Demand for metal products in Europe and North America has weakened dramatically over the past six months, following the collapses in the automotive and construction markets.

But against this gloomy backdrop, the Middle East is emerging as a significant producer of aluminium, with a series of smelter projects due to start production over the next two years. The region is seeking to boost its capacity and take advantage of its low-cost energy resources at a time when rivals are being forced to consider their future.

The speed of the collapse in aluminium prices has left many of the Middle East’s producers in turmoil. In previous cycles, the average duration between peak and trough prices was 34 months, according to London-based metals and mining consultant CRU Group. The latest fall in prices, to $1,468 a tonne in April 2009, comes less than 10 months after highs of almost $3,300 a tonne in July 2008.

Production cuts

The industry has been caught napping. As prices have fallen, producers have maintained production and built up inventories, which are at record highs of 3.7 million tonnes in London Metal Exchange (LME) bonded warehouses, up from 1.1 million tonnes in June last year, contributing to the low prices.

Market prices for aluminium have now fallen to less than the cost of production for the majority of smelters worldwide. The response from most aluminium producers to the massive decline in demand has been drastic, albeit belated, cutbacks in production.

Excluding China, cutbacks in production reached about 1.5 million tonnes a year (t/y) by the end of 2008 and have increased further to about 3 million t/y so far this year.

The majority of cuts have occurred in the export-led markets of Europe and the US, which have collectively announced capacity cuts of 2.5 million tonnes of production.

Since the beginning of 2009, Norwegian aluminium producer Norsk Hydro has cut 500,000 t/y of production, about 30 per cent of its 2008 output. Other producers have followed suit and it is not clear whether the smelters shut down in Europe and the US will be restarted.

Further cuts have been called for. In March, Svein Richard Brandtzæg, on taking over the stewardship of Norsk Hydro as chief executive officer (CEO), said the industry could not wait for demand to pick up, and the only way to reduce inventories was to make further production cuts.

According to Marco Georgiou, section head at CRU, cutting a further 2 million tonnes from production by the end of the year will only stabilise stocks at their current high levels, with demand forecast at 34 million tonnes for 2009.

“With no material improvement in demand, we are likely to need even greater levels of cutbacks among marginal producers to work stock levels down and bring metal prices back above marginal cost levels,” says Georgiou.

Amid the panic in the industry, with many major projects cancelled or put on hold, the Middle East, and the Gulf in particular, is committed to expanding capacity.

The Gulf has a solid outlook for production despite the slowdown. The region has three smelters in operation by Dubai Aluminium (Dubal), Oman’s Sohar Aluminium and Aluminium Bahrain (Alba), and two more greenfield smelters operated by Qatar Aluminium (Qatalum) and Emirates Aluminium (Emal) in Abu Dhabi, which will begin production by the end of 2010. Saudi Arabia is also in the process of building its first smelter at the Ras al-Zour complex.

Despite the cuts in European production, Norway’s Hydro has reaffirmed its commitment to Qatalum, a joint venture with Qatar Petroleum, on the basis that when it becomes operational in the third quarter of 2010, the 585,000-t/y smelter will be profitable because of the low feedstock prices in Qatar, even at today’s deflated aluminium prices. The total cost of the Qatalum project is estimated at $5.6bn, of which Hydro’s share is $2.8bn.

Preserving a competitive cost advantage will not be easy for the Gulf producers, as other industries, such as petrochemicals, compete for precious gas allocations. If securing energy supplies becomes more difficult, and the price of aluminium on the world market drops because of a glut in supply, the economic viability of all of these projects will become less certain. Producers may be forced to turn to more expensive, less efficient fuel oil for power generation.

Building big will be another great asset for the Middle East. Most of the planned plants are among the largest in the world, with capacities of more than 350,000 t/y. By 2012, the region is forecast to double its share of global capacity to about 6 per cent.

Although less volatile than the energy markets, securing feedstocks of bauxite or alumina will still present a challenge to producers. The global financial crisis and plummeting commodity prices hit Saudi Arabia’s aluminium plans in December 2008 when UK/Canadian aluminium producer Rio Tinto Alcan withdrew its financing commitment to the $10bn Ras al-Zour integrated aluminium complex with Saudi Arabian Mining Company (Maaden). Maaden agreed the project with Alcan in 2007, but the Canadian-headquartered firm was taken over by UK/Australian mining giant Rio Tinto in 2007.

