Aluminium Analysis and Forecast Q4 2013
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Aluminium prices set a low at $1,758 per tonne late in June and have since largely oscillated sideways, although there was a significant 10.9 percent short-covering rally in August that was prompted by the combination of better-than-expected data out of China and some dovish comments from the Fed. The rally did not last and prices quickly returned to lower levels, which we take as a sign that there is not much appetite or, indeed, a need to chase prices higher. Given the plentiful supply, high levels of inventory and only limited production cuts so far, it seems likely that the upside potential for prices will be limited to bouts of short-covering.
Fundamentally, prices should head lower - we feel they will end up doing so - but for now the mechanics of the LME and abundant and cheap liquidity are enabling sufficient metal to be kept off market to underpin the market’s price structure. How long these factors remain in force is debateable - there are numerous crosscurrents at work that could bring about meaningful change. Overall, the demand outlook for aluminium remains second to none, but the market is in chronic oversupply as it has been for seven years and market forces are likely to change that before too long.
Despite being in a supply surplus, there seems to be a floor price in the market between $1,760 and $1,770; the market trades most of the time either side of $1,800. Proposed rule changes to LME load-out rates led to lower physical premiums, which in turn are squeezing producers’ margins, but so far premiums have not fallen to the extent that they are sparking additional producer cuts. Quite the reverse. Recent warrant cancellations have lengthened queues in Vlissingen and Detroit and boosted premiums to the $190 area again, following their fall in the immediate aftermath of the LME consultation document. We have also seen a spate of announcements of Western production cutbacks which have had the effect, however temporary, of creating a stable-to-more bullish sentiment. Given the fact that Chinese capacity has been increasing strongly, this sentiment is liable to be relatively short-lived.
That said, with most of the cancelled warrants owned by financial players rather than by consumers, any acceleration of load-out rates is unlikely to increase availability to consumers unless exit queues drop dramatically. For now, enough of the supply surplus is being kept off market to underpin LME prices and the presence of a full contango means metal can still be financed profitably. This suggests the practice of restricting availability to match demand and support prices will continue.
Summary of outlook for 2014 Our view for 2013 has generally been for a rangebound market with a slight downward bias; we will keep this outlook for 2014. China and the US remain the regional bright spots, although Chinese production is ramping up rapidly, albeit regionally subsidised by energy deals and SRB support, there is a danger of increased exports of semis. We have no quarrel with the outlook for aluminium demand but there is a risk that circumstances might change - should less metal be held off market, prices may fall.
Needless to say, falling prices are likely to lead to more pronounced cuts to output, which we feel the industry badly needs for the long term health of the industry. Although cuts would be a bullish sign, idle capacity would restart if prices were to rise too quickly before the excess inventory has been drawn down, so perhaps prices will hold down for longer than many in the market expect (if they expect lower prices at all, that is).
Factors that could bring about lower prices include regulatory rulings, reduced liquidity or a higher cost of money. In the US, the CFTC and the Department of Justice are investigating aspects of the metals market to see if rules and anti-trust laws are being broken and the Federal Reserve is reviewing whether banks should be allowed to trade physical commodities.
An eventual tapering and unwinding of quantitative easing (QE) is also likely to reduce liquidity in the financial system, which might mean banks have less liquidity at their disposal to carry on doing financing deals. The opportunity cost of financing metal might rise. In addition, as liquidity is drained the cost of money may well make financing deals less viable.
So there are numerous potential developments that might lead to the practice of holding metal off market grinding to a halt, which in turn is likely to see prices realign with fundamental drivers.
Supply outlook Aluminium production is at record levels despite the fact that a considerable volume of output has a higher cost of production than current prices. This suggests that marginal producers must have been well hedged but high physical premiums have also helped producers obtain a higher price for their output. Interestingly, rallies in aluminium prices have been short-lived, suggesting that any rally is seen as an opportunity to put on more hedges by producers. This practice is likely to continue.
In the first eight months of 2013, primary global aluminium production recorded by the International Aluminium Institute (IAI), including data for China, was 32.901 million tonnes, up 3.9 percent on the 31.672 million tonnes produced in the same 2012 period. The daily average rate of production in the January-August period was 135,438 tonnes, which was higher than the 130,583 tonnes per day seen over 2012 as a whole, so the picture is one of rising global production, although regionally the picture is more mixed.
