Category Archives: aluminium

The elephant in the room – part 2

Written by Paul Adkins

There’s no doubt that the action taken by the USA against China is prompted by the build up to today’s situation.   The rapid rise of Chinese exports has caught everyone’s attention. But as well as defending today’s US manufacturing jobs, this action could also have the effect of protecting tomorrow’s jobs, and profits.

How?   Consider this – Alcoa, Novelis and others have had a major boost to share prices and outlooks thanks to the decision by the automotive companies to switch to aluminium panels in the US SUV market.   The particular kind of metal needed must have high strength, uniform properties for each panel, must be light weight and must be a certain shape and size and thickness to suit car makers’ specs. All these characteristics mean a highly customised product, which in turn means high margins for the aluminium companies. Hence their share prices have rocketed since the move was announced.

The last thing that Alcoa and the other suppliers would want therefore, is for low-cost Chinese metal to enter this market. Now, that’s not going to happen any time in the near future, as it takes a long while to gain supplier approval from the likes of Ford and GM, and it takes a lot of capital to build the annealing furnaces and other equipment to make the metal in the first place.   But capital is not a problem in China, and with Chinese rolling mills reportedly running at around 50% utilisation, there’s no time like the present to start gearing up to penetrate the US auto market.

Let’s face it. Ford and GM and other car makers are not going to say no to testing Chinese or other imported metal, if it presents an opportunity to drive the price down.   Even if they take years to get around to even testing the metal much less approving it, it won’t stop Ford and GM putting pressure on their suppliers to match Chinese prices.

So quite apart from what this action means for today’s market players, it could also play nicely for the big aluminium companies outside China in the future.

By the way, why am I referring to this WTO action as the elephant in the room?   Because I suspect that beyond an official rebuttal of the claim, we will see little to no official discussion of it.  Possibly an editorial in the China Daily renouncing American politicians, but not much else, and certainly no mention of it inside China.   I suspect China’s actions will speak far louder than its words, in this case.

 

The elephant enters the room

Written by Paul Adkins

The USA has lodged a complaint in the WTO against China’s export subsidies. Aluminium is in the list of products named in the complaint, along with textiles, chemicals, medical products and hardware.

The process of filing a complaint in the WTO is a long one.   The first step involves a “request for consultations”, and full resolution of the complaint could take years. But it’s not the only action being taken.   Reuters reports that the Obama administration has also been trying to convince Congress to new legislature involving trade deals, especially in the Asia Pacific region.

If there’s one area in the aluminium space that will attract attention from both sides of this challenge, it will be the rapid increase in semis exports.   2014 saw a record 3.5 million tonnes of semis exported from China, with a portion of this metal finding its way into remelt facilities in other countries. Metal which leaves China as a semi-finished product, enters new markets as an extrusion billet or P1020 ingot once it has been remelted.

On one level, those who export from China are simply making money on the arbitrage.   When you take LME prices and add the large delivery premium, the net cost can easily exceed the cost of sourcing from China.  That’s a “fair enough” trade, but the point of the action taken this week is that the starting cost and the production costs are being subsidised.

The USA challenge specifically talks about manufacturing hubs inside China where government subsidies can generate as much as US$1 billion in support, according to the Reuters report.   In the aluminium space, we at AZ China have been reporting for a long time that many Chinese smelters are getting no-interest loans, electricity price subsidy, forgiveness of debt, transfers of assets and other measures that keep the smelters open.   These actions also have the effect of reducing the cost of the product. Although in aluminium’s case, the raw metal is then sold on an open exchange, the same subsidies, loans and supports are also supplied to the next tier of the industry. In other words, the “problem” as seen by those who have initiated the complaint, has already been created by the time the metal arrives at the shipping port.

How will China react to this challenge?   It’s now approaching Chinese New Year, so no doubt some bureaucrats have just had their vacations cancelled.   On an official level, China will reject the claims and will provide all sort of evidence that supports their case.   They will likely also agree to the request for consultation, though such a process will be drawn out to the full extent that is allowed in WTO rules.

But the real question is, does China want to have a fight with the USA and the WTO?   I think there’s too much at stake for China at this time, and although Chinese attitudes have been hardening, I doubt they will want to get into a fight.  I think it is more likely that quiet indirect actions will be taken to appease the complaint.   One action is that they could rescind the VAT refunds that exporters receive.   That would automatically make aluminium semis 13% or 15% more expensive (the difference being whether the metal is a rolled product or an extrusion).

