After reading Stuart’s earlier post regarding a potential fall for aluminum, we decided to drill into Alcoa’s latest earnings announcement to identify some of the small signals which would support (or not support as the case may be) the underlying assertions that the aluminum market may stand ready for a correction. To do that, we turn to Alcoa’s 1st Quarter 2010 Earnings Conference Call powerpoint presentation available here.

The good news when looking at Alcoa revenue by end market, growth appeared in 61% of its segments such as automotive, commercial transport, industrial products, alumina and primary metals. Other sectors still show a year over year decline (e.g. aerospace, Beverage and can, IGT, Packaging, Distribution/other). The realized aluminum price according to Alcoa, increased by 8% whereas alumina price realization increased by 13%.   We won’t spend time focusing on Alcoa’s internal cost reduction initiatives though they also appear quite positive. Alcoa sees demand for flat rolled products increasing in the second quarter based on “modest improvement in aerospace and industrial markets. In addition, Alcoa still forecasts a global demand growth rate of 10% from last year (which isn’t saying much but still, a step in the right direction). Global aluminum supply remains balanced, again according to Alcoa and the surplus of primary aluminum is “manageable. That’s the good news.

The not so good news includes the following 39% of Alcoa’s revenues still come from year over year declining revenue changes including aerospace. Looking at Alcoa’s “earnings bridge analysis (that depicts which variables moved favorably vs. unfavorably quarter to quarter) as one can see volume remains light and energy costs dragged income. (The LIFO allowance fluctuates but is always a negative number)

Source: Alcoa

In all sectors of Alcoa’s business, with the exception of Engineered Products and Solutions, volumes hit performance.

Our conclusion? A high and/or rising aluminum price certainly has a disproportionate (positive) impact on earnings. And though the company appears to have made great strides in its own cost reduction and working capital efforts, overall demand still suggests a worrisome set of signals. Combine that with the earlier post on an aluminum market correction and one can see why the analysts feel the Alcoa earnings announcement was a mixed bag.

–Lisa Reisman

Aluminum is looking vulnerable. Although the market has been in oversupply for at least the last two years and exchange traded stocks have risen to record numbers, prices have been supported by a financing game that goes like this. Banks and large trading houses can buy or take delivery of primary aluminum ingot at spot or up to three months forward prices and sell that metal for delivery 15 months out on the LME. The 15 month forward price has been consistently higher than prices for shorter time frames, by virtue of a strong forward price curve or contango, as the following graph courtesy of the LME shows:

For much of the first half of 2009, the difference between 3 month seller and 15 month buyer prices was 8-9% of the 3 month price, leaving room for a little profit after warehousing costs, insurance and finance if you can access the ultra low interest rates that have been available based on Fed/Central bank rates of 0.25% or so as the banks and major traders can. Major central bank rates have not crept up yet although there is expectation that Fed rates will have to rise later this year in the US if the economy continues to sustain its current promise. But the forward price curve has been flattening as the metal price has risen such that now the difference between 3 month seller and 15 month buyer is just 4%. Even after this weeks drop and compared to the cash or spot price the difference is only 5%. As the margin has narrowed investors have kept the ball rolling by taking metal out of comparatively higher priced LME approved warehouses to store it in cheaper off market premises. The approx US$ 45-50 per ton reduction in costs sustained the trade through the third quarter but towards the end of last year and early this year it would seem the game was winding up.

Signs of spot market weakness are beginning to show with Japanese physical premiums down 5% quarter on quarter to US$ 122-124/ton according to a World Aluminum review of the second quarter contract negotiations. With the US dollar looking much firmer this year than last there is less of an incentive to invest in metals as a hedge against a falling dollar, not that aluminum was a principal beneficiary of that trade, copper rose on dollar weakness more as a result of its stronger fundamentals. Even Rusal’s announcement this month that they are looking to park 1 million tons of aluminum into a physically backed electronic exchange traded fund can be seen in light of the closing of the long term finance window as an attempt to find ways of maintaining production rates in an over supplied market.

Some analysts now predict an easing of aluminum prices this year, a position we took in our Price Perspectives report in Q1. That would be welcome for consumers but a blow to the nascent recovery in the distributor market which has just been getting accustomed to a few months of gradually rising prices and volumes. A drop now would bring demand from distributors to a halt as buyers up and down the supply chain revert to wait and see.

