Monthly Archives: May 2013

Arb window to get 5% tougher?

Written by Paul Adkins

News from within the Chinese aluminium industry is that the government is considering resuming import duties on aluminium, in an effort to help consume domestic metal.

At a meeting between industry leaders and government officials, many ideas were floated for addressing the surplus capacity and spare metal that is clogging the industry and depressing the metal price. While industry leaders spoke rhetorically about consolidation and closures of inefficient capacity, their government counterparts offered that the 5% tax may well be re-instated later this year.

China’s aluminium price looks much higher than the price in London, but that’s because China includes a sales tax in the price, where London doesn’t. In order for traders to make a profit selling metal into China (called arbitrage), they must secure metal in Malaysia or other inventory hubs. On top of the metal price, they must pay the physical premium for handling and shipping costs (as much as $250 per tonne), then must pay the freight cost to China. Add Chinese domestic handling and Customs charges, and the sales tax for the sale in China, and the total cost of the trade becomes somewhat higher than for domestic metal. With a 5% import duty, that cost will be that little bit harder to justify.

It isn’t much of a help to the local industry, but when considered in light of the electricity subsidies, strategic metal purchases, cheap capital and easy loans, it becomes part of a much larger fabric of government intervention into the normal operations of the market. But then, who really considers China to be a true market economy? Anyone?

 

Alcoa downgraded - selling assets?

Written by Paul Adkins

The financial press was not short of the headline this morning that Moody’s had downgraded Alcoa’s credit rating to what is rather nastily called “junk” status. This will put more pressure on Alcoa to free up cash to meet interest payments, and make new loans more difficult.

The company has already telegraphed some punches in its efforts to reduce its debt burden and free up capital, announcing its review of 460,000t of operating capacity. That announcement was followed by the closure of two Soderberg potlines at Baie-Comeau in Canada, and casts a shadow over operations such as the Point Henry smelter in Australia. And there are hints of more asset sales to come. A newspaper report out of Charlotte, North Caroline alleges that Alcoa will seek to sell a power station there, while one source close to the company told me that other asset sales are on the cards (though he could not name any.)

 

Cloud over crude prices

Written by Paul Adkins

The European Union is reportedly conducting an investigation into claims that prices for crude oil are manipulated. The claims revolve around the Platts pricing model, in which the trades that occur in the last half hour of the day are used in the index of prices. The investigation involves companies such as Royal Dutch Shell, BP and others.

The US Department of Justice is now being dragged into the investigation, and may launch its own. The Chair of the Senate Energy and Natural Resources Committee recently told a US newspaper, “Efforts to manipulate the European oil indices, if proven, may have already impacted U.S. consumers and businesses, because of the interrelationships among world oil markets and hedging practices.”

Platts, a division of McGraw Hill, appears to have been the unwitting victim of their own tools, as it appears traders were making use of the Platts system to register certain trades but not others.

The price fixing allegations don’t stop at crude oil. The effect of price manipulation at the crude level flows all the way down to the petrol pump, affecting gasoline prices, with the potential to impact inflation and national economies.

Clive to close his portfolio

Written by Paul Adkins

Clive Webber, well-known in the petcoke industry from his 43 years with Conoco Phillips and now the new P66, is set to retire at the end of September this year.

Clive is one of those people who can drill down to the deepest detail without losing sight of the big picture. To call Clive astute would be an understatement.

According to the company press release, Ms Yvonne Reardon will move into Clive’s role, with a 3-month handover.

Way back in 2009, I interviewed Clive for this blog. You can see what Clive had to say about things here. It is interesting to look back at how little things have changed.

Please join me in wishing Clive a long and fruitful retirement.

Xinjiang Smelter Tour

Written by Ken Wangdong

Last week, we visited 4 aluminium smelters and one carbon plant in Xinjiang.

When the taxi just crossed the border of downtown in Wulumuqi (Editor’s note: Urumqi in English - Wulumuqi is the Chinese version of the city’s name), the capital of Xinjiang Province, we were shocked that the traffic was even heavier than in Beijing. Due to road maintenance, only one way is available to go through downtown which we were told normally takes more than 1 hour. We were “fortunate” to experience the heavy traffic each evening in order to return to our hotel.