There are two problems with that.   One is that it punishes those Chinese businessmen who have a genuine export trade business with genuine customers, and hurts their export position. The other is that such an action does not address the point made in the complaint, that subsidies and support are being given in the manufacturing sector.

The problem for us in the aluminium space is that the complain is a broad-brush one.   It covers textiles, chemical products and so on.   This means that it could take some time before we see what the outcome will be for aluminium, and more importantly, it is possible that the Chinese government or the WTO takes a broad-brush response.

What will this action mean for the world’s aluminium market?

Some US based producers and manufacturers will be happy to see this action taken, while others will be hurt by it.   The low costs coming out of China are benefiting those producers and manufacturers who source their raw materials from China.

On a global/RoW basis, it is not likely we will see any immediate reaction, but AZ China has been warning for some time that the rush to export metals will not last, and that we should not count on a sustained growth in exports.

 

Price Divergence emerges

Written by Paul Adkins

Aluminium prices in China rose a little last week, chiefly in response to signals that showed desperation in the market more than anything else. But what was really interesting was that for the first time, the Chalco price consortium has moved their price away from the SHFE.

As readers of our Weekly Aluminium Alert would have seen yesterday, Chalco’s “East” price closed the week at RMB13,300 while the Changjiang price (the closest equivalent) closed at RMB13,100.  That RMB200 difference is the widest we have seen since the Chalco move about 3 weeks ago.

It needs to be remembered that the Chalco price is not a true “free market” price.   It is set on a daily basis, and uploaded to their website at 10am each morning.    It does not suffer the swings of a true exchange price such as those of the LME or Shanghai.   So the fact that the price has opened out is an engineered move, not a natural market move.

It is unclear why this gap opened at this time.   We are now rapidly approaching Chinese New Year, and no doubt many buyers would be closing their books by now, waiting for the holiday period to end.   Perhaps Chalco sought to make some profit from those who had to make last minute purchases – like the price of roses in the last days and hours before Valentine’s Day.  Perhaps Chalco discerned that it had the metal units available where SHFE did not. Perhaps the Chalco price guy was asleep at the wheel and missed what SHFE was doing.

As mentioned before in this blog, the real signals won’t start until after CNY, but it was an interesting move just the same.

 

Aluminium price rises to 13300, but why?

Written by Richard Lu

As we advised yesterday, the People’s Bank of China (PBOC) announced a cut to the Reserve Requirement Ratio (RRR) yesterday. Interestingly, Feb 4 is the “Beginning of Spring” day in China’s lunar calendar. We don’t think it was a dramatic coincidence, but the implications are potentially profound.  Any sign of action by the government will be good news for the commodities business.

It is interesting to note that the price of aluminium rose to as high as RMB13,300. But the rise occurred on Feb 3, the day before the announcement. Could it be that some traders caught wind of the move?

Both Changjiang and Chalco prices are quoted lower today than yesterday. We think any hope traders had of a stimulus arising from the RRR cut has been replaced by a realisation that the cash generated by this move will simply go to shore up the huge debt burden within the economy.  All the over-capacity in aluminium, steel and other sectors that was built following the 2009 financial crisis was built using loans and credit.  Sooner or later, someone has to pay the piper, but meantime, RRR cuts will generate some cash that banks to loan out – adding to the debt burden.

We intrinsically believe no matter what easing policies are implemented, if the structural oversupply can’t be solved, the aluminium price can hardly step into real ascending channel. But structural over-capacity cannot be solved until the debt that underpins the industry is paid or written off. The problem is paying off the debt is impossible, and writing off the debts is unacceptable.

What about regional power grids?

Written by Richard Lu

China Hongqiao (also known as Weiqiao) is one of the most profitable companies in China’s aluminium industry. Even when aluminium prices were in the doldrums in the first half of 2014 and most of its peers were suffering losses, Hongqiao still gained more than 2 billion RMB at that period. There are several factors leading to Hongqiao’s great success, but the core competitiveness is the conspicuously low power costs.

