Having made a somewhat detailed study of the global aluminium...

Having made a somewhat detailed study of the global aluminium supply chain at one stage of my career, I like to think I might be able to shed some light on what is happening.

It starts with aluminium, the primary metal. Colloquially, aluminium is sometimes referred to as "solidified electricity" because of the high degree of energy intensity in its manufacture.

The big appeal of the aluminium market to those who aspire to participate in it is that it has displayed the highest demand growth rates of all the base metals over the past two decades (compound annual demand growth has averaged over 5.5%pa globally).

In terms of it evolution, the aluminium industry was dominated by smelters located in the western world – notably Europe and North America - in the 1950s through to the 1970s.

In the 1980s new, low-cost Asian smelters (Korea and Japan) started to take market share, but technological investment kept western smelters competitive.

Then in the 1990s the first Chinese smelters started to appear on the scene. This was to be the first major watershed for the global aluminium industry.

Spurred on by low capital costs, low energy costs and low labour costs, Chinese smelters gained ascendancy and eroded the competitive position of western smelters, in particular. By 2000, China accounted from around 205 of global aluminium production, from virtually zero a mere decade earlier.

Over the past decade Chinese smelters have continued to expand, today accounting for around half of all global aluminium output. Their impact has been significant...they have caused a structural lowering in the aluminium cash cost curve and have basically undermined the aluminium price for many years through their production-maximising strategy.

As a result western aluminium output began to fall for the first time ever, in the mid-2000s due in part to sustainably low aluminium prices and also to structurally higher input costs, particularly energy costs which have spiked in real terms as most western economies are positioned by policy makers with greener credentials as strategic priorities.

Importantly for the alumina sector (i.e., the intermediate product in the supply chain between ore and primary metal), however, is that this changing downstream landscape was beneficial for alumina producers, which were located on, or in close proximity to, large bauxite deposits in the western world.

In the early-to mid 2000s, alumina producers benefitted by significant demand growth (averaging 7% pa in the decade to 2005) due to the explosive growth in global smelting capacity. It was on the basis of this extraordinarily buoyant period that a lot of today’s new alumina capacity was sanctioned and commissioned, and which has left the alumina sector in an oversupplied situation today, unfortuantely just as western smelting capacity is being rationalised.

In other words, what started to hurt the alumina market in the mid- to late 2000s, and continues to do so today, was a double whammy – a supply side shock that coincided with a demand side mini-shock.

Then, to compound matters, from about 2009/10 - and much to the surprise of many aluminium market practitioner and commentators - the Chinese started ramping up alumina production capability by building refineries in China at a rate of growth of about 20%pa.

This strategy towards further integration has caught most industry specialists by surprise, since conventional wisdom has long suggested that the Chinese were unable to source enough quality bauxite domestically.

The West – including some of the major aluminium producers such as ALCOA, ALCAN, Billiton and AWC - have been caught napping by these developments.

What the Chinese were in fact doing, was sourcing bauxite from offshore, from provinces such as Indonesia, Africa and even South America to feed their rapidly expanding alumina business.

In mid-2012, the Indonesian government placed something of a ban on the export of un-beneficiated bauxite from the country, mandating some sort of value-added requirement.

I sense some market participants had come to the view in recent months that this development would halt the march of the Chinese aluminium industry to increased upstream integration, and therefore limit its investment appetite for additional alumina capacity...which would have explained the stay of execution on the AWC share price in recent months.

With this ban now overturned by the Indonesian judiciary, we find ourselves back to the invidious position of some six months ago, namely that of a Chinese aluminium industry that, having successfully white-anted western aluminium smelters, are now doing exactly the same thing in the alumina space.

For what its worth, I don’t believe for a moment that this process is over. Just as western smelters are being put out of business, so too will alumina refineries in the West end up, including many of AWC’s assets. Already we see the AWAC JV mothballing alumina refineries, and I’ll wager that idled capacity will remain that way forever.

As for AWC as investment opportunity given that somewhat parlous backdrop, I think the company has a seriously challenged future.

I would certainly not countenance buying shares in the business.

Besides the poor outlook for product pricing, and an Australian dollar that remains stubbornly elevated, the company looks undercapitalised.

Analysts keep saying and writing that the replacement cost of AWC’s asset base is upwards of $3.00 per share.

But when you’re making no return on those assets, just because someone made a bad investment decision five years ago to build them, makes replacement cost talk a complete nonsense.

I hate to be the harbinger of bad news, but I thought I’d just try to put some historical context on what has been happening in this industry insofar as I believe firmly that history does inform the future in this case, and in the hope that it prevents someone throw good money after bad.