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Aluminium; parallel universe or the same one? Andy Home

By Andy Home

LONDON (Reuters) - China's production of aluminium cranked up several gears last month to an annualized 22.42 million tonnes. It was the second-highest run-rate ever, eclipsed only by what may have been a holiday-distorted output figure in February.

The world's largest producer churned out 10.54 million tonnes of the light metal in the first half of this year, according to figures from China's Nonferrous Metals Industry Association published by the International Aluminium Institute (IAI).

That represented year-on-year growth of almost 11 percent, pretty much matching last year's pace.

Annualized production jumped by 1.63 million tonnes in June alone. Although China's monthly production figures can be volatile, there is no denying the direction of the trend.

And this from a country where, to quote from U.S. producer Alcoa's quarterly conference call, some 41 percent of all smelters may be financially "under water".

The problem, Alcoa chairman and chief executive Klaus Kleinfeld complained, is that China's aluminium smelter sector is "living on a different universe".

The real problem for the likes of Alcoa, though, is that so too are many smelters in the rest of the world.

THE CHINA DYNAMIC

High-cost smelters have indeed been closing in China, just not at the same rate as new capacity has been ramping up in northwestern provinces such as Xinjiang.

Analysts at AZ China, which specializes in the Chinese aluminium smelter sector, estimate that somewhere close to two million tonnes of annual capacity may have been curtailed over the first six months of this year.

That should give some perspective on the scale of the build-out taking place in the northwest, where a new generation of aluminium producer is capitalizing on stranded coal reserves for the supply of energy, the key cost input for making the metal.

AZ China estimates that about five million tonnes of new capacity is going to come on line in China this year, although it will not necessarily translate into that amount of metal because big smelters need time to build up to full-capacity run-rates.

But even as those newer, lower-cost smelters come on stream, many older higher-cost plants in China's central and eastern provinces continue to defy cost-curve economics.

They can do so largely because of a helping hand from local governments, which don't want to see major contributors to GDP and taxes disappear into oblivion.

Yet again there is talk of widespread power subsidies.

Indeed, Guizhou province has successfully petitioned Beijing for a fundamental change in the way some of its smelters buy their power.

Although many smelters have their own power plants, the price of the electricity has to be mediated through sales to the grid.

No longer in Guizhou, though. Producers there will be allowed to build three new power plants to directly supply their smelters, effectively cutting the cost of power by around a quarter and the cost of aluminium production by around 10 percent.

It remains to be seen whether this is a template for hard-pressed smelters in other provinces.

There is also talk that the central government is being lobbied hard to relax some of its export tariffs on aluminium products.

All of which seems to run counter to the recent rhetoric in Beijing about tackling chronic over-capacity in industries such as aluminium.

Beijing itself, though, is trying to walk a fine line between curbing what it terms "blind investment" and triggering a wholesale collapse of a strategic industry.

The net result to date is captured in those first-half production figures, collective closures running behind the curve of the required collective rationalization.

THE WESTERN DYNAMIC

Alcoa and Russia's UC RUSAL, the two behemoths of western world aluminium production, are also building new lower-cost capacity.

Alcoa's 740,000-tonne per year Ma'aden smelter in Saudi Arabia is currently ramping up, the main current driver of rising output in the IAI's Gulf category.

RUSAL's 588,000-tonne per year Boguchansk smelter is rapidly approaching first-phase start-up.

Both companies have been trimming higher-cost capacity elsewhere in their smelter systems.

RUSAL's 300,000 tonnes of curtailments explain the five-percent drop in output in the IAI's Eastern European category in the first half of 2013.

Alcoa has already mothballed significant capacity in western Europe, where production also dropped five percent in the first half of this year.

It has announced another 105,000 tonnes of capacity will be idled at its Baie Comeau plant in Canada and has a further 355,000 tonnes under active review.

That Canadian closure is due to be completed by August, meaning it's not yet showing in the IAI figures, which are still capturing the return to normal operations at Rio Tinto's Alma smelter after a protracted strike early last year.

A similar resumption of normal service at BHP Billiton's Hillside smelter in South Africa, by the way, explains why first-half production in the IAI's Africa category jumped 12 percent year-on-year.

DEFYING THE ODDS

Elsewhere, though, aluminium smelters that should close at current prices continue to defy the odds.

Three have been brought back from the brink of closure in the last few weeks.

Management at Bosnian smelter Aluminij Mostar was poised to flick the off-switch before a last-minute intervention by the government.

It wasn't a completely unexpected outcome [ID:nL5N0EJ1OQ] but how the 130,000-tonne per year plant will return to profitability at current prices without significant ongoing subsidy remains to be seen.

A similar government intervention in neighboring Montenegro has saved the 120,000-tonne per year Podgorica smelter from imminent bankruptcy and looming closure.

Rio Tinto's 146,000-tonne per year capacity Saint Jean de Maurienne plant in France has been producing aluminium since 1907. Burdened with the need to secure a new competitive power contract, likely closure was averted with a somewhat unlikely sale to Germany's Trimet.

The French government appears to have played a key role in brokering the transaction.

But then, as French Prime Minister Jean-Marc Ayrault, who travelled to the plant to conclude the deal, said: "There is no future for France without industry."

Which is presumably what many provincial governments in China would also say about their loss-making aluminium smelters.

The net result of all this is also evident in the IAI's first-half 2013 production figures.

Western world production was reduced by just 73,000 tonnes annualized over the period, a marginal adjustment that may not even reduce the current market surplus let alone help erode the market's huge legacy stocks.

Not such a different universe after all, then?

(Andy Home is a Reuters columnist. The opinions expressed are his own)

(Editing by David Evans)

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