Aluminum's 12% Summer Swoon Masks Looming Shortage, Turnaround

Aug. 4 (Bloomberg) -- Aluminum, after plunging 12 percent in the past three weeks, may be poised to rebound. Higher gas prices are curbing production that is already failing to keep pace with demand for the metal used in jetliners, drink cans and foil wrap. Abu Dhabi and Bahrain scuttled plans for smelters, and Chinese plants cut output by 10 percent. Alcoa Inc. plans to idle capacity in Texas, and 120,000 metric tons of production will be lost in southern Africa. Citigroup Inc. and Deutsche Bank AG predict a supply deficit through 2010. Barclays Capital estimates a 70 percent jump in the average aluminum price through 2009. ``We are bearish on most metals, but aluminum is the metal we have the most bullish feelings for because of high energy prices,'' said Chris Wang, portfolio manager at SYW Capital Management LLC in New York. A 25 percent jump in natural-gas prices, used by electricity providers in the Persian Gulf, has persuaded governments in the region to shift the fuel to production of liquefied natural gas instead of aluminum. The canceled Mideast smelters would have increased world supplies by 2.8 percent. Even with those projects production wouldn't have kept pace with global demand that is growing at 9 percent a year, twice the rate of the world's economy. `Dead' Smelter Rio Tinto Group, the world's second-largest aluminum producer, said July 22 that the $3 billion, 700,000-ton-a- year project in Abu Dhabi was ``dead'' because the United Arab Emirates decided not to use its gas supplies to generate power for smelters. In February, Manama-based Aluminium Corp. of Bahrain said it shelved a plan to increase capacity by 39 percent to 1.2 million tons because of insufficient gas supplies. Energy accounts for as much as half the cost of making aluminum. ``The Middle East was seen as the most attractive place to build a smelter because of its access to cheap energy,'' said Graham Birch, who manages more than $40 billion in natural-resource stocks at BlackRock Inc. in London. ``But many things have changed in the last year that have meant it is not such an easy route.'' Rio also said it may close a 148,000-ton smelter in Anglesey, Wales, if the London-based company can't secure a new power contract when the current one expires in September 2009. Rio suspended work on a $2.7 billion South African project because it wasn't able to obtain guaranteed power. Lagging Metal Aluminum for delivery in three months on the London Metal Exchange closed at $2,934 a ton on Aug. 1. It traded at a record $3,380 a ton on July 11. Aluminum is cheap compared with the five other metals traded on the LME. Aluminum had an annual return of 12 percent for the five years through 2007, compared with 34 percent for copper and 42 percent for lead. In July, Frankfurt-based Commerzbank AG raised its 2008 average price estimate to $3,600 next year on expectations China, the world's largest producer, will become a net importer. Barclays Capital is estimating an average price of $4,500 in 2009. Beverage Cans Higher aluminum prices have eroded profit margins at can makers and auto manufacturers. Atlanta-based Coca-Cola Co., the world's biggest soda maker, said July 24 that it reduced the size of canned drinks sold in Hong Kong by 7 percent to rein in rising production costs driven by high raw material prices. Demand is likely to increase about 9 percent this year and double by 2020, requiring about 80 new smelters able to forge 400,000 tons each, according to New York-based Alcoa, the world's third-largest aluminum producer. By 2020, Asia will consume as much aluminum as the world does today. Other power-related curbs are compounding the problem. China's top 20 smelters, with a combined capacity of 16 million tons, agreed in July to cut 10 percent of output to ease a power shortage and ensure supplies for the Beijing Olympics. Alcoa said in June it will idle half the 120,000 tons of capacity at its Rockdale, Texas, plant because of higher energy costs. A South African electricity shortage has curbed smelting. BHP Billiton Ltd. cut production at two smelters in the country and a plant in neighboring Mozambique. Rising Stockpiles Still, analysts at Lehman Brothers Holdings Inc. and London-based Dresdner Kleinwort Group Ltd. are forecasting a decline in energy prices, which would ease the pressure on smelters. Crude oil has fallen 14 percent since trading at a record $147 a barrel on July 11. Lehman said July 15 crude will average $93 a barrel next year, from a $114 so far this year. Dresdner said July 31 there will be a ``rapid price retrenchment'' before the year end as new production starts. Furthermore, the aluminum market has yet to experience a shortage. Inventories tracked by the LME were 1.12 million tons as of Aug. 1, 34 percent more than a year earlier. Thomas Benedix, a Tiberius Asset Management AG analyst in Stuttgart, estimates that global stockpiles are about 3 million tons. ``The stockpiles are definitely capping prices in the long term.'' Benedix said. Torsten Dennin, who manages $250 million at Deutsche Bank AG in Frankfurt, is buying aluminum futures. The contract for delivery in 63 months, the furthest forward it can be traded on the LME, has gained 44 percent in the past 12 months, compared with a 11 percent increase in the benchmark three-month price. ``Most producers are having problems at the current energy levels as the industry is very energy-intensive,'' Dennin said. ``I expect project delays and shutdowns.'' Saudi Startup In addition to the two canceled projects in the Gulf, state-owned Saudi Arabian Mining Co. postponed the startup of its $10.5 billion venture with Rio until 2012. The Middle East has about two-thirds of the world's oil reserves and 40 percent of its natural gas. ``The main reason the governments in the Gulf have taken a step back from building new smelters is that they realized they can sell this gas into the LNG market at a much higher price,'' said Nikhil Shah, an analyst at metals consulting company CRU in London. ``It also gives them flexibility to diversify their economies.'' While the Gulf has become less welcoming for producers, no new locations for aluminum smelters have emerged, Shah said. `Risky Areas' ``Companies are looking at areas that are much more risky as a result,'' he said. Moscow-based United Co. Rusal, the world's largest aluminum producer, plans to expand a plant in Nigeria. Melbourne-based BHP, the biggest mining company, is looking at the Democratic Republic of Congo. Rio is talking with Libya and Algeria because those countries still have available gas supplies. ``It's a long time from when a smelter is proposed to when it starts pouring metal and many obstacles can arise in that time, especially in those riskier locations,'' BlackRock's Birch said.