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Aluminium: Shine to be missing

Aug 31, 2002

From the lows in November '01, international aluminium prices climbed to a high of $1,438/ tonne on the London Metal Exchange, as U.S -- the largest consumer of aluminium -- registered economic growth of 5.1% YoY. However, non-ferrous metal prices have weakened since mid-year highs and aluminium prices are trading only 5.4% above November '01 lows.Post September 11 events, aluminium prices -- like all commodities -- collapsed, as the global economy came to a stand still. U.S registered negative GDP growth in third quarter of 2001 for the first time in a decade and business feared for worse to come. Reflective of the same, lows in commodity prices were touched couple of months after the U.S terrorist attacks. We reckon, resilience of U.S consumers and impressive growth in South & East Asian regions is likely to have supported the global economy to rise from the lows.

Excess capacity built during the booms years of the nineties and subsequent economic slowdown has held back operating rates in the U.S. Utilisation rates in U.S industry are estimated at 75%, leaving room for ramp up without undertaking fresh business investments. Also, U.S industry continues to rationalize human resources to align with reduced business activity and increasing productivity to raise profitability. Dry up in business investments and higher unemployment affected consumer confidence. Additionally, absence in corporate earning recovery, accounting irregularity and lack of integrity among U.S analyst led to a collapse in stock markets. The meltdown in markets, leading to a negative wealth effect, seems to be further affecting the economy, especially consumer confidence.

With fears of a double dip recession in the U.S, Aluminium prices have declined by 9% from their highs in March '02. Further, as compared to copper, aluminium prices have exhibited less firmness. Despite unremunerative prices, aluminium production in first half of 2002 grew by 4.5% YoY while U.S, Japan and Europe continue to experience lower consumption. As a result, global aluminium inventory has increased by 86% to 1.3 m tonnes since November '01 while copper inventories have grown 21% in the same period, which explains the underperformance in aluminium prices.

The U.S aluminium industry is the largest in the world with production capacity estimated at 3.7 m metric tonnes (MMT). While the industry, globally, experienced a challenging 24 months, U.S producers were among the worst hit. Besides a decline in consumption, higher crude prices and a power shortage in Western and North-Western U.S led to steep rise in energy costs over 2000 and early 2001. Aluminium is a power intensive industry. With poor realizations and higher operating costs, we reckon, several smelter operations are likely to have turned unremunerative. As a result, an estimated 1MMT of smelting capacity has been pulled out from the U.S market. On global basis, estimates are placed at 2.2 MMT. Over the first five months of 2002, YoY production has been lower in the U.S. However, despite weak markets, production has registered positive growth in the last two months. Considering inventory levels in the system, swing plant capacity (plants turning operational on higher aluminium prices) and soft demand in key markets, the outlook for prices remains subdued. We reckon prices in 2002 are likely to range between $1,300-1,350/ tonne.

Global Slowdown takes toll
Consumption growth19981999200020011HFY02
North America6.7%6.9%-0.5%-14.0%1.9%
Asia-15.0%13.9%12.9%-6.7%3.8%
Japan-10.8%5.7%3.7%-9.0%-7.4%
Western Europe2.1%2.5%4.0%-0.5%-3.0%
China9.9%13.0%15.4%10.2%9.9%
World1.0%6.0%5.9%-4.1%1.0%
Production growth     
World3.9%4.3%3.3%0.2%4.5%
Source: Hindalco Industries Ltd.

At the domestic market level, the recent budget has thrown up a challenge as basic customs duty rate on aluminium was reduced to 15% from 25%. Domestic industry is likely to further rationalize costs to remain competitive. The lower duty rate will lead to increased linkage between international and domestic aluminium prices. Therefore, producers will need to develop systems to better manage volatility in aluminium markets.

The key consuming industries in the domestic market are electricals, transportation, construction and consumer durables. The power industry, among the first sector to be liberalized, has not attracted adequate investment due to lack of political will to push forward reforms. The weak link, leading to the malaise in the system, has been transmission & distribution (T&D) -- driver of aluminium consumption in the sector. Fresh reforms are targeting measures to increase efficiency in the T&D system, which could then attract investments into the sector. Having said that, we reckon, fresh power sector initiatives are unlikely to become visible in the medium term.

Demand for aluminium, in the near term, is likely to be driven by transportation and construction. The transportation sector has exhibited an upturn over the past twelve months. Increasing levels of indigenisation in automobiles could lead to higher consumption growth. Further, sharp reduction in interest rates and fiscal benefits for individuals on purchase of realty has led to rising demand for new homes. Considering India is an emerging market, the long-term demand outlook for aluminium remains intact.


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