Status of Alum Smelters Questioned

Falling power prices in the Northwestern U.S. are raising questions about when the region's aluminum smelters will be brought back on line.

More than 1.6 million metric tons of capacity was mothballed last year - about 8 percent of the western world's total - due to a power crisis in the Pacific Northwest.

Now that power prices are back to normal, some observers believe smelters could be reopened by the second half of the year. This would be welcomed by laid-off workers but could keep aluminum prices depressed for the rest of the industry.

Production cuts by companies such as Alcoa, Kaiser Aluminum and Columbia Falls Aluminum helped balance the market at a time when industrial demand for aluminum was weak. The worry is that any reinstated capacity would disrupt this balance because sharp falls in automotive and aerospace output will keep demand relatively low this year.

This concern is already starting to filter through to the market, where aluminum prices on the London Metal Exchange have slipped from about $1,400 a metric ton earlier this month to about $1,385 - some 7 percent below the 10-year average.

"Half a million metric tons a year of excess production capacity is enough to have a significant effect on the price," says Adam Rowley of Macquarie Bank.

Spot power prices on the California-Oregon border surged to nearly $400 a megawatt-hour last January due to low reservoir levels for hydro-electric power plants and increasing demand from California's electricity-hungry information technology sector.

Smelters agreed to close their plants for two years after the Bonneville Power Administration, the federal agency responsible for providing low-cost power in the region, said prices would have to treble or quadruple.

Since then, high rainfall and new power plant building programs have reduced spot power prices to about $16-$17 per MWh. With rivers and streams brimming full and snowfall slightly above average levels, forward power prices for the next 18 months are about $26 per MWh. This would allow smelters in the region to break even at an aluminum price of $1,250 a metric ton.

There is already a precedent for smelting capacity to be brought back online. In Brazil, which suffered similar power shortages last year, some 200,000 metric tons a year of capacity is being restored progressively as power rationing is lifted.

Macquarie believes that at least a further 200,000 metric tons a year of Pacific Northwest capacity could be brought online by the year-end.

Two smelters with 380,000 metric tons a year of capacity have take-or-pay power contracts with BPA due to start in April, though BPA says it has had no indication to date that they are planning to restart production.

The remaining eight smelters, which have no such constraints, may prefer to buy cheaper power from the spot market while continuing to receive payments of $20 per MWh that BPA was forced to agree to cover labor costs.

"We're continuing to look at all the options and our decision will depend on market conditions," says Alcoa, the world's largest aluminum producer.

Companies thinking of restarting production will have an eye on their Chinese competitors.

Chinese production is expected to grow by about 18 percent this year to 4 million metric tons, according to figures released by Beijing Antaike Information, a state-owned metals analyst.

China's aluminum consumption has grown at an average of 13.5 per cent a year over the last 10 years but slowed to 8 per cent last year. Industry observers believe the country will become a net exporter this year, increasing pressure on western companies to keep their smelters closed.

Not everyone in the industry is bearish, however. Nick Moore, metals analyst at JP Morgan, believes demand for aluminum in China will be buoyed by projects in preparation for the 2008 Olympic games. Moore says it is too early to say whether demand in the western world will recover, but that this possibility cannot yet be dismissed. Financial Times