Hongqiao generates electricity by its captive power generators and transmits through its own grid. In contrast, most other companies who also have captive power generators must transmit the electricity through national grids or at least have the national grids as backups to prevent power outage. Our research tells us that the difference between Hongqiao and other smelting companies in Shandong Province who have captive power generators is about 0.07 RMB/Kwh. Theoretically, the difference derives from the use of their own grid.

What would happen if smelters in other provinces built up their own regional networks. If regional grids were built, members connected to those networks would only pay for fuel costs and small managing costs on a cash basis. Additional costs of transmission and backup could be saved and savings would be substantial. If we conservatively assume 0.05 RMB/Kwh could be saved in Henan Province, the savings would reach over 550 RMB per tonne aluminium on average, which drives average cash cost down by 4%. Other areas like Gansu, Qinghai, and Inner Mongolia, which are rich in smelting capacity could also benefit from such networks, and the savings could range from 3.5% to 5% based on the current cash costs.

Conclusively, regional power grids could shift China’s cash cost curve entirely down by 3%. It seems an excellent deal for smelting companies, but such regional grids are obviously challenging the monopolized electricity market. However, nothing is impossible under the “New Normal”.

2014 production figures released

Written by Paul Adkins

The International Aluminium Institute (IAI) has published the figures for aluminium production for December and 2014.

China came in at 2.48 million tonnes, for a daily production rate of 80,000t.   The monthly figure includes “unreported production” of 300,000t, which is a proxy for Hongqiao’s production, which isn’t in the official figures.

Several commentators forget to add the unreported production, and even worse, some forget that smelting is a continuous process, and spend more time talking about monthly rates instead of daily rates. December’s figure is an all-time record for China, but it’s actually slightly down on November (81kt per day.)

We had been saying that the final figure for China will be somewhere between 27.5 million tonnes and 27.7 million tonnes.   The range comes down to Hongqiao’s production figures.   Since we had them at 3.7 million tonnes, and the IAI uses a straight 300kt per month for Hongqiao, we are pretty close.   According to the IAI, the final 2014 figure for China is 27.54 million tonnes.

The IAI will need to tweak its unreported figure.   Hongqiao is still adding more capacity, and will soon be at 4.4 million tonnes output, or an average of 367kt per month.   And we hear that Hongqiao isn’t stopping there.   Their final capacity target is to grow to 8 million tonnes.   Consider that the world’s leading producers – Rusal and Alcoa – both sit at about 3.7 million tonnes. Even if those two companies re-opened all their idled capacity, the best they will be able to do is match Hongqiao in 2015.

Breaking news – SHFE under threat

Written by Paul Adkins

Our sources inside the China aluminium industry tell us that Chalco has formed a coalition of 13 companies in a plan to sell metal direct to the market, outside the SHFE.   The coalition of companies will be offering direct metal sales in 4 regions – East, south, southwest and central China.

It’s not known at this stage how the metal pricing structure will work, but the combined capacity of the 13 companies represents about 80% of the Chinese aluminium output.   The union allegedly includes companies such as Qintongxia, East Hope and Shenhuo, but we understand others such as Hongqiao and Qiya have not joined.   We do not have the full list of names at present.

This is a major threat to the SHFE’s aluminium trading business.   Chalco has stood outside the market for many years, offering its own pricing structure, which usually sits a few points above SHFE.   But taking 80% of the metal out of play will be a blow to the SHFE.

We understand that at least 100,000 tonnes of metal is already being positioned into this new market.   The market itself is barely aware of the move, as it only came to us in the last couple of days, and originally just as a rumour.  We are still gathering information on the move, and will report more as we hear more.

Late update: The amount of metal being assembled for the new market is 1 million tonnes, not 100,000t.  I missed a zero.

Shandong – curtailing or growing?

Written by Paul Adkins

A news item did the rounds of the aluminium industry a few weeks ago that illustrates how little we as outsiders really understand how things happen in China.

The news article reported that Shandong province will “curtail approximately 9 million metric tonnes of aluminium capacity” in the coming years.  It was picked up and repeated by several news organisations, showing they know more about cutting and pasting than they do about China.

Shandong province doesn’t have 9 million tonnes of capacity to curtail.   Total operating capacity there is 6.3 million tonnes.

