Aluminum Dissonance: Why Have Prices Softened Despite Supply Deficit?

That the aluminum market is in a deficit is a widely accepted fact — but it still remains hard to see in practice.
Usually when markets are in deficit, prices rise. Primary aluminum as quoted by the LME, however, has been at best sideways for the last year or more. Prices have gradually softened within the $1,700-$1,900 per ton range, although a recent run-up has seen prices north of $1,800 per ton this month.
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The problem is the shortfall between production and consumption has been made up from two notable sources.
The first is a gradual leakage of metal stored in off-market stock and finance deals by the financial community. The second is a rising tide of semi-finished metal from China that has depressed prices and caused uncomfortable competition for producers in the rest of the world (outside the U.S., at least).
Chinese semi-finished exports are seen as the release valve for excess domestic Chinese production in a market that produces half the world’s aluminum. The approximately 5 million tons per annum of Chinese exports is significant for the rest of the world, but still a fraction of China’s total output.
By comparison, western Europe consumed just over 5 million tons of flat-rolled and 3 million tons of extrusions in 2016-2017, according to European Aluminium, a trade body, underlining what a significant impact China’s exports can have when they flood mature markets like Europe.
This ready supply of semi-finished metal but more restricted supply of primary metal is one reason why delivery premiums, like the U.S. Midwest Premium, have remained elevated at over $400/ton.
The U.S. has to import much of its primary aluminum in the process, incurring Section 232 duty costs, delivery costs and opening the rather closed market to a speculative environment that has seen futures trades outnumber physical trades. The net result is an elevated Midwest Premium cost to consumers compared to western Europe or Japan (the other two main ROW markets).
But there is a change happening to the global aluminum market.

Despite slowing global demand, the change could be supportive for higher prices next year.
Strict imposition of rules within China on primary producers that prevent the construction of new smelters without the closure of older, less efficient and environmentally compliant capacity has put the brakes on capacity growth, Reuters reported.
Chinese aluminum output increased at a double-digit pace over the first part of this decade, the article reports, but growth slowed to just 1.6% last year. In fact, output has actually contracted so far this year, albeit only marginally. Nonetheless, this is the first time Chinese aluminum primary output has not increased since after the financial crisis in 2009.
Meanwhile, demand growth, while a fraction in percentage terms of what it was a couple of years ago, still remains positive. As such, that growth is creating the prospect that any significant further rise in demand could impact the level of semi exports as the domestic market draws that capacity into local consumption.
Much as producers in the ROW complain about Chinese exports, consumers have come to rely on this rising tide of metal to meet demand and keep market prices subdued.
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If even a part of those exports were to be consumed by the domestic market, it could lead to sharply higher metal prices. That result is unlikely this year — but later in 2020, it remains a tangible risk to prices.