By Stuart Burns
It’s curious how two major metals producers can have apparently divergent views on the future of their industries.
In an interview with the Financial Times, Klaus Kleinfeld, Alcoa’s (NYSE:AA) chairman and CEO, observed that the future for aluminum prices was solid based on a number of observations regarding China’s production costs. As we have observed before, China is not a low-cost producer, and Kleinfeld took the issue one step further, saying that China is actually not a logical or sensible place to be making aluminum at all. Its bauxite supply is limited, forcing the country to import about 40 percent of its needs — a trend that will only get worse as production continues rising (a point we will come back to).
Production costs for turning bauxite to alumina are high — 37 percent of Chinese refineries are in the top quartile worldwide — and power production relies heavily on pollutant-rife coal-fired power stations. Likewise, smelting alumina into aluminum is expensive in a country renowned for generally high power costs (exceptions being hydro for those plants strategically positioned to be able to access such opportunities). Some 45 percent of Chinese smelters are in the top cost quartile.
Even so, the article cites Brook Hunt’s forecast that Chinese aluminum demand will rise from 19.8 million tons this year to 29.8 million in 2015, yet in spite of the 12th five-year plan expressly intent on reducing the expansion of power-hungry and polluting industries, much of this additional capacity will come from domestic sources. By 2015 only 2 million tons, or 7 percent, of primary aluminum will be imported – still a sizeable quantity for a global industry, said by the World Bureau of Metal Statistics to be in surplus by only 378,100 tons in the first seven months of this year.
Alcoa sees this high-cost structure as an opportunity, believing it will open up the possibility of cooperation with Chinese producers looking to set up smelting operations outside the country and in partnering with Chinese firms to make high value-add products within China — typical of Alcoa to see opportunity in adversity. At the same time, Alcoa has announced it will not be proceeding with a long-mooted second smelter in Iceland, expected to be based on geothermal power sources, because the firm could not secure sufficiently attractive power tariff agreements. Maybe not surprising in the current market, although many of Alcoa’s plants are still making money at around $2,200 per ton; smelters elsewhere are not. This cost-of-production issue is another reason Kleinfeld feels the aluminum price has not got much further to fall – for any prolonged period, anyway – capacity would be shut (particularly in China) if prices fell much further.
Meanwhile, on the other side of the world, Rio Tinto (NYSE:RIO) has announced it’s getting out of the aluminum business. It’s splitting its Alcan division into two parts – a six-asset Pacific Aluminum Asian division and a Rio Tinto Alcan division containing the rest – and putting both blocks up for sale with values mooted by Deutsche Bank in a Telegraph article at US$8 billion.
A great result for Rio, having paid some $40 billion just four years ago for Alcan’s aluminum business at the top of the market, and now selling arguably not much above the bottom. How Tom Albanese, Rio’s CEO, has managed to keep a straight face, let alone his job, in the face of such an appalling squandering of shareholder value is unbelievable.
Going back to our opening sentence, clearly Alcoa, which is totally aluminum-focused, and Rio, which is largely an iron-ore producer (plus some other metals), are not going to have the same priorities. But Rio may yet (again) come to regret its decision to sell out of one product area when it’s in a dip to focus on another (iron ore) which arguably is at a peak. All commodities are cyclical.