(Repeats March 11 column with no changes. The opinions expressed here are those of the author, a columnist for Reuters)
By Andy Home
LONDON, March 11 (Reuters) - U.S. aluminium producer Alcoa last week said it had placed 500,000 tonnes of production capacity under review for possible closure or sale.
The company has already idled, closed or sold 1.7 million tonnes of capacity since 2007 but, it seems, now needs to cut deeper.
At one level this is all about Alcoa’s own reengineering of its business model away from pure aluminium producer towards specialist materials supplier.
It has just announced the $1.3 billion acquisition of RTI International Metals, its second foray into the world of titanium, a key material in the aerospace sector.
Such diversification goes hand in hand with transformation of its aluminium production business. The latest review is part of a pattern of pushing down the cost curve by closing higher-cost smelters and replacing lost capacity from the company’s new, ultra low-cost Ma‘aden plant in Saudi Arabia.
But Alcoa’s continued focus on cost-cutting also sends an ominous signal about what it expects of aluminium prices over the coming period, a signal that jars with recent producer confidence the market had finally switched to deficit after years of oversupply.
And there are good reasons for Alcoa’s concern.
On the London Metal Exchange (LME) metal for three month delivery has fallen back below the $1,800-per tonne level from over $2,100 in the third quarter of last year.
Even more worryingly, the seemingly unstoppable rise in physical premiums has not only stopped but has gone into accelerating reverse.
The spectre of a disorderly unwind of the financing trade, which has locked up large amounts of aluminium stocks, is once again hovering over the market.
Physical premiums are weakening just about everywhere.
A Japanese buyer has just struck a deal for shipments in the second quarter at $380, down from a record $425 in the current quarter. It’s the first time the Japanese premium, which serves as a benchmark for the Asian region, has fallen in six quarters.
South Korea’s state stockpiler has just bought 2,000 tonnes of aluminium at a premium of $330 per tonne over LME cash. That’s the lowest level in a year.
Premiums in Europe have been falling hard and even in the U.S., previously the prime driver of the premium machine, there are signs of softness. The CME’s front-month premium contract , indexed to Platts’ assessment of the Midwest physical market, has slid to 21 cents per lb ($463 per tonne) from over 24 cents in February.
Analysts have long debated when and how premiums would stop rising.
Would it be changes to the LME’s warehouse system, where backlogs to remove metal were the original accelerator in the U.S. premium market?
Would it be a change in stance from the U.S. Fed, whose free-money largesse has facilitated the stocks financing trade, which has immunised so much legacy metal from the market place?
Both questions are becoming ever more pertinent as the LME prepares to tweak again its load-out rules and the Fed lays the ground for the first rise in interest rates since the Global Financial Crisis.
But right now, the main pressure on premiums appears to be coming from good old-fashioned supply-demand fundamentals.
The weakness in the Asian physical market, for example, is a direct consequence of China’s growing export flow of semi-manufactured products which is acting to displace demand elsewhere in the region.
Japanese port stocks of aluminium are currently at an all-time high of 449,800 tonnes with other regional consumer markets said to be even more saturated.
The European physical market is deathly quiet, partly due to the region’s stuttering economic performance but also due to buyer reticence.
Having been stung by a ferocious rally in premiums over the 2013-2014 year-end period, consumers ensured they were well stocked going into the first quarter of this year, leaving the spot market drained of liquidity.
Inevitably, material is now heading to the U.S. to capitalise on what were the highest global premiums, causing even this premium bastion to start crumbling.
Metal, meanwhile, is still flowing out of the LME warehouse system every day and it might start doing so faster, if the LME goes ahead with its proposal to force faster queue decay at the two main log-jammed locations of Detroit and the Dutch port of Vlissingen.
So far, most of this outbound flow has gone no further than non-LME registered warehouses, where lower rental costs ensure a better return for stocks financiers.
But even with reduced storage costs the whole financing trade is now working on the thinnest of margins thanks to a contraction of the LME forward curve.
The profits from the financing game come from the difference between forward and spot prices and that difference has been steadily shrinking. The LME’s benchmark cash-to-three-months period CMAL0-3 was valued at just $16 contango at Tuesday’s close. This time last year it was trading comfortably over $40 per tonne.
There is a strong suspicion that metal is now seeping out of financing cold storage as players struggle profitably to roll deals forward.
It’s a potentially toxic bear cocktail for physical premiums with all the interlinked drivers of what has been a multi-year rally going into reverse at the same time.
We are, quite literally, in uncharted territory here. The rise in premiums and the resulting disconnect between the all-in price achieved by producers such as Alcoa and the LME basis price have been unprecedented.
The theory is that falling premiums should be offset by a rise in the LME price, keeping the all-in price stable.
Theory may in the end be proved right, but reality has an annoying habit of playing out faster and more unpredictably than it should in theory do.
The real threat now is that the premium machine goes into self-feeding and accelerating reverse, cracking the financing dam that has immunised so much aluminium from the physical market-place.
Quite how much metal is “out there” beyond the daily reporting scope of the LME is a known unknown. Many millions of tonnes for sure. But exactly how many millions? Your guess is as good as anyone else‘s.
But you can start to understand why Alcoa is taking another look at its aluminium smelting cost structure.
If premiums and LME price keep falling in tandem, plenty of other producers will be following its lead.
Editing by Susan Thomas