Aluminium outlook for H2 2017: Chinese aluminium capacity cut to drive prices

The first six months of 2017 are just over and aluminium has emerged as the best performing industrial metal of 2017 so far by gaining close to 15% in the first quarter itself. It has much outpaced base metals like zinc and copper after posting a 12.43% growth in 2016. Aluminium was the second worst performing base metal in 2016 which jumped up to be the best performing one in Q2 2017. 

Throwback 

Since the financial crisis in 2008-2009, the aluminium market has been inflicted with a supply glut. However, after hitting rock bottom prices, LME aluminium started gaining in the second half of 2016. The growth in in 2016 was driven by quick falling supply in China with the closure of capacity around August/September and demand growth as the result of China’s infrastructure initiatives.

Another factor that had buoyed aluminium price in the Q4 of 2016 and Q1 of 2017 is Trump’s coming to power as the President of America. He aggressively campaigned against cheap aluminium and steel import to the U.S. and reiterated his stand on infrastructure spending. Aluminium is a key source of revenue for several major mining companies such as Rio Tinto, Norsk Hydro and Vedanta Resources and a large number of investors and traders. China’s directive towards capacity cut and Trump’s insistence on trade reforms have inflicted positivity in the market lifting aluminium prices. 

We can see how the average LME aluminium price moved up in the second half of 2016 in the following graph:

The average LME price in the first half of 2016 stood at USD 1,543.92/t, while the same jumped up to USD 1,665.95/t in the second half. This registers a growth of about 8%. If we compare the price growth between Q1 and Q4, the growth rate stands at about 13%. This is one of the best metal performances in the last quarter of 2016.

                         Average LME Aluminium price by Quarter and Half 2016 (USD/t)

The growth accelerated in the first two quarters of 2017.  The average LME aluminium price touched USD 1,852.87/t in the first quarter of 2017 registering a whopping 22.2% jump YoY. Quarter on quarter the prices gained 8.2%.  In the second quarter the average LME aluminium prices rallied further to touch USD 1,909.16/t registering a 21.4% increase YoY. Quarter on quarter average LME aluminium price registered a growth of 3% in 2017.

Smelter Capacity Cut

After tackling excess capacity in coal and steel industries, Chinese authorities are turning their focus towards aluminium in 2017. The development started in Dec’16 when Chinese Ministry of Environmental Protection (MEP) delivered verbal warnings to Chalco, the nation's top aluminium producer, for failing to deal with pollution appropriately.  The price rise followed the supply worries that started in Jan’17 after news of a proposed winter shutdown of 30% of aluminium smelting and 50% of alumina refining capacity in Shandong, Shanxi, Hebei and Henan from November to March to fight air pollution and cut down unprofitable capacity. These provinces account for 70% of China’s total aluminium production. 

In April 2017, authorities in China issued a directive that they will shut down aluminium capacity during the winter in 28 major cities. China’s top economic planning agency, the National Development and Reform Commission has announced plans to crack down on illegal aluminium smelting projects and instructed local governments to inspect smelters built after 2013 on the basis of environmental regulations.

Aluminium stood strong in the first two quarters on the news of suspension of three aluminium operations worth 2 million tonnes capacity in Xinxiang by the Chinese government on the basis of environmental irregularities.  According to the latest news published by Shanghai Metals Market (SMM), China’s aluminium giant Shandong Weiqiao is expected to slash its aluminium production by 1.4 million tonnes and Xinfa would cut 500,000-600,000 mt/year. However, there is still no official confirmation on the actual cut.

During the first six months of 2017, the average LME aluminium price touched USD 1,880.56/t an increase of 21.8% from the H1 2016 average of USD 1,543.92/t. This is an incredible performance for aluminium in a volatile market.

According to CRU, there are plenty of new projects ramping up in China and state-owned companies have been active in announcing new projects. If some projects shut down, new projects would crop up. The Chinese government is hesitant about the job cuts that may follow capacity shut down. The smelters and refineries would work on their environmental regulations to be back on operations. Only an announcement of actual production cuts can drive prices above $2,000 a tonne.

“If such production cuts do not materialise over the second half of this year, price pressures are likely to mount given the domestic market surplus [in China],” analysts at Standard Chartered warned.

SMM has also cautioned investors to refrain from overt optimism following the news of the production cut. Despite large size of the latest round of aluminium output cuts in China, the process might take at least more than four weeks to be completed, SMM estimates.

Moreover, it is projected that there will be more than 3 million tonnes per annum of legal aluminium capacity under construction during 2017-2018. Aluminium capacity of about one million tonnes per annum will come online in the second half of this year. This will offset the planned winter capacity cut in November and December.   

According to Commodity analyst Ed Meir from INTL FCStone Financial Inc., if the capacity cut actually happens in China, it would bring about a significant change by lifting the aluminium prices, but, if it does not happen it may bring down the aluminium prices further to the level it dropped in last two year. The price movement is determined by what happens in October-November 2017. If there is no capacity cut aluminium prices may come down to USD1700/t but if it happens, the prices may cross USD2100/t.

Aluminium Inventory 

Keeping the capacity cut in China aside, when we look at the aluminium inventory situation, LME Aluminium stocks currently stand at 1.36 million tonnes, which is the lowest since 2008 whereas, according to SMM statistics, stocks in Shanghai, Wuxi, Nanhai, Hangzhou and Gongyi totaled 1.25 million tonnes, the highest in last four years. According to the latest data from World Bureau of Metal Statistics (WBMS) published by SMM, the primary aluminium market worldwide was in a deficit of 735,000 tonnes during January-May as compared to 1.1 million tonnes for the whole of 2016.

On the other hand, China’s total aluminium production in the first half of 2017 stood at 16.84 million tonnes, up 8.8 per cent year-on-year. China aluminium producers increased their production to rake in some more profits from the strengthening prices of aluminium which was a result of the government initiated output cut. So, every time there is a rise in aluminium price, China will push its production further offsetting the price rise.

Other than these two factors, Alumina Price Index will also have some impact on aluminium price. If alumina price rises in the second half it may drive the aluminium prices to certain extent.

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SMM believes Current production cuts will be insufficient to reverse supply surplus for this year. Mounting stocks will weigh down aluminium prices in the medium term.  Considering the lack of any speculative events, aluminium prices will now be subject to market fundamentals. 

In our view, if aluminium grows in the same pace like it did in the first half of 2017, it will cross the 2100/t mark in the second half of 2017 registering a growth of about 10% from the current level. The market sentiment would be driven by the proposed capacity cut in China and the way aluminium stock moves in H2 2017. The price movement depends considerably on how Chinese authorities would execute this capacity cut drive and keep the domestic inventories in check.