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Capacity conundrum

Features - Commodity Focus

Aluminum producers will continue to cut back capacity, even in light of growing demand.

Megan Workman January 28, 2014

The global aluminum market has been in a surplus since 2008. This overcapacity has proven challenging for aluminum producers and scrap processors, and aluminum companies continue to cut capacity in an attempt to balance supply and demand.

Nick Madden, senior vice president and chief supply chain officer for the aluminum firm Novelis, headquartered in Atlanta, says that while aluminum producers reduced production by 2 million tons during the global recession, demand dropped by 5 million tons. The oversupply, therefore, has been partially a consequence of production cutbacks not matching demand reductions dating back to the recession, he says.

“Producers have cut back to reduce losses in an attempt to return the global market to a balanced position,” Madden says. “Demand has since recovered, but not sufficiently to balance production.”

Madden says he predicts the aluminum market will see a turnaround in the next two years as strong demand and further producer cutbacks gradually rectify the imbalance.

As long as pot line closures continue, he says, aluminum prices will see improvements this year. These additional closures are indicative of the ongoing problem with oversupply that dates back several years.
 

Continued closures

The aluminum oversupply has found its way into financing and warehousing deals both in LME (London Metal Exchange) and off-exchange locations, Madden says. There are several reasons why this has happened, including “a very strong contango (referring to a situation where the future spot price is below the current price and people are willing to pay more in the future than the actual expected price of the commodity), low interest rates and low demand,” he comments.

Scrap dealers have felt the effects of these issues affecting primary aluminum markets. Processors’ and brokers’ margins continue to be tight as demand for aluminum scrap is high but generation continues to lag, Madden says.

Matt Kripke, president of Kripke Enterprises Inc., a second-generation nonferrous scrap metal brokerage firm based in Toledo, Ohio, says the warehouse financing deals as well as the rising U.S. Midwest aluminum premium have supported the oversupply of prime material. These deals have encouraged producers to continue producing instead of shuttering excess capacity, he says.

Kripke says the U.S. premium for aluminum, paid on top of the LME price for physical delivery, is “unprecedented. We’ve never seen anything like this.”

Scrap dealers are seeing prices increase, spreads decrease and supply lagging, Madden says.

Reuters reports that aluminum premiums in mid-January surged to record highs, renewing concerns about the dwindling supplies and rising costs of the nonferrous metal, even as the market struggles with sizable stockpiles.

The U.S. premium for aluminum surged in excess of 45 percent in a matter of days in mid-January to a record high of roughly 20.5 cents per pound, according to Kripke.

He says the increased premium is preventing primary smelters from shutting down capacity because they are still making money.

He continues, “What’s going to end it? If interest rates rise, that’s going to put pressure on the financial deals … For the short-term, this high Midwest premium is preventing people from shuttering excess capacity as they’re still making money.”

Madden says that while inflated premiums continue to provide producers with relief from low LME prices, this may encourage them not to make the capacity cutbacks that companies such as Novelis have announced, prolonging the malaise in the primary aluminum industry.

“Premiums are very high for artificial reasons,” Madden adds. He predicts that closures will continue into 2014 because of a large overhang of inventory, which is weighing down the LME price, despite the high premiums.

“There are probably 10 to 15 million tons of [inventory], and with this backdrop we see prices continuing to slide, putting pressure on producers to cut further. We believe there will be more cutbacks,” Madden says.

In addition to Novelis, another large aluminum producer announced plans to shutter capacity. In its quarterly report, released Jan. 9, 2014, Alcoa, based in Pittsburgh, reported $1.7 billion in “noncase goodwill impairment tied to legacy smelting acquisitions.” The company says it has taken 16 percent of its global smelting capacity offline as a result.
 

Premium plus

For Novelis, excessively high local market premiums (a result of the warehousing deals, Madden says) have been a sore subject. This notable aspect of the market over the last few years has been a cause of concern for the aluminum firm and its customers in light of inflated prices and supply chain risk, he adds.

