Aluminium producers unnerved by falling premia
Their low costs notwithstanding, Indian aluminium makers are treading on thin ice of profitability. Aluminium is trading at a four-year low on the London Metal Exchange (LME). At these prices, large swathes of global aluminium capacity are not recovering cash costs. If the industry here has managed to keep its head above water, it is because of the high premia buyers are paying over the LME cash price to secure physical metal.
In this business, a few groups across the world, including Hindalco, are faring better than the rest, owing to their portfolios of value-added products (VAP). Such products are far less prone to price fluctuations than aluminium, as a commodity. According to Hindalco Managing Director Debu Bhattacharya, pursuing a "focused strategy of value maximisation", the company raised VAP sales four per cent to 2,40,000 tonnes in 2012-13, while aluminium production fell six per cent to 5,42,000 tonnes. The acquisition of Novelis, the world leader in VAP, in 2007 created an ideal environment for Hindalco to seek to make products requiring the use of complex engineering, the first time in India. Soon, its product portfolio would be enriched by the addition of can body stock and ultra-thin gauge foils, resulting from the transfer of machines from Novelis.
The further Hindalco travels along the VAP route, the more it would be shielded from the anticipated falls in aluminium ingot premia. In fact, the premia have remained under pressure due to skittishness about the likely impact of the new warehousing rules LME had proposed on July 1. Such rules would require LME registered warehouses with buyers queuing for more than 100 calendar days to deliver more aluminium ingot than they receive. While these rules are subject to a three-month consultation and LME would take a decision in October, the premia have come under pressure. Moreover, the change of warehousing management rules, if any, would be implemented from April 2014. But the movement of aluminium ingot prices and the premia producers demand for ready delivery since LME announced the proposed warehouse load-out norms shows the market is increasingly turning jittery.
The pace for the Indian aluminium market is set by price movements at LME and the premia prevailing in major markets. In a report, Metal Bulletin said the European spot primary aluminium business was drying up, with premium bids falling short of producers' expectations, as many buyers had decided to wait for "further dips in premium before covering their fourth quarter needs". In any case, since the July LME announcement, duty-paid premia in Europe and the US have lost ground.
Our industry officials are watching with interest the battle of wits aluminium producers and Japanese buyers are now engaged in for determination of premia for the December quarter. In anticipation of a modest demand recovery in aluminium-using sectors, some leading US and European producers are asking for premia of $250 a tonne for shipments to Japan in the next quarter, the same as this quarter. But emboldened by premia falling in the West, Japanese buyers are asking for lower rates. Producers, on the other hand, feel the improving Japanese demand for automobiles and houses and declining aluminium stocks justifies unchanged premia. Arguments and counter-arguments would continue for some time, before the fourth quarter premia likely settle at about $240 a tonne.
Why is there so much focus on premia? It is simply because with LME aluminium prices down about a third since the May 2011 peak of $2,803 a tonne, in premia, smelters have found major sustenance. In the past, producers could demand and get premia well in excess of $300 a tonne, as large volumes of aluminium resulting from supply exceeding demand found their way into LME warehouses. Currently, LME-registered warehouses have stocks of about 5.5 million tonnes (mt). Much of this inventory is tied up in financing deals. The system has worked, as low financing costs have allowed forward sales. In the interim, the low cost of storing is an added advantage. But what forced LME to propose changes in warehouse rules, along with stronger scrutiny by regulators, was the lengthening of queues seeking metal deliveries.
The warehouse reforms would lead to liquidation of LME warehouse stocks. Liquidation would not, however, happen in torrents. The release of stocks, irrespective of the size, would affect market sentiment, leading to a fall in aluminium prices and premia. Reuters has quoted financial services group Nomura saying the changes in LME rules would shave warehousing profitability $127 a tonne in Europe and $82 a tonne in the US. If that happens, there should be a corresponding shrinkage in premia in those two markets. A BNP Paribas official says physical premia are destined to fall "although these may take some years to return to historically normal levels". Nomura doesn't rule out the possibility of LME aluminium prices sliding to a low of $1,500 a tonne, amid stock liquidation. Will this not provide a push to further idling of aluminium smelting capacity?
Source: Business Standard