Production is rising in Africa, China, the Arabian Gulf, East and Central Europe and North America and it is falling in Oceania, South America, Western Europe and Asia (ex-China). Collectively, production in the world ex-China totalled 17.06 million tonnes in the first eight months of the year period, down from 17.131 million tonnes in the same period of 2012 - all the growth is in China, where production climbed to 15.841 million tonnes in the first eight months of the year from 14.541 million tonnes a year previously.
What is interesting is that very little primary production is exported from China despite all the growth there, although exports of semis are on the rise. Therefore, some of the new production is being exported in the form of aluminium products; this might become a bigger problem for Western smelters as capacity continues to build in China.
Despite low prices, there seems to be no stopping the growth in aluminium capacity in China, with new capacity tending to be built in China’s western provinces where cheaper energy is available. Aluminium smelting capacity in China in 2013 is estimated to be around 96,775 tonnes per day, while production is running at 66,500 tonnes per day, which highlights the extent of overcapacity. This compares with capacity in the world ex-China of some 76,100 tonnes per day and where production is running at 69,300 tonnes per day. China’s new government says it plans to cut investment in areas where there is overcapacity, so it will be interesting to see if it manages to wrest control of the industry away from local governments.
Non-Chinese production cuts of 760,000 tonnes per year have been announced this year but this will be insufficient given that the market is already in a surplus and more capacity is being added. New capacity outside of China is expected to increase some 600,000 tonnes per year next year, with EMAL ramping up output at its Al Taweelah smelter in Abu Dhabi ahead of schedule, Hindalco stepping up output at its 360,000 tonnes per year Mahan smelter and the Ras Az Zawr (Ma’adan) smelter in Saudi Arabia also ramping up output from 237,000 tonnes this year to 630,000 tonnes next year and 740,000 tonnes in 2015.
Although China is cutting output - smelters agreed earlier this year to suspend 1 million tonnes per year of capacity, including 380,000 tonnes per year at Chalco, 150,000 tonnes per year at Yunan Aluminium and 120,000 tonnes per year at the Xinheng Group - these are dwarfed by expansions. In 2014, an extra 3.86 million tonnes per year is scheduled to come on stream so we wait to see if the government’s attempts to curb new capacity are effective.
In 2013, production is expected to rise 2.2 million tonnes, of which some 1.8 million tonnes is expected from China and 0.4 million tonnes from outside China. In 2014, we expect production to rise 3.0 million tonnes, with around 2.1 million tonnes coming from China and 0.9 million tonnes from outside China. But these figures may well be revised downwards because we expect cuts to output.
Demand outlook Demand for aluminium is particularly robust considering the state of the global economy but the metal is seeing organic growth and is gaining market share from numerous other materials, including copper, steel and glass. Being a light metal and a relatively cheap one, it helps manufacturers produce more efficient and environmentally friendly products. So aluminium is winning market share from galvanised steel in the transport industry and copper in the electricity cable industry; it is also making inroads into the bottling industry because aluminium bottles are much lighter than glass bottles, which saves on shipping costs.
Demand is also strong. The aerospace industry is doing well, as are the auto industries in China and the US, although vehicle sales in Europe remain depressed - data for September showed sales were at their lowest since 1990. In addition, capital flight, in anticipation of QE tapering, and tougher times in many emerging markets are likely to weigh on auto sales in these regions.
There are also some concerns that auto sales in the US may start to suffer as rising bond yields force up the cost of vehicle financing. Sales in September slowed to an annualised rate of 15.3 million units from 16.1 million units in August but whether this is a blip in the data or the start of a period of weaker sales remains to be seen. The construction sector in the US had become a stronger growth area for aluminium - earlier in the year it looked as if the industry was picking up momentum - but recent data has shown that growth has slowed. Housing Stats in
August rose 0.8 percent to a seasonally adjusted annual rate of 891,000 units and building permits declined 3.8 percent to 918,000. While this could be a dip in the data, the fact it coincided with a time when bond yields, which affect mortgage rates, were on the rise may be a harbinger of how the economy could be affected once tapering begins. In China, fixed asset investment (FAI) in construction, railway networks and power distribution are helping to restart the investment cycle. In the first eight months of the year, FAI climbed 20.3 percent; within that, construction climbed 24.2 percent. Although we expect aluminium demand to remain robust, we are concerned that on a global level, less liquidity in the financial system and measures to tackle debt are likely to weigh on economic growth.
