Aluminium prices foil Point Henry

Alcoa may have spent the past two years reviewing the future of the 50-year-old Point Henry aluminium smelter near Geelong in Victoria but the results of that review, and the closure of the smelter announced today, have been an increasingly foregone conclusion.

It is a small part of a global restructuring of the industry, or at least the Western world segments of it, to reflect the fundamental changes to the industry that have occurred since the global financial crisis.

Only last week the world’s biggest producer, Russia’s Rusal, said it had taken 8 per cent out of its capacity last year and that the industry’s non-Chinese production would have to be cut back by another 1.2 million to 1.5 million tonnes this year. Point Henry’s 190,000 tonne capacity is only a fraction of that; indeed it represents only a part of the 551,000 tonnes of capacity Alcoa itself has either shut down or cut back since May last year.

Before the crisis, thanks to surging orders from China, demand for aluminium had been growing at about 8 per cent a year. Then the crisis erupted, demand fell away, the price initially tumbled, then recovered and then, since 2011 has fallen away. Prices are now at about half their pre-crisis peaks and about 35 per cent below their level in 2011.

Prices might have fallen but the geography of production responses hasn’t been what the industry expected, or theory might have suggested. There was an expectation that higher-cost production – most notably China’s domestic smelters – would have been forced from the market.

Instead China’s smelters, and smelters in the Middle East, have continued to increase their output, with China’s production roughly doubling from its pre-crisis levels and now accounting for about half of global production.

While there might be some level of sub-economic behaviour occurring within the Chinese industry, lower energy costs, increased hydro generation and bigger and more modern smelters located close to domestic bauxite resources have lowered China’s position on the cost curve.

The impact of the crisis, the fall in prices and the failure of China and the Middle East to respond as the textbooks might have led the rest of the industry to expect, and most notably caught Rio Tinto by surprise.

Its ill-timed and overpriced $US38 billion acquisition of Alcan (out-bidding Alcoa in the process) has produced writedowns within that business of nearly $US30 billion. Rio was punting on China’s smelters being pushed out of the market because of their position on the cost curve and by increased concerns about carbon emissions and pollution.

That didn’t happen, although Rio still harbours hopes that in the longer term China’s increasing concerns about pollution might yet see it salvage some value from what’s left of Alcan.

With the current price around $US1700 a tonne, Rusal and others estimate the existing industry needs a price of about $US2000 a tonne to break even and properly compete against China and Middle Eastern producers still increasing their capacity and output. The only way to bring about a balance of supply and demand and to begin to push prices up towards the level that would sustain Western producers would be to shrink supply by either shutting down or mothballing capacity.

While there might be other factors cited – the carbon tax and rising energy costs are inevitably going to be identified as contributing factors – the reality is that Point Henry was too old, too small and too high-cost to survive at a time when Alcoa and its peers are carving into their global capacity and focusing on their newer and lowest-cost plants.

Point Henry’s 190,000 tonne capacity compares with the 740,000 tonne capacity of a brand new low-cost Middle Eastern smelter in which Alcoa has a minority interest and the group’s remaining smelting capacity of 3.76 million tonnes a year.

The closure of the Geelong smelter isn’t the first and won’t be the last of the withdrawals of capacity from the Western world’s share of the industry as it seeks to restructure its way towards stability and more acceptable levels of profitability.

It’s extremely unfortunate for Alcoa’s employees at Point Henry and at the two rolling mills in Geelong and Yennora in New South Wales that will also be closed, but they have been caught up in a dramatic and painful restructuring of a global industry that started some years ago and probably still has some years to run.