Aluminium surpluses and the price conundrum

Barclays looks at a number of growth and production scenarios in a bid to determine the likely path of aluminum prices in 2013.

Aluminium prices are likely to trade close to the $2,000/tonne mark this year on the back of a 1.8 million tone surplus, Barclays says.

But, it says, while the above fundamental narrative is a simple one, it belies a number of significant distortions that mean the metal is “generally viewed in far more uncertain terms by market participants in 2013″ than it would be otherwise.

Writing in its latest Metals Magnifier publication ‘Short aluminium and nickel at current price levels’ the bank points out, “despite significantly sized consecutive surpluses and a subsequent downward trend in LME prices, particularly over the past two years, market forces have failed to drive supply rationing of the scale needed to tighten fundamentals. If anything, the reverse is anticipated to take place.”

There are two primary reasons for this, Barclays, says, the first is that the metal has been more “overtly influenced by inventory financing and associated effects than any other base metal.”

This, the bank explains is the result of a strong contango in the forward market, created by the significant surpluses and the current cost of capital environment which, when combined, have resulted in a tying up of much of the available inventory.

And, the bank says, this tied-up inventory, exacerbated by bottlenecks in LME delivery, “has created a bullish environment for physical premia.”

The second reason for the lessening of margin pressure that should have been clearly evident in a market with such significant surpluses is the presence of government intervention “in the form of subsidies or renegotiated power contracts to smelters – particularly though not exclusively in China – which have also offered a buffer against LME (or SHFE) price weakness driving a supply response,” the bank writes.

These distortions have resulted in a lack of urgency on the supply side and inform Barclays base case scenario of a rise in the market’s stock to consumption ratio to 9.3 weeks from 7.9 weeks at the beginning of the year on the back of stable production from the US and Europe and a 12% jump in production in China on the back of new, low-cost capacity in the north west of the country.

On the demand side, Barclays says, “Whilst demand dynamics are anticipated to offer a robust performance also, with global consumption rising close to 6%, bolstered by China’s modest rebound and US auto demand yet again being strong, the surplus outcome holds.”

As a result, as its base case, Barclays says, the average aluminium cash price in 2013 is likely to average $1,990/tonne for the year, or slightly lower than current price levels.

But, given the current difficulties in predicting both the actions of the aluminium market in particular and the global economy more broadly the bank has tested a number of other scenarios as well.

Scenario 1: production cuts everywhere but China.

Should the world see constrained production in the world ex-China, and instead of a 3% rise in global production as is currently expected, we see a 1.8m tonne cut in output, the market would be roughly in balance for the year, the bank writes.

If this were to happen, the LME cash price would average $2,030/t, with the market trading at close to $2,100/t by year-end.

But, the group writes, ” we are sceptical that the market will see a production scenario where 1.8Mty is cut from our baseline target.”

Scenario 2 – Chinese production is constrained, resulting in a balanced market.

If Chinese production were to grow at 5% instead of the expected 12%, the global balance would be reduced to a small surplus for the year, Barclays says, ending the year with a 7.3 week stock to consumption ratio.

Such a scenario would mean an LME cash price over $2,200/tonne by the end of 2013, with an average price around $2,100/tonne.

This scenario, Barclays says is certainly plausible, “First, in China currently we see close to 30% of Chinese smelting capacity benefitting from power subsidies, with a good proportion kept in profit because of this,” it says.

 But it adds, “Perhaps the most likely scenario where Chinese production is constrained is related to bottlenecks regarding the ramp-up of new capacity in Xinjiang province, where close to 2Mty is anticipated to ramp-up in 2013.

Scenario 3: Chinese economic growth surprises to the upside resulting in a demand boom.

The bank’s base case is predicated on global demand growth of 6.3% (+2.9 million tonnes) in 2013 with Chinese demand growing at 9%.

“If global demand surprises significantly to the upside but the supply-side performs as per our base case. In that scenario, global aluminium demand growth comes in at 10%, supported by a 15% demand growth level in China, which would ultimately mean the global market balance is in a negligible surplus.”

If this were to happen, Barclays says the average LME cash price in 2013 would be around $2,320/t “with an upward slanting profile” with prices in the fourth quarter close to $2,500/tonne.

“The plausibility of such a scenario is more a question of macro prospects than underlying fundamentals – needless to say, in the case of potential upside risks to Chinese growth, a ramp-up in infrastructure spending and a boost to domestic consumption could be upside catalysts after the 12th National People’s Congress in March 2013,” Barclays writes.

Scenario 4: Production cuts in the world ex-China and a global demand boom.

Definitely the most bullish scenario but, Barclays maintains that the likelihood of both events occuring concurrently is very low.

The problem with such a scenario, it says, “is that the two effects are not mutually enforcing – if global demand picks-up and price rises, as the scenario has shown, this is likely to weaken the case for production cuts”.

But, if it were to happen, Barclays says, the annual LME cash average would come n around $2,365/t, while the Q4 average would likely be $2,700/t with some possibility of touching $2,900/t by year-end.

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