Similar to other capital cities in China, Wulumuqi looks good from the outside and you can see that the local economy is burgeoning. The State government is busy pursuing investment to improve GDP growth by offering cheaper energy or other forms of preferential policy, but VAT refund is excluded.

The 4 smelters we visited were located in three separate industrial parks, and are all giants in the industry with a typical design capacity of 1.6 million tpy and one with 2.4 million tpy. Captured power plants, anode plants and downstream processing mills are included in each project to take advantage of the cheaper coal, natural gas and benefit of circular economy. All of them entirely or partly adopt advanced Chinese technology, such as 500KA potlines designed by SAMI. Wind turbines are pervasive there, replacing water cooling towers to deal with the lack of water. So far all of them are operating smoothly and also busy working on sequential construction of their Phase II, III.

Everybody is seeing an apparent aluminium boom in Xinjiang, but who is thinking about the underlying issues there?

1. Unsustainable policy

Most companies invested in Xinjiang were promised by the local government that they would benefit from preferential policy but at least one confirmed they were cheated. This company invested there on the premise that the local government guaranteed natural gas supply with a very low cost, but after they invested there the government ate their words.

Another interesting story we heard was about overhearing two government officials chatting. One man was concerned that it was immoral to persuade companies to invest and then cheat them, but the other said, no matter what way you choose, the first priority is getting them to invest here.

Due to the unsustainable policy, CPIC finally decided to suspend their investment plan in Yili, Xinjiang.

2. Transportation and climate limitation

The distance from Xinjiang to the central and east coastline is extremely long which means large amounts of freight will be wasted. This freight will largely offset the savings from cheap energy. Other costs also stem from this limitation. For instance, one smelter who doesn’t have a captured anode plant is now facing a big headache on dealing with butts. Without recycling butts, the carbon cost is quite high.

Limited transportation facilities is another severe problem smelters there have to face. As a large amount of fruit is transported via railway, especially during harvest time, no railway station likes to discharge dirty petcoke or other carbon products which could contaminate food.

The freezing winter is another shortcoming of Xinjiang. During winter, protecting anodes from cracking will definitely become a major concern. However, after a captured anode plant is built up, this risk will reduce.

Considering the above issues, we will probably see seasonal fluctuations on both aluminium price and carbon price. For instance, aluminium transportation will be suspended during harvest time. After then, large amounts of aluminum destocking will surely impact the market. Smelters have to stock up from early August to prepare for winter. We may see intense demand during that period which will drag up the carbon price.

3. Unwillingness to have long-term operations

We heard some holding companies are also sniffing the opportunity in Xinjiang to invest in the industry. However, they were much more concerned about capital returns rather than long-term operations in Xinjiang. One of them who is setting up a smelter is seeking a partner to build captured anode plants without spending more money. Companies with aluminium background may have a better contribution to this industry than those just trying to make a buck.

Xinjiang’s debut is the icon of structural reform in the Chinese aluminium industry. This will absolutely lead a campaign on optimizing the resource allocation. However, unbalanced economic structure and external limitations are telling us that the Chinese aluminium industry has a long way to go.

AZ China at LME Week Hong Kong

Written by Paul Adkins

If you are planning on attending LME week in Hong Kong at the end of June, be sure to attend the Friday morning session. I will be giving a paper on China’s aluminium industry, and answering questions.

If you would like a meeting during the week, please feel free to contact me here at AZ China.

When sunny days return for aluminium companies

Written by Ken Wangdong

Aluminium? That’s a word usually associated with ‘death’ in the base metals space right now. The overcapacity situation is well documented and well known. Much of that overcapacity stems from China’s tremendous buildup over the last ten years. Invariably, the aluminium equities have not been terribly rewarding since 2011. Price on the SHFE has just got calmer in recent months; but more recently, macro risks are resurfacing to blow into the faces of the executives.

