Aluminium: Fork In The Road With Risks To The Downside

BMI View: Going into 2014, we believe aluminium prices face a crucial juncture. Global overcapacity has resulted in production outpacing consumption since 2005, leading to sustained surpluses and in recent years, weaker prices. With the metal currently trading below US$1,800/tonne, prices are below production costs for some firms, and our core view is that further supply rationalization will lead to some price support. That said, two key downside risks loom large. These are LME reform and the potential for an increase in Chinese exports.

Aluminium prices remain persistently weak, and the next quarter is likely to give significant clarity as to the metal's direction as the effect of production cuts and LME reforms on the global aluminium market becomes clearer. In October 2013 we revised our 2014 aluminium price forecast downward to US$1,900/tonne, noting persistent global overcapacity and potential LME reforms, since approved, that could bring more metal onto the market.

For now, we are expecting some stabilisation in prices over the coming quarters. Though aluminium prices are currently trading around 5% below US$1,900/tonne, we note that according to various industry estimates, sustained prices below US$1,800/tonne renders significant amounts of production unprofitable, with costs exceeding prices. Therefore, embedded into our price forecasts is the assumption that announced supply cuts by Alcoa and Rusal will be forthcoming, and that other companies may follow suit in curbing output. However, given significant overcapacity in the global aluminium market, we believe further supply cuts will be needed to result in a sustained rally in prices. Far more drastic cuts among western producers would be needed to fully equalize market supply and demand. Indeed, global production, excluding China, grew in the first three quarters of 2013, driven by increases in production in Germany, Qatar, the UAE, and Canada. Production in these four countries made up nearly a quarter of global refined production ex-China during the period. Growth in Germany grew 18.2% from the same three quarters in 2012, while Qatari production grew by 14.7%. Canada and the UAE saw more muted growth of 9.7% and 4.7%, respectively. While Germany remained a significant net importer of the metal, the other three all remain large net exporters, further adding to the global surplus. We note two factors that present major downside risks to our price view:

Aluminium Continues To Underperform
Price Ratio: Aluminium/S&P GSCI Industrial Metals Index

BMI View: Going into 2014, we believe aluminium prices face a crucial juncture. Global overcapacity has resulted in production outpacing consumption since 2005, leading to sustained surpluses and in recent years, weaker prices. With the metal currently trading below US$1,800/tonne, prices are below production costs for some firms, and our core view is that further supply rationalization will lead to some price support. That said, two key downside risks loom large. These are LME reform and the potential for an increase in Chinese exports.

Aluminium Continues To Underperform
Price Ratio: Aluminium/S&P GSCI Industrial Metals Index

Aluminium prices remain persistently weak, and the next quarter is likely to give significant clarity as to the metal's direction as the effect of production cuts and LME reforms on the global aluminium market becomes clearer. In October 2013 we revised our 2014 aluminium price forecast downward to US$1,900/tonne, noting persistent global overcapacity and potential LME reforms, since approved, that could bring more metal onto the market.

Testing Support
Three-Month LME Aluminium, US$/tonne

For now, we are expecting some stabilisation in prices over the coming quarters. Though aluminium prices are currently trading around 5% below US$1,900/tonne, we note that according to various industry estimates, sustained prices below US$1,800/tonne renders significant amounts of production unprofitable, with costs exceeding prices. Therefore, embedded into our price forecasts is the assumption that announced supply cuts by Alcoa and Rusal will be forthcoming, and that other companies may follow suit in curbing output. However, given significant overcapacity in the global aluminium market, we believe further supply cuts will be needed to result in a sustained rally in prices. Far more drastic cuts among western producers would be needed to fully equalize market supply and demand. Indeed, global production, excluding China, grew in the first three quarters of 2013, driven by increases in production in Germany, Qatar, the UAE, and Canada. Production in these four countries made up nearly a quarter of global refined production ex-China during the period. Growth in Germany grew 18.2% from the same three quarters in 2012, while Qatari production grew by 14.7%. Canada and the UAE saw more muted growth of 9.7% and 4.7%, respectively. While Germany remained a significant net importer of the metal, the other three all remain large net exporters, further adding to the global surplus. We note two factors that present major downside risks to our price view:


Although China is only a very modest net exporter of aluminium at present, we see a risk that exports from the country could rise in the coming quarters, exacerbating global market slack. Chinese aluminium production has expanded significantly over the past year, though the country consumes most of its production. In the first three quarters of 2013, Chinese refined aluminium production rose 7.6% over the previous period in 2012. However, China's aluminium market is largely self-contained, with domestic consumption amounting to slightly over 99% of domestic production. China's relative small footprint in global aluminium markets is also apparent. Between January to August 2013, Chinese exports accounted for just 2.7% of global exports, while Chinese imports made up just 1.6% of global imports.

Still Going Strong
Global - Aluminium Production & Percent Change

Given Chinese growth in aluminium production capacity, we note the potential for the country to expand exports abroad, possibly putting downward pressure on global prices. We recently wrote that despite announced supply cutbacks announced by some western firms, increases in Chinese production over the coming quarters may well exceed such cuts, leading to increasing global supply ( see ' Aluminium Equities: Not Out Of The Woods Yet,' December 5). Significant Chinese surpluses, which we believe are likely given our below consensus view on Chinese fixed asset investment in 2014, could result in greater volumes of cheap aluminium shipments from China entering the global market. This would mirror the trend that has already been playing out in the global steel industry, where cheap Chinese steel exports have been putting pressure on other global producers. China is the world's largest aluminium producer, at 44% of global output in 2012, and the commissioning of new smelting capacity in the country could further enhance market supply despite the exit of high-cost production in western markets. It is estimated that around 10mn tonnes (mnt) of annual production capacity (or 20% of global aluminium output in 2012) could be built in western China between 2013 and 2015 as the coal-rich Xinjiang province is being transformed into an aluminium hub.


Recently approved LME reform also pose a downside risk to prices at the end of Q114 when new regulations are set to go into effect. The reforms, which also aim to reduce premiums for immediate physical delivery, may lead to more metal coming onto the market. We acknowledge that much remains unclear, and highlight the issue as causing uncertainty within aluminium markets. Though it remains to be seen how much more metal would likely be released to end users, we highlight upcoming reforms as likely being deflationary in effect, adding supply to an already bloated global market at a time when aluminium consumption growth is slowing. Indeed, we see global consumption for refined aluminium averaging 3.3% per annum through 2017, significantly lower than average growth of 6.1% observed from 2003 to 2012. This in turn leads us to forecast persistent surpluses of over 1mnt through our forecast period.

Surpluses To Persist
Aluminium - Global Production Balance (LHS) & Stocks-To-Use Ratio (RHS)

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