening of prices. That clearly is the market’s assessment, too, otherwise prices would have fallen significantly after the announcement.

After surging more than 50% in the last four months, palladium — that previously little-discussed Platinum Group Metal (PGM) — reached $1,255.12/ounce, surpassing gold for the first time in 16 years last week, according to The New York Times.

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Driven by both investor and trade interest, palladium appears to be responding to strong demand from the auto industry (from which 80% of its consumption comes).

A swing to petrol engines has boosted palladium demand, in preference to its sister metal, platinum, which is used more in diesel engines. The metal is also used in alloys for products like surgical instruments, dental alloys and certain electronic applications, The New York Times notes, but it is a combination of catalyst demand and constrained supply that has caused shortages, leading some dealers to run out of metal.

According to the report, citing consulting firm Metals Focus, demand for the metal for catalytic applications will reach a record high of 8.5 million ounces this year. Tighter emissions legislation and the switch to petrol cars is driving surging demand, such that consumption is expected to outstrip supply by 1.2 million ounces this year, with the market remaining in deficit next year.

Miners have found it difficult to keep up.

Mines in South Africa, in particular, have faced worker disruption and are said to be struggling to cover costs, as PGM prices generally remain depressed but mine inflation challenges profitability and deters investment.

The world’s largest producer is Norilsk Nickel in Russia. Buyers were heartened by the firm’s announcement last week that it plans to invest $12 billion in mine expansion over the next five years, according to The NewYork Times report. Supply may come onto the market just as the long anticipated but equally delayed arrival of electric vehicles finally begins to become a reality.

But for now, the metal seems a good bet for 2019, providing vehicle sales do not falter. Investors have driven Palladium ETFs up 12.3% this year, even as gold has fallen 6.4%.

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The big money has been made, but palladium’s fundamentals remain better than gold’s — providing global growth and vehicle sales hold up in 2019.

With all this talk of trade wars and weakness, both on the Shanghai stock market and in the Chinese currency, you would expect that steel production in China would be heading south fast.

In actual fact, steel mills continue to churn out product at near-record levels and imports of iron ore remain robust.

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Platts reported this week that Brazil’s iron ore exports to China were up 2% in November to just under 20 million tons for the month and that China remains the destination for nearly 60% of Brazil’s total ore exports.

The futures market, however, is taking a dim view of the fortunes for steel products with Chinese steel futures dropping for three days in a row this week. Both Baoshan Iron & Steel Co Ltd and Wuhan Iron and Steel Co lowered their prices for January, despite forced output cuts as part of China’s winter-heating-season struggle to fight air pollution. Reuters reported that Tangshan ordered steel mills and other industrial plants to make further output cuts in December as part of a growing crackdown on air pollution.

The trade war does, however, appear at least to be having an impact on China’s steel exports.

China’s steel shipments dropped nearly 9% to 63.78 million tons in the January to November period, according to Reuters. All the more significant because during that period the currency has been steadily depreciating, a trend that would normally boost exports by making domestic producers more competitive in dollar terms.

The futures market probably has it right: weakening car sales and lackluster infrastructure investment combined with weak exports will gradually create a position of oversupply if, as expected, the crackdown on steel mill output during the winter season is not as robust as last year.

Source: Business Insider.

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In the last few days, iron ore prices have dropped sharply, with the biggest fall being in lower purity 58% fines down over 2% to $42.45 per metric ton, compared to a slide of just 0.8% in high purity 65% Brazilian fines, which are down to $82.70.

The wide disparity between less-polluting high purity material and more-polluting low purity material shows no signs of narrowing.

We tend to view the issue of China’s excess aluminum manufacturing capacity through the simple lens of its impact on the U.S. and European markets, but comments in a recent Aluminium Insider article show that the flood of low-cost aluminum from the People’s Republic of China is having a global impact.

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Markets like the U.S. and EU have mechanisms they can swiftly employ to counter a rising tide of cheap imports as the U.S. has shown, but some developing countries are still struggling months or years after western markets have already put some form of protection in place.

Despite repeated requests made to the government by some private sector primary aluminum producers like Hindalco and Nalco to impose anti-dumping tariffs on imports of primary aluminum and scrap, an Indian aluminum trade organization spokesman dismissed such claims as simply an attempt to profit by raising import prices.

What are We Agarwailin’ About? 

Anil Agarwal — a ‘patron’ of the Aluminum Secondary Manufacturers’ Association, according to AI, not the eponymous chairman of Vedanta Resources — is quoted as saying that the import of 17,000 metric tons in ingot and wire rod is so small in a market with a production capacity of 4 million metric tons, half of which is exported, that imports have a negligible impact on domestic mills. He is quoted as going on to challenge the notion that increasing scrap imports is undesirable, as suggested by many.

Referring to an increase of 29% over a three-year period, Agarwal noted imported scrap is typically used in automotive and detox applications where primary aluminum is cost-prohibitive. Rising scrap imports should be seen as a positive sign of the health of these industries rather than a worrying undermining of primary producers’ positions. Pointing to a 21% increase in primary metal exports between April and September of this year, jumping from 638,000 metric tons last year to 772,000 metric tons this year, he suggested Indian primary producers remained competitive in the international marketplace despite China.

The problem, though, is not just the excess Chinese downstream capacity but even more so of displaced capacity that had previously served the U.S. market (much like U.S. concerns over the health of the domestic downstream manufacturing sector), Agarwal raised concerns that India’s downstream semi-finished manufacturing capacity was under threat of substitution from cheap Chinese imports if action wasn’t taken.

Over the past seven years, imports of downstream products into the Indian market have grown at some 12% per year as a result of which the market share for imports as a percentage of domestic consumption has increased from 40% in 2011 to 60% now, a further article reports.

Whether India will impose anti-dumping or raised tariffs on China’s semi-finished aluminum products remains to be seen. Narendra Modi has his hands full with state elections at present that are not going well for him personally or his party, and do not bode well for upcoming national elections in the spring of next year. On the other hand, maybe picking a trade fight with India’s old adversary is just the sort of distraction he may welcome to divert attention.

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Correction: We were misled by the original Aluminium Insider article, which did not clarify the difference between the two Anil Agarwals, and thus we initially stated that the Agarwal mentioned in that article was indeed the Vedanta chairman – which he is not. Read their correction here.