(The following excerpt from The Commodity Refiner, a monthly publication of Barclays Capital Research, provides an overview of the current aluminum market.)
Primary aluminum prices continue to perform better than expected. Although they have not necessarily risen faster than any of the other base metal prices, they have failed to retrace in an environment of oversupply.
There are several explanations to this, the chief one being that on the London Metal Exchange (LME), persisting borrowing activity is keeping nearby spreads in a backwardation, and this is providing support. An additional explanation is that more moderate Chinese export volumes to the Western World are raising hopes that the Chinese market will soon return to balance. After all, power shortages, strong alumina prices, governmental restrictions, and closures of environmentally unfriendly Sderberg capacity all suggest that this might be possible (though, in our view, unlikely before 2005-2006). Finally, consumer interest, partly related to currency moves, has increased around the lower end of range.
Is demand really as lacklustre as feared? Certainly not in China, where it is growing at +15% per year. Furthermore, according to CRU International, Western World demand is growing stronger than production, albeit from low levels. Data for January-May show that consumption was up by 4.1%, year over year, after a strong first quarter.
However, the aluminum-intense auto industry is having problems and remains a concern for the outlook for demand. Auto production cuts are in place in the U.S., as vehicle inventories are too high and sales slow despite aggressive incentive programs. U.S. order books for aluminum confirm this, with the latest data from the U.S. Aluminum Association on net new order mill products showing that although orders improved somewhat over the month, they registered a hefty decline again, compared with the previous year. Declines in physical premiums also highlight the persistent imbalance between supply and demand, while spot business is even quieter with the backwardation in place.
There are reasons to believe that aluminum will continue to underperform on the LME but hold key support levels. Western World supply continues to grow strongly, despite the fact that high power and alumina prices have removed about 350,000 tonnes per year of output so far this year. Nonetheless, the lack of producer discipline in a market where Russian and Chinese producers are dominating is a key hurdle to the aluminum market. The large number of new projects is likely to ensure that forwards are well-offered.
In short, we expect the aluminum market to maintain a sizable supply overhang over the coming year, and that a more moderate flow of metal from China will have a positive influence. In fact, monthly trade statistics show that exports are running behind our previous expectations for this year by about 60,000 tonnes.
Perhaps aluminum is also better-placed from a demand perspective than some of its LME peers, as aluminum has greater exposure to the U.S. market, where a pick-up in economic activity can be expected sooner than for Europe. While the third quarter is expected to be relatively quiet for seasonal reasons (especially if the U.S. dollar strengthens), attention will continue to surround power prices. The Bonneville Power Administration, in the northwestern U.S., is now considering a reduction to the planned hike in October, which could affect the future of
After more that doubling since the trough in the fourth quarter of 2002, spot alumina prices have stabilized just below US$300 per tonne. Somewhat softer alumina prices in early June reflect seasonal factors and reduced buying activity from China.
Global alumina capacity is building, and some reduced primary smelting capacity has helped ease the alumina market tightness that was evident in the first half of this year (an approximate deficit of 100,000 tonnes in the first quarter, according to the International Aluminum Institute). This, together with the potential for drawdowns of large Chinese alumina stockpiles, is likely to keep upside pressure on alumina prices restricted.
Aluminum futures open interest and prices have moved largely in tandem on the LME this year. This suggests that rising open interest and prices during the first quarter were the result of fresh buying of long positions. However, the data also suggest some of these long positions were liquidated at the end of the first quarter, when open interest and prices were falling together.
The volume of aluminum futures trading on the LME dipped in April after three consecutive months of increase, falling to 2.1 million lots. This recovered somewhat in May, to 2.2 million lots, which represents a substantial 13% increase over the same month a year earlier. Aluminum remained the most heavily traded metal on the LME in April and May, with an average of more than 500,000 contracts.
The backwardation in nearby spreads (with focus on July/August dates) has remained firmly in place for several months. Continuous borrowing activity keeps these spreads well-bid, and there are no signs that tightness will ease in the near term. In addition, the flat shape of the curve remains, with rising primary production keeping far-forwards well-offered.
