By Stuart Burns
"I don’t like aluminum."
Daniel Brebner, a metals analyst at Deutsche Bank, is quoted as estimating that the operating profit margin for a marginal aluminum producer has been 14% over the past decade, compared with 43% for copper - against a backdrop which saw one of the greatest commodity booms in history.
As prices slide again in recent weeks, producers have been reporting their results. Apart from Klopper’s BHP, which the FT reports made a pre-tax loss in aluminum in the six months to December 2011, Rusal, the world’s largest producer, saw a 72% drop in profits from its operating activities in the final quarter of last year; while Rio Tinto’s (NYSE:RIO) top brass passed up their bonuses after the company took an $8.8 billion write-down on its aluminum assets. Only Alcoa (NYSE:AA) appears to be bucking the trend at the moment, turning a Q4 loss into a Q1 profit on the back of improved aerospace and automotive semis sales offsetting continued poor primary numbers.
Quoting Kloppers again, “Our view is that aluminum has had a structural profitability downturn, as opposed to a cyclical profitability downturn.” Years of over-capacity have seen global inventory rise to some 12 million tons, according to the paper, as rising demand has been outstripped by rising output.
Much of this is in China. Despite many producers struggling to simply break even, aluminum production jumped to 53,000 tons per day in February; the paper quotes industry executives who estimate up to 10 million tons of new capacity will be added in western China over the next three years.
The hope has been poor profitability will force Chinese smelters to close and the country to up imports, creating the demand needed to eat into rising inventory levels, but that’s failed to happen. If the lure of cheap coal is realized the over-supply may actually get worse.
Alcoa Making Some Predictions
Alcoa announced back at the turn of the year that it would close some 12% of its capacity in a bid to improve profitability, but set that against global producer announcements of just 4% cuts, and it suggests over-production is here to stay.
Alcoa, in this week’s quarterly return, is again proposing an alternative view. Announcing a dramatic turnaround in results from the end of last year, Alcoa’s Klaus Kleinfield predicted 2012 would see a slowing of demand increases from 15% last year to 11% this year, but is still predicting a global demand deficit of 450,000 tons.
The main plank of Alcoa’s position appears to be that Chinese production is uneconomic and the planned $45 billion investment in new capacity in the west of the country just won’t take place. China’s aluminum industry has confounded the West before, even the normally well-researched resources of Alcoa.
We’d bet widespread closures of Chinese capacity are unlikely and a surplus is here to stay, at least this year and next. With so much inventory tied up in comparatively short-term 12-24 month deals, you can’t help feeling even if the market were to go into deficit, that inventory is like a reservoir behind a dam - just waiting to flood out if the conditions to retain it do not persist.