KEY FACT

World aluminium production is expected to increase 8 per cent to 43.8 million tonnes in 2011

Source: MEED

Aluminium is the world’s most abundant metal and its most widely used after steel. It is a vital commodity for a wide range of industries, including automotive, aviation, packaging, construction, power distribution and consumer electronics. Even though aluminium is costly to produce because it is power-intensive, prices have come under pressure in the past two years.

In July 2010, aluminium was trading at just $1,800 a tonne on the London Metal Exchange (LME), amid fears of a double-dip recession in the US. However, world prices began to harden in the second half of the year and recovered steadily to reach $2,300 a tonne by December 2010.

Middle East countries are channelling their oil and gas wealth into new aluminium smelters in the region

Analysts read the trend as an early sign that the world economy was at last emerging from the doldrums. Key indicators included improved demand from the automotive sector and manufacturing sectors. But while there are signs that world demand is recovering, prices have lagged behind, due to high levels of stockpiled aluminium.

Aluminium price trends

When it comes to predicting aluminium price trends in 2011, analysts are divided. Critical factors include new capacity in emerging markets such as the Gulf, questions over whether China will reopen capacity shut down last year and market demand for new aluminium exchange-traded funds.

Renewed Middle East demand could also boost world prices. As regional construction regains its confidence

China is due to unveil a new five-year plan this month. Its previous plan pledged to reduce national power consumption. Several of China’s least efficient smelters ceased production when the government cut off power supplies in late 2010.

Chinese aluminium output is reported to have fallen from 17.5 million tonnes in 2009 to 14.5 million tonnes in 2010, eroding the country’s stocks. Long term, Beijing is expected to become a net importer of aluminium. But its short-term decisions will be crucial, as it accounted for 40 per cent of world production last year.

Nevertheless, new producer countries are emerging, particularly in regions with access to cheap and plentiful energy. Aluminium is incredibly power-intensive. Electricity accounts for two-fifths of the metal’s production costs.

Middle East countries are channelling their oil and gas wealth into new aluminium smelters as part of their drive to diversify their economies. And so, whether China restarts its capacity or not, smelters across the Middle East plan to ramp up their own aluminium output this year.

World aluminium production is expected to increase 8 per cent to 43.8 million tonnes in 2011, boosted by new production in India and the Middle East. This follows a 10 per cent increase in production to 40.7 million tonnes in 2010. Growth may slow from next year, however, as new smelters in the Gulf and India edge towards capacity.

Several analysts believe high stocks and new production will dampen price growth this year. Analysts including the US’ Morgan Stanley and Goldman Sachs forecast prices ranging between $2,125 and $2,500 a tonne during 2011. This falls far short of peak trading in July 2008, when aluminium reached $3,380 a tonne.

But other analysts, including the UK’s Barclays Bank and Germany’s Deutsche Bank forecast stronger price growth. These analysts point to the two-year peak on 7 February, when aluminium briefly traded at $2,574 a tonne. The benchmark aluminium contract climbed to $2,500 a tonne for the first time since September 2008.

This has led some to predict that aluminium prices will reach $2,700 a tonne in 2011. Several factors make this possible. Hedge funds have started to buy aluminium and sell copper, which is now a record four times more costly. Compared with other metals, aluminium is arguably under-priced.

Growing aluminium demand

Growing Chinese demand could provide a further boost. The US’ Alcoa, the world’s largest producer of aluminium, forecasts a widening 700,000 tonne gap between Chinese production and demand in 2011. Some observers believe China will decide not to resume production at mothballed smelters, to cut back its energy use.

Strong economic growth in Brazil, India and Russia and a recovery in mature markets across Europe and North America could also yet boost aluminium consumption this year.

“We believe that the fundamental indicators for aluminium are strong,” says Tobias Merath, head of commodity research at Swiss finance house Credit Suisse. “With China cutting its power supplies to smelters last year and problems with Australia exporting coal this year, there are signs of aluminium production falling at a time when consumption is increasing.

“Meanwhile, there is growing pressure on the cost side … Aluminium is trading now [February 2011] at $2,500 a tonne. We believe that prices could reach $2,700 or even $2,800 a tonne this year.”

