| Commodity prices are heading for their biggest quarterly drop in 50 years. The Reuters-Jefferies CRB Index, a global benchmark of commodities prices, has fallen more than 23.5 per cent since June-end. Along with other commodities, aluminium, the metal used in jetliners, drink cans and foil wrap, has seen a price correction of late.
Despite a correction of over 20 per cent in the past few weeks, aluminium fundamentals warrant a rebound. Higher gas prices have curbed the recent production of aluminium, which is already failing to keep pace with demand. Energy accounts for as much as half of the costs of making aluminium. Demand from China, the slowdown notwithstanding, continues to escalate. China in 2008 could make up 36 per cent of world demand, compared with 31 per cent in 2007. Chinese demand in 2008 will be 14.9 million tonnes, compared with 6.8 million tonnes for the US. Indian demand will rise by 8.3 per cent and Europe is expected to be higher as well, as will the rest of Asia and countries, such as Brazil and Russia.
BRIC (Brazil, Russia, India, China) economies continue to increase their influence on the long-term development of the aluminium market, either as a driver of consumption or location of new smelter capacity. Per capita consumption in India is only 0.8 kg against 25 kg in the US, 19 kg in Japan, 10 kg in Europe and the world average of 8 kg. This shows that India has a lot of catching up to do. The rural electrification push in India is expected to be a demand driver, along with increased purchase of automobiles.
At the current dollar rate (2008$), long run marginal cost (LRMC) of aluminium and alumina have increased sharply from their 2007 levels. There has been a sharp escalation in operation and capital costs with the LRMC (2008$) for aluminium capturing a 23 per cent rise in the shipping cost index and a 44 per cent increase in the carbon cost index.
A 16 per cent jump in natural gas prices, used by electricity providers in the Persian Gulf, has persuaded governments in the region to shift the fuel to production of liquefied natural gas instead of aluminium.
West Asia was originally looked upon as the most attractive place to build a smelter because of its access to cheap energy. Abu Dhabi and Bahrain have scuttled plans for smelters, and Chinese plants have cut output by 10 per cent. Alcoa plans to idle capacity in Texas, and 120,000 metric tonnes of production will be lost in South Africa. In February 2008, Manama-based Aluminium Corp of Bahrain said it had shelved a plan to increase capacity by 39 per cent to 1.2 million tonnes mainly because of insufficient gas supplies. Republic of Montenegro’s Privatisation Council and Economy Restructuring and Foreign Investment Agency fear that KAP (Kombinat Aluminijuma Podgorica), the country’s major aluminium producer, which accounts for more than 50 per cent of Montenegrin exports, could soon be closed or sold by its owner, Russian billionaire Deripaska unless the power problem is quickly resolved.
Rio Tinto said recently that the $3 billion, 700,000-tonne-a-year-project had to be called off because the UAE decided not to use its gas supplies to generate power for smelters. The canceled West Asian smelters would have raised world supplies by 2.8 per cent. Even if these projects had come onstream, production would not have kept pace with global demand that is growing at 9 per cent, double the rate of the world’s economy.
The world’s second-largest aluminium producer is also on the verge of closing a 148,000 tonne smelter in Anglesey, Wales, if the London-based company fails to secure a new power contract when the current one expires in September 2009. Rio Tinto has already suspended work on a $2.7 billion South African project since it was unable to procure guaranteed power.
Aluminium smelters in China have cut more than 10 per cent of their capacity due to severe power shortages and weak export demand. This will further diminish supply of aluminium in the world market and boost prices.
Aluminum is the cheapest compared with the five other metals traded on the London Metal Exchange. Aluminium had an annual return of 12 per cent for the five years through 2007 (since the commodity boom began), compared with 34 per cent for copper and 42 per cent for lead. So, aluminium has a lot of catching up to do. Even in terms of the downside, its price fall has been relatively moderate compared with other commodities. Frankfurt-based Commerzbank AG has raised its 2008 average price estimate to $3,600 by 2009, on expectations that China, the world’s largest producer, will become a net importer. Barclays Capital, meanwhile, is estimating an average price of $4,500 in 2009.
Although fresh capacity is expected to come onstream in India in 2009, the worldwide shortage in aluminium supplies will ensure that prices remain buoyant in the near-to-medium term. Speculative interests can have only that much impact on the upside or the downside of any asset class, especially commodities. Ultimately, aluminium is bound to return to equilibrium based on its true fundamentals. The fundamentals of aluminium remain quite robust and its prices should start factoring in this resilience once again. (The writer is the CEO of Global Capital Advisors. Financial Chronicle does not warrant the quality or accuracy of the article. It shall not be deemed a recommendation by FC for buying or selling or investment of any kind. Investments are subject to market risks. Past performance does not guarantee future success. It is advisable to seek advice from a qualified independent adivsor before investing) |