So is it over for aluminium? When do investors get back onto the aluminium wagon? Let’s suppose the post 2011 deflation is due to overcapacity in China and in ROW (Rest of the world). The cyclical nature should tell us that the overcapacity will need to either be digested by increased demand, or simply close down. On the demand side, we know recovery is just a matter of time, although the timing could be vastly different depending on the global and Chinese economic situations. Recovery will help to digest some overcapacity; the rest will need to close down due to aluminium price deflation. We are seeing some of those close downs right now globally and in China. So naturally, the time to get back onto the wagon is right after the ‘rebalancing’. The assumption here is of course that China does not fall off a cliff and the world gradually returns to prosperity after the current global economic turmoil.

Depending on the timing of that anticipated rebalancing, opportunities will present itself through the aluminium equities once more. Of course the investor would have to search through a variety of companies to get a good proxy for aluminium. Broadly speaking, all major aluminium companies such as Alcoa, Rusal and even Chalco and Nalco move with aluminium price at various degrees. With a good proxy at hand, the investor may find a good resurgence in the price of the underlying commodity and in the company’s shares. Without providing a forecast on the exact date for that anticipated moment, the investor could assume current prices as low, some ‘fishing’ may not be a bad idea. Then again, it depends on how far away we are from that rebalancing moment.

Perhaps, what is more useful to know is that the said recovery in price will be subject to dismissing marginal return. The recovery in equity return adjusted for inflation diminishes quickly over a 2-3 year window. The moderating growth in China will start to temper that stream of return in the longer run.

Unfortunately for the investor, global macro risks including China continue to cloud the judgment on timing. But fortunate for the investor is the fact that the general trend is currently positive, therefore, current aluminium equity prices may be deemed low given the said scenario. While the current focus is on sectors other than the bearish aluminium sector, one could expect great returns when the sector rebalances, and the correct company can provide the exposure to that potential.

 

From commodities to the Aussie dollar

Written by Ken Wangdong

We have witnessed the beating of the Aussie in the last few weeks. The market darling has been supported by a variety of positive factors until recently. Some of those positives for the Aussie included strong fundamentals in the Australian economy; a good proxy for China’s growth; a strong proxy for commodities and a place where international capital desired to find a home.

Much has changed since just a few weeks ago. China is showing clear signs of struggle in its current recovery, the overcapacity in China’s secondary manufacturing has meant its adjustment process will demand less commodities. The fundamentals of the Aussie economy have also been on shaky grounds. A shrinking mining investment sector, a difficult labor market have meant fading consumer confidence, which will not support the private consumption dominated economy. The RBA, with good knowledge of the current weakness slashed rates to provide support.

The Australian dollar finally dropped below parity to the US dollar, reflecting a bearish view on the Australian economy; moreover, the selloff was in response to interest cuts and a broad belief that China’s demand for commodities will weaken.

We have discussed the global supercycle in past writings. The global supercycle to us, means a chain effect that started with a slowdown in the advanced economies due to the end of a long credit cycle. The slowdown in advance economies undermined the export models of manufacturing economies such as China, whose internal overcapacity combined with the failure of the export model to translate into lower demand for commodities. This invariably depresses the hard commodity exporters. If the supercycle framework is true, we can assume a structural downgrade for the demand of commodities from manufacturing economies. The current level of the Aussie dollar seems to reflect that bearish viewpoint.

Iron ore price could be a rough proxy for the Aussie dollar. We have simplified the many variables that may affect the Aussie dollar here, but iron ore price does reflect an overall demand picture. Here, the focus is on global demand and China demand in the coming years. In the past, iron ore pricing has been a strong one; that is now turning, towards a softer pricing mechanism since demand is softening.

The outlook for Chinese demand is generally a positive one if we take a forward five year view. However, there is a structural slowdown in Chinese demand for metals. This simply means the outlook for metals is generally positive; however, some overbought sectors may suffer softer pricing going forward. Iron ore is likely to be a soft one. The Aussie dollar will gain when its economy does better, but it will be softer than before. In our view, the underlying structural change between China and Australia has already begun. A depreciation of the Aussie dollar will no doubt aid the adjustments in the Australian economy.

