COVID-19: impact on the aluminium industry and reasons to be positive
Prices take a dive
Aluminium prices struggled throughout 2019, prices for the year averaging the lowest since 2016. However, there were grounds for optimism as the year ended, with prices moving away from lows with an expectation of improved global demand through 2020. The optimism remained until mid-to-late January 2020 when the world started to navigate through the impact of COVID-19. Aluminium prices have since plummeted with the market collapsing to multi-year lows. When adjusted for inflation, prices are at levels last seen during the 2008/2009 global financial crisis.
China takes the first hit...and the rest follow
The wave of manufacturing closures in China as COVID-19 spread sent shock waves through the industry. Not only does it account for one-half of global demand but it's also a key supplier of parts and materials to the west. The need to manage costs has resulted in supply chains in many industries becoming heavily reliant on Chinese suppliers.
Manufacturing cuts in China and the closing of complex transportation routes was immediately felt outside of China. Faced with the prospect of stocks running dry, manufacturers were required to slow or suspend production or urgently locate new supply sources.
The demand-side of the aluminium industry was therefore impacted well before country-specific lock-down measures were introduced. The eventual introduction of these measures provided a secondary and much greater impact on aluminium demand outside of China. Faced with falling demand for their products and under government guidelines, consumers of primary aluminium such as rolling mills and extrusion plants reduced or suspended operations. This has led to a massive shock to global aluminium demand.
Smelters and refineries struggle on
While the downstream and end-use aluminium sectors have been closing production units, aluminium smelters, in contrast to their customers, have generally continued to operate. There have been very few major production cuts announced at primary aluminium smelters and alumina refineries. Some of the key reasons are:
- Essential services: in many countries these operations have been designated as "essential" and can continue to operate within certain guidelines. With that said, companies have generally reorganized shift patterns, require only operational and maintenance staff to work at the site, and have deferred non-essential maintenance or project work to minimize workforce requirements. One example is that some smelters have suspended relining pots as they fail.
- Cost penalties: aluminium smelters cannot simply be turned on and off. There is a cost and time penalty to closing production. Raw material and energy supply contracts are often "take or pay" and thus require operations continue or penalties be incurred.
- Long-term outlooks: many alumina refineries and aluminium smelters are currently losing money on a cash basis, however history tells us that producers will generally keep going for as long as possible in the hope that conditions will improve. It can therefore be better financially for smelters to continue operating in the short term even if every tonne produced loses money.
Where is all the metal still being produced going?
Even before COVID-19 took hold, it was expected that the world's primary aluminium market would move into a small supply surplus this year. That supply surplus is now looking much bigger. The combination of ongoing primary aluminium production coupled with a collapse in demand only has one outcome: industry stocks will rise substantially. There's a genuine risk that the market will accumulate a surplus which may take several years to work through. In recent history there have been similar events that led to surplus aluminium stocks:
- Collapse of the Soviet Union in 1991/1992 and associated surge in exports to the West from Russian producers
- Global recession in 2001
- Global financial crisis in 2008/2009
In reaction to each of these events there was a supply-side response, with production cut and prices supported. It's clear that similar production cuts will be needed this time too to bring the market back to equilibrium, and likely that it will be weaker producers forced to cut their operations.
Reasons to be optimistic about the future of aluminium
While the previous discussion does not necessarily lend itself to optimism, it's important not to lose sight of positive factors:
- The collapse in aluminium prices has been fueled by negative expectations. However, the market has not yet priced in an expected recovery in demand in the a second half of the year, nor has it accounted for potential supply-side cuts. It's likely that demand will recover strongly as the world returns to some form of normality, with some manufacturing units in Europe already given the go-ahead to restart operations.
- Aluminium prices are currently very low by historical standards, with history suggesting that prices will rally sharply and quickly once upward momentum is established.
- Medium- to long-term demand prospects remain positive, with compelling growth stories across many aluminium end-use consumption sectors. Such an example is the use of aluminium in the automotive sector.
- Aluminium smelters, together with society as a whole, will have discovered new ways of working, with these lessons learned and efficiencies gained carried forward after COVID-19 eases.
The aluminium industry–along with most industrial sectors–has been hit hard by the COVID-19 pandemic. Prices have collapsed and stockpiles have grown. How the industry deals with the current oversupply is likely to determine whether any recovery in prices can be sustained.