By Andy Home
Is the world aluminium market in a supply-demand deficit or surplus?
It’s a simple enough question but an extraordinarily difficult one to answer.
That much was clear at last week’s LME Seminar. Two respected bank analysts, Citi’s David Wilson and Natixis’ Nic Brown, offered diametrically different views.
Deficit, according to Brown, and one that will steadily increase over the next two years. Surplus, according to Wilson, with no sign of deficit until 2017 at the earliest.
Calculating supply-demand balances in any industrial metal is a tricky business, but the problems are compounded in aluminium.
There is, for example, no aluminium equivalent to the International Study Groups that do so much of the statistical leg-work in the copper, zinc, lead and nickel markets. The International Aluminium Institute (IAI) releases monthly production figures but only for primary metal, leaving the secondary scrap component of the supply chain shrouded in statistical darkness.
The thorniest problem of all, however, is assessing what is going on in China. It’s a problem that is not unique to aluminium, but it has acute resonance in this particular market, given that China is both the world’s largest producer and consumer of aluminium.
And it is China that lies at the heart of the difference in analysts’ opinions on the market balance.
Analysts would probably all agree on one thing. China itself is currently in supply-demand surplus, while the rest of the world is in deficit.
That inference can be drawn from those monthly IAI production figures.
Production outside of China has been trending lower since 2012, when producers first started curtailing and closing capacity in response to low prices. Average daily production outside of China has fallen from 70,000 tonnes in December 2011 to 66,500 tonnes in September 2014 as the ramp-up of new smelter capacity in the Gulf region has been more than offset by closures elsewhere.
Expressed in annualised terms, production outside of China has declined by almost 1.5mn tonnes. Consumption, by contrast, has continued growing to the point that the market is widely believed to have tipped into supply deficit over the course of this year.
In China, however, production has grown by an annualised 7.2mn tonnes over the same timeframe. Daily Chinese output of 68,030 tonnes in September was a fresh record high.
Chinese smelters have suffered from the same margin compression as their Western peers, but local government subsidies, particularly in the form of help with power tariffs, have helped protect the weak even while a new generation of plants has sprung up in the northwest of the country.
Chinese consumption has also been growing, but the growth rate has slowed this year, mirroring the broader trend in all industrial metals.
Which is why the Chinese domestic market is widely believed to be in surplus, a collective assessment that seems to be borne out by the significant underperformance of Shanghai aluminium prices relative to those on the London Metal Exchange. But by how much is it over-supplied?
Back to those production figures. They represent hard data collected from producers by the IAI and the China Nonferrous Metals Industry Association.
Not all producers, however, report their production figures. The IAI, for example, estimates “unreported” production of 90,000 tonnes per month outside of China, equivalent to just over 1mn tonnes annualised.
The IAI has an extensive reporting system, meaning that it has a pretty clear idea of what it is missing. Indeed, it lists the non-reporting countries on its website.
But what of China?
The IAI’s current assessment of unreported production in China stands at 250,000 tonnes per month, equivalent to 3mn tonnes per year.
That’s a big variable, bigger for example than the combined output of Australia and New Zealand, a significant albeit declining aluminium production hub.
And even that may be a serious underestimate, according to some analysts.
Paul Adkins at China AZ consultancy, speaking in the Reuters Base Metals Forum a couple of weeks ago, warned that the IAI’s estimate “is way too low”. According to Adkins, one producer missing from the Chinese reporting system, Weiqiao, will on its own produce more than 3mn tonnes this year.
And it’s far from being the only Chinese producer not making it into the official figures.
In other words, even the relatively hard production figures for China only paint a partial picture. That inevitably blurs any assessment of domestic market balance.
At least we can quantify the impact of any over-supply in the Chinese market on the rest of the world using another hard data series, the country’s trade figures for aluminium.
China has historically been a net importer of primary metal and a net exporter of alloy and products, although it became a small net exporter of primary in the last two reported months. That’s more because imports have collapsed than because exports have boomed.
Far more significant is the export flow of semi-fabricated products. It’s not a new phenomenon. China has been a consistent net exporter of aluminium in this form since 2005, although the pace is increasing all the time.
And it is tempting to believe that such exports have no relevance to any assessment of global primary market balance. After all, they are products, not raw metal.
Citi’s Wilson would beg to disagree. His argument is that they cause a double-count in the global consumption calculation because of the differing methodologies used in different countries.
In China they get counted as first-use consumption. If, however, they are then exported to a country such as the United States, where better data allows the construction of a bottom-up demand calculation, they get counted again.
No-one doubts the fact that aluminium benefits from a far more robust consumption growth story than just about any other metal, thanks to light-weighting in the automotive sector. It’s just possible, however, that it may not be quite as statistically robust as widely perceived.
And what if some of those product exports aren’t product at all?
There is growing wariness among aluminium analysts about the nature of some of these exports. Is it possible that some Chinese players are performing minimal transformation of primary metal into basic “products” to skip through China’s export tax regime?
The incentive is there, given that primary exports are hit with a 15% tax, while product exports qualify for a partial VAT refund.
If true, such product would be going only as far as a remelter to be transformed back into its original “commodity-grade” form.
It’s understandably a highly sensitive subject, but Adkins is not alone when he cautions that “we think the volume of metal leaking from China is greater than most people think”.
It’s also a statistician’s nightmare.
And one that is going to be get worse because China’s product exports are steadily rising. September’s count of 340,000 tonnes matched the all-time high recorded in May 2011, while year-to-date export growth is running at 10% over 2013 levels.
Few expect the trend to reverse any time soon. Most, in fact, expect product exports to keep accelerating.
This export flow supports a fundamental picture of a Western market moving steadily into deficit with China supplying aluminium, in whatever form, to fill the resulting gap.
But while both sides of the debate agree on that, it blurs the calculation to the point that Citi’s Wilson and Natixis’ Brown can be at such odds in their assessment of the global market balance.
The opinions expressed here are those of the author, a columnist for Reuters.