Premiums have generally eased, with the physical aluminum spot market quiet, partly in light of the backwardation on the LME. As supply and demand remain out of step, U.S. midwest premiums are now reported at less than US3 per lb. in some cases, which is about 25% lower than recent levels. Easing tightness in the secondary market has helped this development. However, for deliveries in the last quarter of the year, premiums are a bit firmer, which reflects an expected pick-up in demand.
Net new order data for U.S. aluminum mill products rose 17.1%, month over month, according to the latest data from the U.S. Aluminum Association. However, they were still 9.6% lower compared with the same month a year earlier. Excluding highly seasonal can-stock data, the index rose 9.3% from April, but was 16.7% lower over the year. Although these data signal that U.S. aluminum shipments might pick up in the next few months, any improvements are from a very low base. An ailing auto industry is likely to restrict significant near-term gains in the index.
In light of the persisting nearby backwardation, more metal has flowed out of LME warehouses in recent times, with the total LME aluminum stockpile approximately 120,000 tonnes (or about 8%) lower in the first half of the year. Drawdowns have been geographically widespread, but most pronounced in Asia, with the LME stockpile in Singapore reduced by more than 30% (or 70,000 tonnes) over this period. Aluminum inventories at the Shanghai Futures Exchange are also low overall, and are now holding about 20,000 tonnes (a year ago, the figure was 40,000 tonnes). Strong Chinese demand is likely behind these drawdowns.
Following the peak of 180,000 tonnes in April, cancelled LME aluminum warrants have declined. However, partly in light of the nearby backwardation, an additional 80,000 tonnes are still awaiting outward delivery, which is likely to keep total LME aluminum inventories in an overall downward trend. Nonetheless, a few sizable net inflows were reported during the second quarter, with the European destination suggesting possible Russian origin, following weather-related shipment problems earlier in the year.
The International Aluminum Institute (IAI) reported that unwrought aluminum inventories at Western smelters rose to 1.7 million tonnes in May, representing a level 3.2% higher than that of a year earlier (+51,000 tonnes) and marginally higher (+0.1%) than the previous month (+10,000 tonnes). As a result, we estimate that total reported stocks (also including those at exchanges, consumers and merchants) stood at about 3.2 million tonnes at the end of May, which was 63,000 tonnes lower than at the
end of the previous month, primarily because of declines in exchange inventories in all geographical regions.
Total reported inventories expressed as weeks of Western World consumption remain above eight for the sixth consecutive quarter. Following a peak of 8.6 weeks in the first quarter, we expect this ratio to fall somewhat (to 8.2 weeks) in a seasonally stronger second quarter and in light of reported inventory declines at LME warehouses.
A relatively high stock-to-consumption ratio, compared with the last decade, reflects the oversupply situation, and in addition there are concerns over large off-warrant stockpiles of aluminum.
Net Chinese aluminum exports were relatively modest in May, at 27,000 tonnes, bringing net exports for the first five months of the year to 145,700 tonnes. On an annualized basis, this is slightly below our previous expectations of 400,000 tonnes for the full year.
If power shortages become more acute and if closures of Sderberg capacity are successful (we have heard as much as half, or 400,000-500,000 tonnes, could be closed this year), then net exports to the Western World might continue to be restrained. A return to balanced conditions in the Chinese market would be a key positive to the global aluminum market.
Primary aluminum production in the Western World continues to rise, according to the IAI. Data for May shows that Western smelters produced a total of 1.85 million tonnes, compared with 1.78 million tonnes in April 2003 and 1.79 million tonnes in May 2002. As a result, daily average primary aluminum production rose to 59,900 tonnes per day, up 3.5%, year over year, and up 0.5%, month over month.
Growth (in excess of 3.3%, year over year) was registered in all regions, bar Africa (-1.8%, year over year), with the Western World’s largest producing region, North America, raising output by 3.9%, year over year, to 474,000 tonnes in May.
— Kevin Norrish is head of commodities research/energy and Ingrid Sternby is the base metals analyst for Barclays Capital Research. The opinions presented are the authors’ and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to the authors at kevin.norrish@barcap.com and ingrid.sternby@barcap.com
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