–Stuart Burns

The recent change from the 40 year-old annual price benchmark system for the pricing of iron ore to a quarterly price fix is having ramifications beyond the steel industry. The change has come from the suppliers’ desire to see prices more closely mirror the spot market for these products following several years in which spot prices have exceeded long-term contract prices. The same iron ore suppliers are also major players in the mining and sea-borne trade of other commodities such as coking coal that has also moved from an annual to a quarterly price fixing. Now BHP Billiton is pushing the market to consider a quarterly price fixing for alumina, the bauxite ore to aluminum intermediary, pre-cursor for aluminum smelting. Like iron ore, alumina has traditionally been fixed via annual or even longer term contracts of up to five years and generally at a fixed percentage of the average finished price of the aluminum as reported on the LME. Recently this has been around 13.0 to 13.5% of the three-month forward price of aluminum on the London Metal Exchange. The LME average for March was $2236.50 per ton giving an alumina price of $300 per ton. April’s will be higher, probably closer to $350 per ton due to higher recent aluminum prices, but still some way below spot prices. In fact the benchmark price for alumina has been below the spot price for the last five years and therein lies the problem for the major suppliers like BHP. Every month that spot sales outperform contract sales represents in their eyes a loss of profit running into hundreds of millions of dollars in the $25bn a year alumina market.

In a Financial Times article it goes on to say that it is not just BHP that is suggesting a change to the pricing formula. Major aluminum producers like Alcoa are also getting behind the move. “It is time for the industry to develop a pricing methodology that is reflective of alumina fundamentals,” says Timothy Reyes, president of Alcoa Materials and head of commercial activities for aluminum, alumina and bauxite at the company. He suggests replacing the current system with an index based on spot transactions, similar to the new pricing system for iron ore. “We have had discussions with parties interested in developing this index, and we believe that the number of transactions in the spot market allow a reliable index to be created,” he said. Not everyone agrees however, not surprisingly most of the smelters are strongly against a change seeing it as increasing their risk and almost certainly their costs.

The smelters may have a hard time preventing a change, at least in the longer term. Historically most aluminum producers were vertically integrated from bauxite mine through to finished aluminum products like foil, forged car wheels, window sections and building systems but with the rise of Asian and Middle Eastern producers focused purely on the smelting of alumina to aluminum many producers are sourcing their alumina from third party suppliers. According to the FT, this has grown from 7m tons in 1980 to 35m tons today, and alongside that third party market has developed a spot price for alumina and a sufficiently liquid market for an index. As with iron ore’s development of a spot price being the precursor for change, the article concludes with the observation that the same may be happening for aluminum.

–Stuart Burns

If you are in the aluminum business and are wondering about the increase in Chinese origin plate products being offered for sale you may be interested in an article published this week in Reuters. Recent data suggests the Chinese market is experiencing a significant surplus of primary aluminum. According to the article, stocks in China have increased more than 45% since January on increased production.

Stocks of about 1.6 million tons of primary aluminum, 1.2 times China’s February output, may now be stored in warehouses, fabricating plants and smelters compared to about 1.1 million tons in late January, smelters estimated. An administration official at a large smelter in Henan said some warehouses in Guangdong province and Shanghai city refused to accept new deliveries because they are overloaded with the metal. Apparently a trader in Guangdong’s Nanhai City, one of China’s main aluminum consuming areas, said warehouse operators had asked smelters not to send supplies for storage. More than 300,000 tons of the metal may be stored in Guangdong, he estimated.

It may be the rise in stocks has more to do with the fact smelters stayed open during the February Chinese New Year holidays producing primary aluminum while the fabricators consuming that metal closed down. Daily aluminum output in February this year rose to about 46,714 tons versus 40,710 tons in January and 44,148 tons in December when the monthly output hit a record of 1.37 million tons. Nevertheless consumption has not risen as fast as anticipated and questions are being asked about whether these rising stocks represent a softening of demand and if so could primary ingot find its way onto export markets. Because of duties levied on exports of primary metal it is unlikely ingot will be offered for export the differential between domestic and export prices is some $300 per ton for Chinese smelters, so there is every incentive to hold onto metal and hope it will be consumed. On the issue of softening demand it would appear fabricators may also have excess capacity, even though the economy appears to have grown at 11.9% in the first quarter, rolling mills are offering aluminum plate for export. China’s exports of aluminum plates, sheets and strips rose 106% to 107,848 tons in the first two months of this year. Rolled products benefit from a 13% rebate from the 17% VAT they incur on cost inputs actively supporting exports, but round bar extrusions on the other hand not only incur the 17% VAT but also suffer between a 5 and 15% export duty depending on the diameter of the bars. More varied profiles though are, like rolled products, supported by an 11% rebate making rolled products and profiles viable for export but bar products not.