We have already seen capital flight in emerging markets in anticipation of QE tapering; when tapering actually starts, the impact could intensify. So we have lowered our expectations for global demand growth in 2013 to 6.3 percent from 7.0 percent earlier - we feel these headwinds will limit growth to six percent in 2014.
Chinese trade Primary aluminium net trade in China dropped 73 percent in the first eight months of the year, with imports slipped to 150,000 tonnes from 400,000 tonnes in the same period in 2012. Exports remain relatively constant but are insignificant given the size of the market. Imports of bauxite remain strong at 46.4 million tonnes in January-August compared with 28.9 million tonnes in the same period in 2012, although alumina imports dropped 38 percent to 2.0 million tonnes from 3.2 million tonnes in 2012. The run-up in bauxite is no doubt in anticipation of tighter supply next year when the Indonesian export ban comes into effect. We would not be surprised if this trend continues; indeed, the market may get more concerned generally about China’s production capability next year if Indonesia implements its ban in full. Still, China has broadened its bauxite supply base in recent months and has built alumina capacity near domestic bauxite supplies.
LME stocks changed direction in July - having climbed to a high of 5.486 million tonnes aluminiumstocksin mid-July, they have since fallen to 5.328 million tonnes. This change in trend, however, is not thought to reflect a swing to a supply deficit but market mechanics tied into proposed changes to LME load-out rates.
The LME announced its proposed changes in early July and if the new rules are implemented then that could shorten the exit queues and in turn that would mean metal might not stay in warehouses as long. Based on that, warehouse companies have reduced the incentives they were offering to attract metal into warehouse so less metal has been delivered in. Inflows into LME warehouses averaged around 11,000 tonnes each day in the first half of the year; this has dropped to an average of around 5,200 tonnes per day since the LME announcement.
If load-out rates increase, more metal could hypothetically leave warehouses, in turn lowering physical premiums. But as things stand, most of the cancelled warrants are owned by financial institutions looking to take metal out of LME warehouses to finance it in cheaper non-LME warehouses. In turn, a faster drawdown of LME inventory could give the impression of a tightening market but this would be misleading if the metal was merely going into other warehouses.
It is now very difficult to gauge how much metal is held outside exchange-registered warehouses given the complicated movement in stocks but it is generally thought there are likely to be around 4-5 million tonnes of unreported stocks. The combination of these and exchange stocks means there is around 10 million tonnes of aluminium stock. This metal poses little threat to the market while it can be financed, as is now the case, but that would change if any of the components that make financing viable change. A change in regulations that disqualifies banks from owning commodities, a closing of the Fed free-money window, less liquidity, a pick-up in interest rates/bond yields or higher warehouse rents due to regulatory changes could all alter the dynamics of financing metal.
Balance As things stand, the aluminium market is expected to remain in a supply surplus as new capacity comes on stream at a faster pace than production is idled. We expect demand to remain healthy but the tapering of QE and later reduction in liquidity as the Fed’s treasuries mature, could produce headwinds for economic growth in the US and in emerging markets in 2014.
So far this year, prices have held up well despite another year of supply surplus. In January-September, cash aluminium prices averaged around $1,870 per tonne. For the fourth quarter, we are looking for prices to trade in the $1,775-1,900 range and to average $1,830 so we will raise our forecast for the average of this year to $1,860. Looking to 2014, we forecast an average price of $1,800 given another year of supply surplus and the presence of large stockpiles that might become less tightly held, making the market look more vulnerable. Global Supply/Demand Balance in Primary Aluminium (million tonnes)
Conclusion Aluminium demand remains robust but contagion from a possible winding-down of QE next year is likely to weigh on global growth. The supply side of the equation is, however, a potentially more bearish factor - we feel the developments on QE, LME load-out rates and tighter regulation will end up making it harder for producers and traders to hold metal off market, which would raise supply and lower prices. Since prices are already well into the marginal cost curve, lower prices are likely to trigger production cuts. Generally, we are looking for prices to trade in a $1,750-2,000 range but there may well be downward spikes below $1,750 if the market gets nervous about extra availability.