In early December 2008, Rio Tinto announced it was shedding 14,000 jobs worldwide and would slash investment budgets for 2009 in a bid to rein in debt.

Industry expansion

Maaden and Rio Tinto Alcan subsequently signed two agreements in March, including a technology transfer deal for the mine-to-metal aluminium project. Under the scheme, Maaden will refine and smelt bauxite ore mined in Zubairah, in Qassim province. Rio Tinto Alcan will provide Maaden with its bespoke smelting technology and offer technical support, as well as being involved in the procurement and supply of raw materials.

The alumina refinery will have a capacity of 1.6 million t/y, while the smelter will have an initial capacity of 720,000 t/y. Commercial production has been pencilled in for early 2012 and more than 70 per cent of the plant’s output is intended for export.

Despite the financing difficulties on the Ras al-Zour project, the falling cost of construction is working to Maaden’s advantage.

According to Stuart Clough, senior aluminium specialist at Australian design and engineering firm WorleyParsons, there is now a 12 per cent saving to be made on the physical cost of building a greenfield smelter, compared with 2007. There will be similar savings for brownfield sites.

“Over the past three months, there have been price declines in 95 per cent of the listed commodities, so it is apparent that the bottom has not yet been reached,” says Clough. “In short, the negotiating power is firmly with the buyer.”

Progress on building aluminium plants in the Gulf, from initial concept to production, has also been fast. Emal, a 50:50 joint venture of Dubal and Abu Dhabi state-owned investment company Mubadala Development Company, for example, was first signed in February 2007, and is expected to deliver its first aluminium by mid-2010.

The smelter at Taweelah will have an output of 700,000 t/y once work has finished on phase one in April 2010, rising to 1.4 million t/y, the largest capacity in the world, when phase two is completed.

In March, when asked by a delegate at the MEED Aluminium conference in Dubai whether Emal would have set out on its joint venture in 2007 if it had known what was to come, Duncan Hedditch, its CEO, responded with a categorical “yes”.

“Success depends on a good business plan, finances, low-cost production, the avail-ability of resources and production escalation,” he added. “Of these, maintaining low-cost production is the most important factor for survival.”

Oversupply may have been a concern when the project was first conceived, given the number of planned smelting projects in the region at the time. But Emal’s business plan was put together on conservative economic assumptions, with the expectation that in the event of a downturn, production would be cut at smelters with high energy and production costs.

With the technical experience of Dubal behind the company, the financial acumen of Mubadala and a reliable supply of energy from Abu Dhabi, Emal is well placed to become a robust and significant entity in future regional aluminium production. Downstream, there is also plenty of potential in the region, which exports about 84 per cent of its primary aluminium production, according to Modar al-Mekdad, general manager of Jebel Ali-based extrusions company Gulf Extrusions.

While the Gulf is currently a net importer of flat-rolled products, it is expected to be a net exporter by 2012. The bulk of demand, some 70 per cent, comes from the extrusion industry, fuelled by the region’s recent spectacular growth in construction.

More than 200,000 tonnes of extrusion capacity has been added in the Gulf over the past two years as a response, says Al-Mekdad.

Nonetheless, GCC demand for extruded products in 2008 was about 400,000 tonnes, while supply exceeded 700,000 tonnes.

By developing a downstream aluminium industry, the Gulf smelters could raise the region’s consumption to at least 50 per cent of production, from 16 per cent today, reducing the risk of being beholden to inter-national markets, says Mekdad.

Mekdad says several European companies are considering relocating production to the region to take advantage of low-cost smelters. The clearest opportunities for investors will be in rolled and cast products, since the extrusion sector is already saturated.

In the absence of a local automotive industry, the scope for casting in the region has traditionally been limited, catering almost exclusively to the construction sector. Outside construction, the largest producer of aluminium castings, AluWheel in Bahrain, exports its entire production of 17,000 t/y.

This year will be a severe test for aluminium producers across the globe. Cutbacks in production have not been enough to keep pace with falling demand and rising stock levels.

As with other commodities, such as petrochemicals, the Middle East is set to continue to grow its aluminium production capacity because of its competitive advantages: low energy and labour costs compared with the global average.

Many people in the aluminium markets claim the bottom of the market has finally been reached, but after six months of production cutbacks that have done little to buoy prices, producers are wary of such proclamations and are waiting for firm evidence of increased demand in the form of fresh orders.