LONDON: Another month, another Chinese aluminium production record.
China's giant smelter sector churned out an average 105,000 tonnes per day in September, according to the International Aluminium Institute, with year-to-date production up 3.3% on 2019.
More records will be broken in the months ahead. China's smelters are capitalising on strong margins as demand rebounds and government stimulus flows into infrastructure and construction.
Such is the history of the aluminium market over the past decade. China's excess capacity, periods of over-production and high-volume exports have kept a lid on prices in the rest of the world.
But is the Chinese aluminium juggernaut running out of road?
HITTING THE CEILING
Goldman Sachs thinks so.
"There is little doubt in our view that the age of structural oversupply in China's aluminium market, driven by overcapacity in the smelting sector, is now behind us," the bank's analysts said in an Oct. 27 research note.
Citi turned bullish on aluminium in August for the same reason.
The old era of aluminium, characterised by seemingly infinite Chinese smelter capacity expansion, multi-year surpluses and high inventories is coming to an end, Citi said.
The bank said it believes a new era of aluminium is coming, founded on a slowdown of capacity additions and enhanced supply discipline ("A New Era of Aluminium", Aug. 2,2020).
It's still something of a heretical view, with Citi admitting "we continue to hear pushback on our medium-term bullish view", but a significant moment is undoubtedly approaching.
Beijing has been giving the aluminium smelter sector the structural reform treatment since 2016. National capacity has been capped at 45 million tonnes a year and the authorities have kept a tight grip on new smelter construction, only allowing it as an offset against the closure of old capacity.
That ceiling is now very close to being reached.
Actual production was running at an annualised rate of more than 38 million tonnes last month and notional capacity is set to hit or exceed the cap by 2022, the two banks agree.
There may be some wriggle room for special-status projects and there is still some so-called illegal capacity left over from a clearout of unauthorised operators in the early stages of the sector's reform programme.
But after one last lift over the next 12 months, both Citi and Goldman are looking for the aluminium smelter juggernaut to grind to a halt.
What happens then?
Might the government change its mind and relax the capacity cap? It's possible, but a major restraining influence will be President Xi Jinping's commitment to carbon neutrality by 2060.
The country's aluminium sector is heavily coal-dependent for its power.
There has been a sizeable migration down to Yunnan province with its hydro resources. Yunnan's smelter capacity has surged from 1.5 million to 4.1 million tonnes a year in the space of three years, but the province is running out of energy space and there isn't an obvious clean-power alternative, according to Eoin Dinsmore, aluminium research manager at research house CRU, speaking at last week's virtual LME Seminar.
Coal will remain the dominant power source everywhere else, which leaves the smelter sector facing considerable uncertainty as Beijing faces up to the trade-offs between its past commitment to industrial prowess and its future decarbonisation promise.
While China's primary metal producers are heading for the capacity wall, the country's demand profile is expected to remain strong as the metal benefits from rising usage in construction and green infrastructure as well as recovering automotive output.
Chinese capacity to produce semi-fabricated products such as foil, tube and plate has continued growing even while that of primary metal has been constrained.
Investing downstream has come with the added benefit that the product can, if necessary, be exported with a value-added-tax concessions.
It is exports of these "semis" that have displaced demand for primary metal in the rest of the world and generated a lengthening list of anti-dumping complaints and sanctions.
Underpinning Citi and Goldman's shared bull view is a projection that the country may be approaching the point where it will not be able to produce enough primary metal to meet ever-growing demand from its fabrication base.
It may already be happening.
China's imports of primary aluminium have surged this year, flipping the country to net importer of the metal in all forms in July and August for the first time since the financial crisis of 2008/09.
An arbitrage window opened this year between an exuberant recovery-mode Shanghai market and a lagging international price.
China was a net exporter again in September, but only marginally so with inflows of primary metal remaining strong.
Goldman analysts argue that rather than being a one-off, periodic primary import phases into China, supported by open arbitrage, will be a continued influence on physical market trends.
Physical traders seem to agree with surplus metal gravitating towards Asian locations where it can be easily shipped to China.
"We have noted significant reductions in aluminium exports from Russia, Middle East and India to Europe this year, and a significant increase from those countries to Asia," Goldman said.
London Metal Exchange (LME) warehouses in Malaysia's Port Klang and Johor currently hold 936,000 tonnes of registered aluminium, accounting for 64% of total stocks.
Asian locations also held 1.1 million tonnes of LME shadow stocks at the end of August, representing 80% of total reportable, but not warranted, metal.
Compare and contrast with the last crisis of oversupply, when metal accumulated first in Detroit and then the Dutch port of Vlissingen over the early 2010s.
The global inventory axis has tilted eastwards in the last year or so and it has done so as the physical market anticipates periods of supply-demand mismatch in the domestic Chinese market.
Those were fleeting in the past because there was a seemingly endless pipeline of new smelters ready to fire into action.
That old era looks to be drawing to a close, however, even if many are still hesitant to proclaim the dawn of a new one.- Reuters
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