The increased volume of plate exports could be a reflection of both rising premiums in export markets as those economies recover. Certainly plate premiums have increased in North America and Europe over the last 6 months, and lower domestic ingot prices relative to the LME or world price has allowed Chinese fabricators to compete this year where last year they struggled. Chinese mills are notorious for turning the export tap on and off depending the demand from their domestic market so it will be interesting to see how export volumes hold up and these primary metal stock levels fluctuate over the coming weeks certainly a metric to track going forward.

–Stuart Burns

An interesting looking building is taking shape at the Olympic Park Precinct of Melbourne Australia locally called the Melbourne Rectangular Stadium (MRS) but officially known as AAMI Park after the insurance company sponsor. Let’s get the name out of the way first, Australian Rules Football is played on an oval field so European soccer and Rugby are played on what is known as a Rectangular pitch hence the name as this new stadium will be home to two soccer teams, a rugby league team and a rugby union team plus extensive coaching, administrative and sports injury clinic facilities.

Source: ThyssenKrupp Business Services GmbH

More intriguing is the roof of the new structure, as the photo provided by the steel suppliers ThyssenKrupp Business Services GmbH in Germany shows, the structure is based on the geodesic dome designed by the American architect Richard Buckminster Fuller. This type of dome is made up of many small triangles held together by a fine lattice-like structure. It mimics construction principles that can be found in nature, is extremely stable and can enclose large spaces using comparatively small amounts of material. The panels are made up of a 4 sandwich of thin steel enclosing a foam core giving great strength but low weight, which is just as well since the design calls for 20 foot unsupported spans. The construction method, so the designers claim, uses half the material and hence weight than a conventional cantilever style roof. To provide long-term protection, the steel panels are supplied first with a zinc coating and then a 25 micrometers PVDF coating that is chemical and sunlight resistant to ensure many years of aesthetic quality.

The stadium is designed to seat 30,000 spectators and encloses a 450 x 270ft pitch but only uses 2,500 tons of steel in the roof shell even though the design calls for 280,000 sq ft of cladding. In addition there is 24 miles of custom built aluminum framework as part of the roof structure and 10 miles of roof guttering all the rainwater is collected and recycled into potable water for use in the stadium. Environmental sustainability being a strong part of the case made for the final choice of design according to the local government media material.

Is this the shape of roofs for large span structures in the future? I expect architects and sponsors will be looking to see how the structure performs and whether other construction costs outweighed the lower raw material requirements. But with raw material costs rising and the obvious aesthetic appeal of the structure in its favor one can be sure this won’t be the last.

–Stuart Burns

You are a Somali pirate in your high speed launch roaming the Indian Ocean in search of slow moving tankers or cargo ships. You are a South American drug runner stealthily running across the Caribbean towards the southern states with your cocaine haul. You feel secure in your high speed boat capable of 30-40 knots and lightly armed, large frigates can’t keep up with you or follow close into shore. So imagine your sense of foreboding when this looms over the horizon, bearing down on you at up to 50 knots and capable of firing 2 diameter shells at a rate of 4 per second or short range missiles from up to 24 miles away:

This is one of two new designs for what the US Navy calls its Littoral Combat Ship (LCS), littoral being the area between low and high tide and meant to indicate the vessels shallow water capability. The Navy is pursuing two options, both of which break the mold in terms of design and capability from anything that went before. Naval defines the core capability as a full load displacement draft of 10ft allowing the ships to access very shallow waters. The ships will have a top speed of about 50kt and the range at sprint speed is 1,500nm. At an economical speed of 20kt, the range is 4,300nm.

The first design as above is General Dynamics futuristic high-speed trimaran, based on Austal of Australia designs and experience with vessels like the US Marines’ Westpac Express high-speed transport and the Army and Navy’s TSV/HSV ships. The  Austal design is built at their Mobile, AL yard. The hull  and superstructure are marine grade aluminum, but the trimaran design offers additional stability options, and may help with hits to the ship’s sides under combat conditions.