Nevertheless, aluminium stockpiles have grown significantly since the financial crisis. LME-registered warehouses held nearly 4.6 million tonnes of inventory in February 2011, which included 250,000 tonnes of new stock added during January. Worldwide, analysts say aluminium stocks could amount to more than 10 million tonnes.

The reason prices have not crashed is that banks have locked the stockpiles into long-term financing deals, which keeps the aluminium off the market. But cautious analysts see January’s increase in LME stocks as a factor that will depress prices, despite increased demand.

Uncertainty about market trends is borne out by key producers’ decisions for the year ahead. Many shut down inefficient capacity during the financial crisis. But while Alcoa plans to resume production at three laid-up US smelters by June, rival producer Norway’s Hydro says it has no plans to fire up its idle capacity, citing high inventories and market oversupply.

Longer-term prospects for aluminium look more positive, however. Goldman Sachs believes the market may flip from surplus to deficit from 2013. New initiatives in China to improve energy efficiency could see the country slow its aluminium production. Meanwhile, Chinese demand for aluminium is expected to increase by 8.2 per cent to 2015.

For the past 40 years, demand growth for aluminium has outpaced demand for other base metals. Morningstar equity analyst Bridget Freas believes that aluminium is poised for an upsurge in demand from developing countries, even though oversupply is “unlikely to recede in the next couple of years.”

Steel market

Meanwhile, world demand for steel is emerging from the worst slump in half a decade, according to the Organisation for Economic Cooperation and Development’s steel committee. Industry figures suggest that global steel capacity stood at nearly 1.9 billion tonnes in 2010, representing a surplus of 300 million tonnes.

However, during the third quarter of 2010, the committee reports, global demand for steel was “6 per cent higher than pre-recession levels seen during the second quarter of 2008”. The first nine months of 2010 saw a 20 per cent increase in world steel production to 1.046 million tonnes over the same period in 2009.

Announcing the figures, the OECD steel committee reported Chinese demand was already a third higher than before the financial crisis.

The World Steel Association expects global demand to increase 5.3 per cent in 2011. Globally, steel consumption comprises 1.4 million tonnes a year (t/y). The Middle East trades and consumes about 50 million t/y. Dubai is a conduit for steel exports eastbound from the Black Sea to Asia and westbound, from China and India to Africa and Europe.

Last year, the Middle East was the only region apart from India and China to increase its output. Regional production is concentrated in Iran, Libya and Egypt. The GCC has among the world’s highest per capita steel consumption at 380 kilos a head, according to Dubai Multi Commodities Centre.

International steel prices began to strengthen early in 2010, following a surge in iron ore, scrap and coking coal prices, even though demand remained slow at the time. However, some analysts believe that steel prices could rise as much as 30 per cent this year, due to global restocking since the final quarter of 2010 and soaring costs of raw materials.

This year’s Queensland floods in Australia have disrupted supplies of coking coal that powers blast furnaces. Queensland generates 55 per cent of the world’s coking coal.

Middle Eastern steel producers have an advantage when it comes to input costs. Most source their power from natural gas and do not use coking coal in the production process. This has shielded regional producers from shortages of raw materials, while allowing them to benefit from higher steel prices.

Renewed Middle East demand could also help boost world prices. As the GCC construction sector regains its confidence, observers expect delayed infrastructure projects to resume this year. Governments across the region are investing heavily in new industries, transport, oil and gas, healthcare, education and petrochemical projects.

Political unrest in the Middle East

But other observers fear that political unrest across the Middle East could dent business confidence and delay the recovery in the construction sector. Price tracking service Steel Prices Middle East warned in mid-February that buyers were becoming increasingly cautious, following the spread of popular protests across the Middle East.

Mid-February saw sluggish trading in Turkish-made rebar in the UAE. It reported that traders were struggling to shift the metal at $650-655 a tonne last month, down from $750-755 a tonne in January.

“An abundance of position cargo is waiting on the sidelines to play havoc when the speculative bubble bursts,” Steel Prices Middle East cautioned. “As a result, most buyers in the Middle East are postponing their immediate requirement in anticipation of an imminent crash.”

Despite the positive outlook for the metals sector at the start of the year, geopolitical uncertainty could stall the recovery in demand.