China may dull shine of aluminium profits
As Russia's Rusal returns to black, growing Chinese exports of the metal threaten to flood global market as tax rebates encourage greater output
For the world's hard-pressed aluminium producers the current outlook is the rosiest in many years.
Russian giant Rusal, for example, has just returned to profit for the first time in five consecutive quarters.
That is largely thanks to the combination of a robust London Metal Exchange price, currently trading about US$2,100 per tonne, its highest level since early last year, and historically elevated physical premiums.
The price recovery is being underpinned by a tectonic shift in underlying market dynamics. After years of structural surplus, the global aluminium market finally appears to be turning to supply deficit on the back of accumulating capacity closures.
Rusal, which reported an 11 per cent drop in production in the first half after its own curtailments, is forecasting a 1.5 million tonne global deficit this year.
That may be at the high end of the spectrum of forecasts but it no longer sounds like a producer pipe dream. In a recent poll of analysts, four out of 14 submitting a market balance assessment for this year forecast deficit, the number rising to almost half for next year.
The main threat to this market optimism comes from China. Production there is rising. More disconcertingly, so too is the stream of semi-manufactured products leaving the country.
In the world outside China aluminium production has been trending lower for a couple of years. Annualised production in July was 24.38 million tonnes, down by more than 1.5 million tonnes from the record high of 25.92 million tonnes in October 2011.
Over the same near three-year period Chinese production has grown by 5.7 million tonnes annualised to 23.28 million tonnes in July, according to figures from the China Nonferrous Metals Industry Association.
Not that Chinese smelters have enjoyed better margins than anyone else. But local and, at times, central government has subsidised losses, mostly by tweaking power rates.
Even where Chinese smelters have been forced out of business, their places have been more than filled by a new generation of lower-cost smelters.
But China, to quote a phrase coined by Klaus Kleinfeld, chief executive of Alcoa, exists in a different aluminium universe, one that has little bearing on what happens in the rest of the world.
To a certain extent, that is true. Certainly, when it comes to primary aluminium, what China produces largely stays in China. And it has done ever since the country's authorities increased the tax on exports to 15 per cent back in 2006.
China has been a net exporter of aluminium alloy for years. The tonnages are not huge, just 347,000 tonnes last year, but enough to counterbalance what enters as primary aluminium.
The country is a much bigger exporter of products and has been for almost a decade. This is in part down to government-led pressure on mainland smelters to go down the value-added chain, meaning more product capacity, and in part due to the simple fact that Chinese products are highly competitive, since exporters receive a tax rebate.
There have always been suspicions that some of those product exports may not be quite what they appear, given the incentive to transform primary metal just enough for it to qualify for a tax rebate rather than be hit by the export tax.
Analysts fear such tax arbitrage, if it is taking place, acts to disguise the true nature of Chinese surplus.
Macquarie Bank analysts, for example, contend that primary metal is "exported under a sheet trade code such as continuous cast coil which is then remelted, cast and alloyed to specifications in the destination countries".
"We believe this is a trade that many Chinese aluminium fabricators started to follow over the past couple of years to avoid 15 per cent tax on primary aluminium, which supports our view that some Chinese aluminium surplus has been replaced by other forms," the analysts said.
Such concerns are increasing because Chinese product exports are also increasing.
Product exports rose 3.7 per cent in the first half of this year but July brought a steep change with 320,000 tonnes leaving the country, marking a 14 per cent jump on July last year. One month's data do not a trend make, but the underlying trend is only going in one direction and that is upwards.
It is just a question of how the trend evolves. And most analysts seem to be expecting an acceleration in Chinese product flows over the coming months.