Madden says, “In October, the LME announced a rule change, which is intended to mitigate this problem; but, surprisingly premiums have since risen to previously unimaginable levels, and we are very concerned about supply chain risk.”

The LME, the world’s largest metals marketplace, announced changes to its metals storage system in late 2013 after years of complaints about wait times of more than a year and large premiums to withdraw metal from the warehouses it monitors, according to Reuters.

The LME outlined plans to slash these waiting times to a maximum of 50 days, among other measures, which analysts and manufacturers had hoped would lead to lower premiums, especially given that the aluminum market is oversupplied, Reuters reports.

Kripke says because of Midwest premiums, consumers have to overpay for the aluminum scrap supply that is available. People are paying a premium plus a premium, he says.

“There’s not enough readily available prime at reasonable prices because people are willing to pay almost over for scrap what the intrinsic value of scrap is,” Kripke explains. “The supply is out there: You have to overpay to get it.”

Aluminum scrap dealers, he says, have been struggling to maintain margins over the last year, making 2013 a challenging time for many of them.

Kripke Enterprises Inc., which does about 95 percent of its business in aluminum volume, had a record year in terms of volume, handling more pounds of aluminum in 2013 than any other year in its 21-year history, Kripke says.

“We never did more volume than last year, but we never worked so hard to make so little,” he adds.

“The scrap dealers in aluminum have been struggling to maintain margins over the last year. I know for brokers like us it was a challenge to get there,” says Kripke.

He says a correction in the market is coming, whether it is reflected in the LME price itself or in the premium, “one or the other has to give.”
 

Highway star

Matt Meenan of the Aluminum Association, Arlington, Va., says the national trade association is encouraged by improving demand opportunities that will drive the future growth of the industry.

At the 2014 North American International Auto Show (NAIAS), held in Detroit in January, officials announced an increase in the use of aluminum in the automotive industry, including Ford’s F-150 truck.

Demand for aluminum used to produce vehicles is expected to double by 2025, according to Meenan. “One of our big stories is the automotive sector, where we’ve seen 40 years of uninterrupted growth in aluminum use,” he says.

“Demand for aluminum in the United States and Canada is up 30 percent from the depths of the global recession in 2009 and approaching record levels set in the mid-2000s,” Meenan says.

Kripke says as someone whose job depends on aluminum, he hopes the metal will play a much larger role in new automobile models.

“I’m hoping that it turns out that we’re not in an oversupply two years from now and it just was that the market was changing with changes in automotive,” he says.

“If aluminum truly takes a bigger bite of the automotive pie, then the demand for automotive sheet is going to create overall happy days for those of us in the aluminum business for the next four to five years, and I hope that happens,” Kripke adds.

He says that as demand for aluminum scrap increases, there will be a short-term shortage, but it won’t last long. Scrap dealers also can look forward to additional zorba production from auto shredders in the next decade, he says.

“Whenever there’s a ramp up in demand, there’s always a shortage of scrap initially,” Kripke says.

Madden says he predicts an upsurge in aluminum demand in the next five years as a result of auto industry consumption of aluminum, which also means an increase in the consumption of aluminum scrap.

“The conversion of automobiles from steel to aluminum parts will add dramatically to aluminum demand in the next five years,” he says. “We expect CAGR (compound annual growth rate) of 30 percent in automotive through the end of the decade,” Madden adds.

As for aluminum markets in 2014, he says, “auto will be the star.” The building and construction industry also will provide support for aluminum in North America, he adds.

In the transportation market, aluminum shipments grew 14 percent between 2011 and 2012 and shipments in that sector have grown by two-thirds since 2009, Meenan says.

Aluminum used in the building and construction sector grew 6 percent year over year in 2013 and has grown nearly 10 percent since 2009, according to Meenan.

“Building and construction is another bright spot,” he adds. “As the economy continues to come back online, we are looking at these market sectors in particular as key bellwethers for the industry.”

 


The author is associate editor of Recycling Today magazine and can be reached at mworkman@gie.net.

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