The second is led by Lockheed Martin and offers a proven high-speed semi-planing monohull based on Fincantieri designs that have set trans-Atlantic speed records. The design will use a steel hull and aluminum superstructure. The Lockheed prototype has required additional bolt-on buoyancy fittings, however, and there have been persistent reports of weight and stability issues.

Unfortunately both designs are riven with controversy and some are questioning whether they really meet the Navy’s requirements. The Navy is calling for 55-60 of these vessels at a probable in service cost of US$600m each. They want to replace 30 frigates, 14 mine counter measures vessels and 12 coastal mine hunters. And therein lies the problem. The LCS is being asked to be a high speed shallow draft mine and submarine hunting jack of all trades. As a result, it lacks the firepower to play an effective role as a conventional frigate, the cargo carrying capacity to field serious helicopter support or the endurance needed by a global naval power and is meeting widespread criticism even from within the Navy. As Naval analyst Raymond Pritchett described the compromises on offer in a Defense Industry Daily article as:

…the LCS is a 3000 ton speedboat chaser with the endurance of a Swedish corvette, the weapon payload of a German logistics ship, and the cargo hold of a small North Korean arms smuggler.

Both yards are building two vessels for assessment and according to Defense News sometime this spring or summer, the Navy will choose one of the designs as the basis for a further 51 more LCS ships. Which way it will go remains to be seen but both teams have had their second vessel canceled and then re-instated after cost overruns and design changes were required. Still as metal-heads we are glad to see a conservative organization like the US Navy pushing design boundaries in this way. In the long run, it will be good for naval ship design. Meanwhile aluminum suppliers must be viewing the project with baited breath. The commercial market for fast catamarans alone spawned enough marine grade aluminum business to stimulate the development of specialist marine alloys by producers like Pechiney, now Alcan, and Hoogovens, now Corus nearly ten years ago. The military market for LCS and the very similar non combatant HSV transport vessels could have an equally beneficial impact on North American aluminum producers in the decade to come.

–Stuart Burns

These past few weeks, some of you may have noticed our more frequent discussion of variables impacting metals prices. Whether you track steel, aluminum or copper prices, everyone wants to know where prices are going and what will push prices in one direction or another. Whether you look at these five metrics that we covered last week or this handful of Chinese economic indicators or news stories saying that Boeing is increasing production and March auto sales show an economic rebound, at least one person sees quite different writing on the wall.

We caught up with Rick Davis, a self-described “numbers geek physicist who runs the Consumer Metrics Institute out of Lakewood Colorado. Davis started his, for lack of a better description, consumer data research firm out of a frustration with the inherent biases in current economic research data. He shared with me some of his thoughts and rather than draw conclusions for you, I’d like to share with you some of Davis’s research so you can make your own decision. But first, what biases does Davis take issue with? He thinks the retail economic indicator “same store sales has two design flaws. The first, the notion of under-reported casualties that same store sales only report the stores that are still around, not the stores that go belly-up. This results in a bias because the data will appear more favorable than the underlying economic reality. He went on to describe Circuit City and Best Buy as an example. When Circuit City went out of business, Best Buy picked up share, which looks favorable from a reporting standpoint and even suggests growth when in fact, Best Buy may only be gaining share left from the void of Circuit City. Rick calls this Ëœsurvivor bias’ (maybe it’s also the proper economic term, I don’t know)

The second issue with economic data that troubles Davis involves the delay in relaying data. According to his site, “Leading Indexes that rely on data published by governmental departments are generally updated monthly several weeks after the month’s end. Often the governmental data includes some estimates and is necessarily preliminary, so a final set of numbers is published yet a month later. Going through the myriad of charts, statistics and analyses that Davis has on his site, one can see why he draws that conclusion. Take a look at this chart below:

The pink line is what the government is reporting but look at where the Consumer Metrics Institute line goes. According to Davis, “production trails consumption. A healthy factory is going to respond to consumer demand. So what explains some of the positive factory/producer statistics including greater capacity utilization?” Davis believes, “producers may be re-stocking but are lagging consumer demand. Upturns in manufacturing may just involve re-stocking and response to consumer demand from the third quarter of last year. It’s hazardous for manufacturers to ramp up production too rapidly.

In a follow-up post, we’ll examine some of the other key economic indicators Consumer Metrics Institute tracks, their own biases and how these indicators square against the rather positive headlines of the past few days.

