Electricity surge to power aluminum prices

Aluminum prices, stable in recent months while other metals have hit records, look set to rise as the cost of electricity used in its production escalates and demand from China and elsewhere soaks up supply. Expectations of higher aluminum prices have been supported by an audacious $38.1 billion bid by miner Rio Tinto (RIO.L: Quote, Profile , Research) (RIO.AX: Quote, Profile , Research) for Canada's Alcan (AL.TO: Quote, Profile , Research), which will create the world's biggest aluminum producer. Fund managers say Rio's bid is an attempt to buy a large slice of the aluminum industry before prices take off. "Rio's bid for Alcan indicates that they think long-dated aluminum is going to become more expensive," said Bradley George, fund manager at Investec Asset Management. Investors sensing the changing dynamics have been piling into aluminum contracts for delivery in 2010 and 2011. The December 2010 contract traded on the London Metal Exchange has jumped nearly 15 percent since January to about $2,520 a tonne. Further gains, possibly towards or above the $3,300 a tonne record high set for the three-month contract in May 2006, are expected as the aluminum surplus narrows over in years. nstitutional fund investors have also been shifting money into long-dated aluminum as they have not been getting attractive returns on near-term contracts, bank analysts say. Near-term prices for aluminum have barely been affected by the rush for buy long-dated forward contracts, which is firmly focused on the next three years ahead. Three-month aluminum has hugged a tight range between $2,500 and $2,900 a tonne since late last year. By 1135 GMT on Thursday, the contract stood at around $2,760 a tonne. POWER PRICES Electricity accounts for around one-third of smelting and electricity prices are rising along with oil and coal. The cost of carbon emissions is already a large component of generating costs and is likely to push prices up further, analysts say. Power was a major reason why aluminum production costs rose about 40 percent in 2006 to an average around $2,100 a tonne. "Costs will definitely put a price floor to aluminum contracts in the long term." said Nadja Bickelhaupt, metals analyst at Wermuth Asset Management. Meanwhile, industrialization in China, India and other developing economies is expected to boost demand for the metal used in the power, construction and packaging industries. "Like other industrial metals, the demand for aluminum cycles with world economic growth," investment manager Sanford C. Bernstein said in a recent research note. "Demand has accelerated steadily over the past five years." Michael Skinner, analyst at Standard Bank said the rate of growth in production, but not actual production, would slow. "There is value to be had further down the curve, which has picked up significantly," he said. Analysts expect the aluminum surplus in 2007 at around 400,000 tonnes compared with a previous estimate of 600,000. The estimate for next year is for a surplus of about 550,000 tonnes as China's capacity -- up by around 35 percent over the last 12 months -- to churn out aluminum holds up. CRUNCH But the crunch comes in 2009 when the surplus could fall to 350,000 tonnes and again in 2010 to around 155,000 tonnes, less than two days global consumption using current figures. That narrowing surplus is expected partly because of falling output in China, seeking to rein in use of subsidized power and a belief that some small producers with little or no negotiating clout may not survive higher electricity prices. "The ability to deliver additional supply matters more in the medium term," Bickelhaupt said. Within the aluminum industry growing confidence was highlighted by Rio's chief executive Tom Albanese. "The demand outlook for the next 10 years is quite positive with expected world demand growth to 2011 of over 6 percent and demand growth in China alone of over 15 percent per year," Albanese said earlier this month. Rio said last week that it would unwind Alcan's aluminum hedgebook -- sell forward at fixed prices -- if it succeeded in its bid. The company's policy is not to hedge. But hedging by other aluminum producers has been a significant factor behind subdued prices. Shareholder pressure could prompt miners to drop that practice. "It was a shackle that kept the forward curve very much under pressure, but it has become difficult to explain to shareholders," Skinner said. "A shareholder wants absolute returns and he wants to be exposed to the aluminum price."