April 29, 2019 / 2:43 PM / a month ago

Column: Aluminium's bull narrative is lost in the shadows

LONDON (Reuters) - “This is a tangible, clear story which is really going to effect price, spreads and premiums”.

A worker controls forming of aluminium ingots on a conveyor belt at the foundry shop of the Rusal Krasnoyarsk aluminium smelter in Krasnoyarsk, Russia October 3, 2018. REUTERS/Ilya Naymushin

The story in question, according to Eoin Dinsmore, head of primary aluminium and products research at CRU, is a building supply deficit in the aluminium market.

Dinsmore’s presentation at the research house’s aluminium conference in London last week was titled: “Don’t doubt the deficit”.

Yet hardly anyone outside of the aluminium market believes in this unfolding bull narrative.

Financial players are “simply not interested” in aluminium, according to Colin Hamilton, managing director of commodities research at BMO Capital Markets.

“Over the past year client questions on aluminium have been few and far between,” Hamilton wrote in BMO’s round-up of the conference, adding that the lack of investors at the meeting was itself a sign of the broader lack of interest. (“CRU Aluminium Conference Feedback,” April 28, 2019)

The indifference is also clear to see in the London aluminium market where prices have done little more than trudge sideways since the start of the year. At $1,830 per tonne, aluminium is the second-weakest performer among the base metals after perennially out-of-favour lead.

WHAT YOU SEE

Aluminium’s “clear” deficit narrative is playing out in the shadows, while visible dynamics fail to generate any such signs.

True, London Metal Exchange (LME) stocks have fallen a long way from their mid-decade peaks of almost 5.5 million tonnes to 1.07 million tonnes currently.

But the market knows much of this drawdown has simply been movement of inventory from higher-cost LME to lower-cost off-exchange storage as warehousing dynamics trump fundamentals.

Occasional mass inflows of metal into the LME system, such as the 54,875 tonnes that turned up in this morning’s stocks report, underline the message that what we see in the aluminium market is dwarfed by what we don’t see.

And then there is China.

Each month brings a reminder of just how much aluminium China is exporting to the rest of the world in the form of semi-manufactured products. March’s tally of 546,000 tonnes was the second highest on record.

That outbound flow touches on another apparent truth, namely that China is still sitting on massive underutilised production capacity with the potential to flood the market at any moment.

Supply-side reform and environmental clampdown do not appear to have stopped the Chinese aluminium production juggernaut.

Too much capacity, too many exports and too much stock overhang is the popular perception of the aluminium market so it’s not entirely surprising that financial players and investors have been giving it a wide berth.

WHAT YOU DON’T SEE

Each of those apparent bear drivers is questionable.

Take China’s excess production capacity, which is said by some to be as high as 10 million tonnes.

“The perception of Chinese surplus capacity is feeding into depressed prices,” said Duncan Hobbs, research director at Concord Resources, speaking at the CRU conference.

Perception is different from reality, however. The problem, according to Hobbs, is that accurate estimates of Chinese capacity are simply not available unless you pay a “lot of money” to research houses such as CRU.

In the absence of any drill-down transparency into China’s aluminium sector, the market has been using the country’s export flows as a proxy for excess supply.

But that ignores the fact that it’s one flow within the global market and one which is going to meet a widening deficit in the rest of the world, Hobbs argued.

The opacity veiling China’s aluminium production profile darkens further when it comes to off-market stocks.

CRU’s view is that inventory accumulated in the wake of the global financial crisis is being drawn down to fill a supply deficit which exists even with China’s massive exports.

Dinsmore, Hamilton and Hobbs were all challenged to give an estimate of just how much is out there beyond the statistical exchange light and all three came up with a figure of around 10 million tonnes.

Which sounds a lot until you consider that global aluminium consumption is running at around 180,000 tonnes each day.

Expressed in terms of global usage, inventory is approaching a pinch point. Next year. Maybe the year after.

No-one has an exact time-line given the statistical guess-work that is involved but the consensus among speakers at last week’s conference is that a day of reckoning for aluminium prices is definitely coming, sooner rather than later.

Data-bias in the aluminium market means too much weight is placed on the highly unreliable reported stocks from the LME, so those who aren’t paying for bespoke research remain blind to a key part of the bull story.

INCENTIVE PRICE

Aluminium’s lost narrative isn’t just about how to entice fund players back into the market.

Potentially more significant is how the current price indicates that the world doesn’t need more production capacity, even though the market “requires new smelter capacity with investment decisions needed in the next two years”, according to Rusal’s head of market research, Inga Simonenko.

Rusal is reactivating its long-stalled Taishet smelter project in Siberia but the only other advanced greenfield project outside China appears to be that of Israel’s Delek Group, which is planning a two-stage, one-million-tonne-per year plant using energy from a newly emerging natural gas hub off the country’s coast.

Even with backing from the Israeli government, Delek might struggle to persuade financiers that aluminium has a bright future beyond currently depressed prices, “high” stocks and Chinese “overcapacity”.

Today’s negative optics, in other words, are storing up trouble for aluminium supply in coming years.

“We believe that aluminium is fundamentally tight,” Dinsmore told last week’s conference.

If he and CRU are right, a price reaction is coming at some stage and the longer it takes, the more violent it will be.

The opinions expressed here are those of the author, a columnist for Reuters. 

Editing by Kirsten Donovan

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