–Lisa Reisman

Investing in aluminum production has always been an activity for those with deep pockets. New smelter projects are measured in billions of dollars and production capacities for green-field are rarely less than 500,000 tons nowadays. Witness the latest leap of faith, this time by BHP Billiton who is reported to be looking at damming the Congo River to build a 2.5GW hydro plant and building an 800,000 ton per annum aluminum smelter fed by Guinean alumina according to Reuters. The hydro plant alone is expected to cost $3.5bn and the smelter will no doubt be a further $1.5bn+.

This decade will see a lot of new capacity coming on stream. We have previously mentioned Alcoa’s Maaden JV in Saudi Arabia, Century Aluminum is re-starting work on their 360,000 ton geothermal powered plant in Greenland. Rusal is back at full production with further enhancements in the pipeline. Emal in the UAE is aiming at 700,000 tons eventual capacity. Existing plants like Aluar in Argentina are increasing capacity by 10% this year with plans for a further 10% later.

Meanwhile the elephant in the room is China. Production last year came in at just under 13 m tons according to stats from the International Aluminium Institute but capacity is close to 20 m tons. With prices at $2250/ton plus there is certainly no economic reason why that production capacity will not follow the global trend and start up this year.

Meanwhile stocks are at or near record highs on the LME and IAI un-wrought stocks yet prices remain firm and the physical premiums remain high, held up by that gravity defying conjuring trick called long term financing. I am not sure I would be rushing to buy Vedanta’s proposed de-merged aluminum holdings rumored to be coming to market this summer as a spin off entity. Vendanta may have a low cost production in India but even their projections would be hit if there is a substantial correction in the metal price. In the long run, either the price will come down or the stocks will come down, but the level of stocks and the price cannot remain high forever, it defies common sense. The key has been long term financing which in turn has relied on the forward price curve for aluminum on the futures markets remaining at a decent premium to spot, otherwise known as contango. For the time being, there seems no reason for the game to not roll on, but as we know all too well, all good things come to an end eventually.

–Stuart Burns

For any of you aluminum and stainless steel buyers out there, you will not want to miss MetalMiner’s first webinar given tomorrow, Wednesday March 10 at 9:00am CST. The webinar provides an in depth look at the global markets for aluminum and stainless steel and we will be joined by guest host, Tony Amabile from TW Metals who will cover domestic market trends for both metals. This webinar dovetails with MetalMiner’s new Price Perspectives Series, research that examines not just historical data but the drivers impacting prices looking forward through 2010.

As any metal market observer, buyer or analyst knows, the degree of commodity volatility occurring within the base metal, ferrous metal and precious group metal marketplace has never been greater. Forecasting, budgeting and planning have become more challenging as a result, forcing everyone to pay much closer attention to a broader range of factors impacting metals markets. We believe attendees of the event will walk away with the following:

  • a clear understanding of the drivers of current prices
  • the role and impact of China on both metals
  • cross-industry insight into where demand is coming from
  • tips, ideas and strategies for mitigating costs and reducing risk

The registration process takes less than 20 seconds. Please join us on Wednesday. If you have any comments or questions, please feel free to leave a comment here or drop us a line at lreisman (at) aptiumglobal (dot) com.

–Lisa Reisman

Last year we heard from dozens of MetalMiner readers that you would like to see a few metal market overviews via webinar. Based on the feedback we received, our audience appears split between the steel and nonferrous metal market updates. Therefore, we will split events up and stick to a one-hour format until you tell us otherwise. Initially, the webinar will include an approximate 20-minute overview of both aluminum and stainless steel markets. The market overviews will examine raw material costs, global supply and demand, with a special emphasis on Asian demand. Hosted by MetalMiner editors, Lisa Reisman and Stuart Burns the overview will set the stage for a deeper analysis of the US market led by Tony Amabile, Director of Marketing for TW Metals, a specialty metals market distributor and sponsor of the event.

The webinar is a no cost event for attendees and will appear live on Wednesday, March 10 at 9:00am CST. Readers can learn more about the event and register here MetalMiner Perspectives: Q2 Aluminum & Stainless Steel Market Update

About TW Metals: TW Metals has a leading position in the specialty metals market. TW stocks and processes pipe, tube, bar and rod in stainless, aluminum, alloy and carbon, as well as a variety of high alloys such as nickel and titanium. Headquartered in Exton, Pennsylvania, TW has a large distribution network in the U.S. as well as Europe and Asia.

We hope you can join us!

–Lisa Reisman

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