The LME 3-month aluminum price jumped 4% yesterday on announcement that Norsk Hydro (NHYDY) will temporarily close the Alunorte alumina refinery in Brazil because of a water treatment dispute. This outage will curtail the supply of alumina, which is an ingredient used to make aluminum.
The alumina market has been tight over the past few months due to U.S. sanctions on Russia's United Company Rusal. Despite the plant running below 50% capacity, given the games circulating in the aluminum market, news of any supply disruptions catches the market by surprise. Alumina price is up 45% this year, but higher prices will and have encouraged other producers to start production. China has now become a net exporter.
Some observers have pointed to the low LME (London Metal Exchange) aluminum inventory stocks -- which are down 17% over the past few months -- as yet another bullish trigger. These are at the lowest since January 2006, at 608,500 tonnes.
But there is a warehousing game going on that is causing these stocks to be depleted, as opposed to "tightness" in the market. What we are seeing now is the reverse of the LME inventory stocks boom in 2009, which was exacerbated at the time by falling demand -- but also a squeeze on credit.
Rather than a squeeze on aluminum per se, this is more about how the warehousing companies are managing their inventory based on spreads, physical premiums and carry. Following the rule change on queues allowed, caps on rent and faster load-out requirements, it has allowed metal to shift to alternative sources. This is all just an unwind of the excess prior to 2008. These inventory moves are all part of warehousing games -- and we will see the metal appear and disappear based on the financial metrics that drive these companies.
The aluminum market is definitely supported by the alumina price going into the fourth quarter. Rusal accounts for about 13% of the global output outside China. It produced 3.71 metric tonnes of primary aluminum in 2017 and earned about 14% of its revenue from the U.S., its largest importer.
The key question is what will happen to the sanctions imposed on Rusal. The deadline is November 12. An extension of the deadline will help European buyers purchasing from Rusal's refinery in Ireland. But if the sanctions are not lifted, the market can potentially lose 1.5 million tonnes.
As we enter Q4, Chinese capacity cuts can also materialize. During the winter period, aluminum/alumina production is cut by 30% to clear the smog in provinces. But smelters have yet to announce their plans for the winter. If they can manage to meet the minimum discharge limits, perhaps production can be cut by less.
There are a lot of moving parts in the aluminum market. If these sanctions are not lifted, aluminum could be in for a doomsday scenario and prices could shoot towards $2500/tonne. Especially if Chinese stimulus boost to infrastructure plays out and demand recovers, the market can move higher. It is not as tight as, say, copper, as there is supply out there, it just needs to be free to hit the market.
Despite cheap valuation, Norsk Hydro will not be able to benefit from higher prices, given its legal and operational problems. If Alunorte is out for the remainder of 2019, its earnings can be downgraded significantly, with the company turning free cash flow negative. Alcoa (AA) is doomed by its strikes. Indian producers stand to benefit the most from these U.S. sanctions and higher prices -- especially integrated domestic producers like Hindalco and National Aluminum Company.