In fact, the Shandong government’s blueprint calls for the industry to limit itself to 9 million tonnes.   So the real intent of the document seems to be to promote expansion, not curtailment.   The government is actually calling for another 2.7 million tonnes of capacity to be added.   But hang on, even that is not the full story.

We believe the reason why Shandong put out this announcement was to act as a subtle brake to the expansion plans of Shandong province’s most famous and most profitable aluminium company – Hongqiao.   Hongqiao is doing very nicely at present with about 3.7 million tonnes capacity, and will be at 4.4 million tonnes by the end of this year. But we understand that the long term plan could see them grow to as much as 8 million tonnes. That would put Shandong province north of 12 million tonnes capacity.

Could it be that the local government was simply saying, “Hold your horses”? Are they really saying “Make sure you talk with us and get our approval.”  We are not suggesting there is any bad blood between the local government and any of the players, but since Hongqiao is the largest and most important player, the announcement is relevant to them above all.

Cut and paste stories about China at your peril.   There’s usually more to the story than we realise.

 

Defying the laws of market gravity

Written by Richard Lu

It’s a fact that about 70% of China’s aluminium capacity is now under water. Our latest Cash Cost Curve analysis (see below) shows only 30% of capacity is at break even or better, with almost 2 dozen plants in the top quartile and losing at least 2000 RMB per tonne. Economic theory tells us that businesses whose revenue cannot even cover variable cost will eventually die, a Darwinian self-healing process for the market. If the laws of market economics were to  apply in China’s aluminium market, that 70% capacity should quit the market.

But they don’t close and won’t, and here’s why.

First, let us look at the balance sheet of the entire aluminium industry in China as of the end of 2014. Our data shows the total assets of China’s aluminium industry run to about 1.5 trillion RMB, while total liabilities are about 1 trillion RMB. The net profit of all upstream sectors including bauxite mining, alumina refining and aluminium smelting was about -6 billion RMB in 2014, while net profit of all downstream sector is about 20 billion RMB. Those two numbers together leads to a net profit of the entire industry at 14 billion RMB. It means it will take a minimum 70 years to pay back all the debts. If we take the accrued interest and inflated downstream profits (inflated to reduce financing costs) into consideration, the time span would be much longer, perhaps 100 years.

China’s aluminium industry is living on debt.

As most of the loans are provided by local banks who are backed by local governments, bad debts are simply taboo. Bad debts are not allowed to appear on the books at all. Considering smelters may borrow millions or billions of RMB, one bad debt write-off may trigger a collapse of a small bank, leading to a spiralling situation and a run on the whole banking system.  History has shown in the past how quickly these situations can escalate once triggered.

Here comes the second question – given the smelters cannot close but lose money if they keep running, how do the local governments, banks and companies manage this dilemma? There are two major approaches to deal with that problem.

One way is that banks stop charging interest on the loans but keep the debts on the book. They expect price rally to earn profit and return the loan gradually. That approach is actually another kind of subsidy, but the effect may be far less than enough. If the first way doesn’t work as the price further drops, a debt-to-equity swap will be ultimate approach to avoid immediate bankruptcy. If it happens, those assets will become state-owned assets again which allows for a longer period to amortize the bad debts. Therefore, government doesn’t worry about the industry at all if the facilities are not dismantled, even without running.

For this reason, any plants which throw up their hands and declare defeat will not be dismantled.   They will be declared to be idling awaiting a price recovery.   economic We think the overall slowdown may lead to closures of businesses in 2015, but not in the aluminium industry. We estimate that there will be approximately 0.5-1 Mtpa shutdown in 2015 if the price doesn’t move up. Transfers of ownership from private to state-owned will not be publicised, and will be difficult to track, but we will be watching closely.

For this reason, if any smelters in the “dog” quartile do close, they are likely to be privately-owned companies. State-owned companies will enjoy somewhat more protection.

I mentioned before that 70% of smelter capacity is presently under water.   That figure comes from our latest Cash Cost Curve analysis.   We will be issuing a Client Briefing Note in a few days time, which will examine that number in much more detail.   Make sure you are on the mailing list, by completing this simple form.

 

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Exclusive – VAT refund under review

Written by Paul Adkins

This post has been removed at the request of our sources. There is a possibility that they could be identified from the information in this post.  We respect their right to remain anonymous.

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