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20 August 2013

Winners and Losers in the Aluminium Stakes

Since LME aluminium warehousing hit the headlines and the lawsuits started to be flung around, premiums have begun to soften across major markets. Whether it’s the lawsuits or the proposed increase in daily minimum load-out rates that is the cause is not really clear, but what is generally understood is that one or other – or both - of those changes will almost certainly sharply reduce the incentives offered by warehouses to obtain material.
Good for Consumers

Now, that looks good for consumers, particularly since it is specifically the premium (as opposed to the total price) that they have been exercised about over recent months. If the warehouse incentive drops, it’s logical to assume that the physical premiums will as well.

Mixed for Warehouses

For the warehouses, the effect is not completely clear. For sure, it will improve their cash-flow in the short-term, because they will not be paying out so much, but at the other end of the trade, the result will not be obvious until we see how the withdrawal of metal actually goes. If we heed the queues as they are at present, we would expect to see the stockpiles wind down; but, since most informed observers would probably agree that much of the queue is created by metal ostensibly required by non-consumers, it is by no means obvious that that will be the case. It is perfectly possible for large stocks to be in warehouse without any artificial queues keeping them there. If the truth of the supply/demand balance in aluminium is such that there is a genuine surplus of the metal of the size of the current stockpile, then there is no reason to expect the stocks to decline. In those circumstances, consumers will pay a lower premium and warehouses – although obviously without the certainty of the queue-inspired money machine - may also end up seeing improved returns.

The big Losers

The big losers, of course, would be the producers. They would see the incentive they are paid to put metal into storage reduced, a corresponding decline in physical premium and unless demand were to pick up, no improvement in the basic underlying price. In order to stimulate better prices, something else has to happen as well.

Most informed observers would agree that the range of applications for aluminium is growing – its combination of lightness, strength and formability puts it in a strong position vis-à-vis many of its competitor materials. So it’s fair to assume that as (or if) and when global economies truly begin to grow again, aluminium should be a substantial beneficiary.

Brooding Stockpile

But if only it were as simple as waiting for growth to solve the problem. Sadly, it’s not. First, there is the stockpile itself, which sits in the market like the brooding presence of problem-free smelters in Europe and the USA. That metal is there (and given a resolution of the current warehouse problems) available; no smelter problems, no power outages, no production hiccups.

Secondly, there is the question of overcapacity in the market. Aluminium producers know this; at roughly the same time as its CEO predicted higher prices ‘very soon’ (May/June 2012), United Co Rusal also said it would be cutting production by 600000mt/year. That was later revised to 300000mt, but the reality, I believe, is sub-100000mt. There are supposed to be further steps towards the total by the end of this year.  UC Rusal are not alone; others have been painfully slow to reduce production. 

Now, I fully understand that governments do not want to see smelter closures, particularly in times of economic slowdown, and neither do the smelter operators; indeed nobody, apart possibly from some fringe eco-crazies, wants to see modern, effective manufacturing plants sitting idle. I have every sympathy with the management of producers who will try almost anything to avoid closure, but it’s getting very close to the time when the industry has to face reality. 

Has the game been worthwhile? Has the low price/high production equation been better than what would probably have been a higher price/lower volume one? We will never really know, but the truth is that the much-maligned warehouse trade has been the reason why the aluminium industry has been able to defer making the painful decisions since the financial crisis hit; with the prospect of that trade falling out of favour, the need to make those decisions gets closer and closer with each passing day.

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