Our view at the current time is that, the Aussie dollar is a little beaten down than its fair value.

League ladder

Written by Paul Adkins

Our colleague Ji Yuan has prepared a table of the who’s who of aluminium smelting around the world, in response to my post of earlier today, and in response to the general question that Andy Home of Reuters asked: “Alcoa may have rung the bell for round two but the key question is how many others heed the call.”

Company Capacity (mt)

Rusal 4.6

Alcoa (ex Ma’aden) 4.3

RTA/PacAl 4.3

Hydro 2.06

Gov’t of Dubai 1.4

Vedanta/Sterlite 1.4

BHP Billiton 1.3

Century 0.8

Ma’aden JV 0.74

Bahrain 0.7

Votorantim 0.47

Nalco 0.47, followed by the likes of Tajikistan, Aluar and so on.

It’s a good thing that she did prepare this table, because it helps me realise that I forgot a couple of key players in my post this morning. It is easy to overlook that India has an aluminium industry that is struggling with bauxite and alumina issues, as well as the logistical nightmares created by the lack of infrastructure in that country.

It starts to become conceivable that we transition to a situation where aluminium is produced in major hubs, such as Quebec and the Middle East, with the majority of countries importing their requirements. Perhaps countries such as Australia, New Zealand, Brazil and others must forgo their metal capacity.

But the problem with any scenario that calls for production cuts is that too many of the companies outside the “million tonne club” are pure play aluminium companies. For many countries, aluminium smelting is a vital industry, one that provides a base load for electricity generation, jobs, export income, and a metal that is an important contributor to the country’s strategic and security priorities.

So, besides India, Andy Home’s question remains - who exactly is going to take the pain?

 

 

Capacity cuts - from where?

Written by Paul Adkins

Andy home, a commentator with Reuters, recently wrote an excellent article looking at the announcement from Alcoa that Baie-Comeau would lose its two Soderberg potlines, amid a general review of 468,000t of capacity. Alcoa’s announcement parallels that of Rusal, which is taking out 300,000t of capacity.

In it, he posed the question,

Alcoa may have rung the bell for round two but the key question is how many others heed the call.

But who exactly can be considered a candidate to heed the call?

Alcoa has a little over 4 million tonnes of smelting capacity, so their cuts represent roughly 10%, once all cuts are done. Rusal’s haircut represents about 6%-7% of their capacity. Outside China, the next biggest corporate player is Rio Tinto Alcan. Next on the list Norsk Hydro and BHP Billiton, then the only other member of the “million tonne plus” club is the RTA offshoot Pacific Aluminium. Beyond them, you run into single site mega smelters such as Dubal, Alba and later this year EMAL, followed by smaller companies such as Noranda, Ormet and Century.

It is difficult to see how the smaller operators can be expected to take out enough capacity to make a difference, without wiping out shareholder value. And the Middle Eastern bloc are running at sufficiently low cash cost that they are even considering increasing capacity, not cutting.

That leaves 3 companies and 4 groups of assets in the spotlight. With the exception of PacAl, which is a subsidiary of Rio, the three companies are all multi-commodity players, as opposed to the likes of Alcoa and Rusal which have only aluminium in their portfolio (Rusal has a small investment in nickel and the Rusal holding company has other interests.)

RTA has some European assets which could definitely feel the knife, but their North American plants have the benefit of low energy costs. Likewise Hydro, which enjoys low electricity costs in Norway, and has the JV in the Middle East. BHP Billiton has already signalled that their aluminium assets are under review. PacAl has some of older, higher cost assets in Australia/New Zealand, in an environment laden with disadvantages - strong currency, high labour costs, carbon tax and so on.

So if I was a bookmaker, I would probably run a book along the following lines:

Favorite: RTA Europe to provide a small contribution

Second favorite: BHP Billiton to make a false start - announcing a spin-off of assets ala RTA and PacAl

The rest of the field - won’t even make it to the starting barrier.

Dark horse - Alcoa to lap the field and extend its lead in the Capacity Reduction Stakes.