slightly improved outlook

Outlook Improved For Alumina, Aluminium
August 15 2005 - Australasian Investment Review

The Chinese government’s decision to remove the existing tax breaks on alumina tolling is reason to remain positive on the outlook for alumina and aluminium prices, say analysts at Macquarie and Smith Barney Citigroup.

Tolling is an agreement to convert alumina to aluminium
for a non-related company, with the concessions in China meaning imported alumina was free of both the 8% import tax and 17% VAT provided the aluminium produced was exported.

Macquarie suggests the removal of these concessions will have a negative impact on the cost structure and margins of many smelters in China, as it has pushed down the domestic aluminium price compared to the LME spot price.

SB Citigroup agrees, noting the removal of the concessions is a continuation of the government’s desire to reduce smelter production.

In Macquarie’s view the full impact of their removal will take up to 12 months to flow through, given existing tolling contracts will need to be honoured.

The removal of the tolling will also mean less primary aluminium will be exported to Guangdong via Hong Kong, forcing Guangdong customers to purchase more from the domestic market.

This should continue until prices adjust sufficiently to allow domestic producers to make profits from selling in Guangdong, after allowing for the transport cost differential from selling in Shanghai. On Macquarie’s
calculations, Chinese smelters buying imported alumina at spot prices are currently losing money when selling
onto both the domestic and export markets.

But the situation is worse for exporters, as at current alumina and aluminium prices the losses on exports are about US$250/t more than the losses from selling domestically.

Despite this, the broker calculates 82% of China’s first half exports of aluminium ingot were based on tolling,
while about 17% of China’s total aluminium production of 3.7mt in the first half of 2005 was related to tolling exports.

As Macquarie notes, spot alumina prices have risen recently due to a combination of increased buying following a heavy rundown in stocks, a tightening of availability globally given production losses and the recent rally in aluminium prices. As a result, the outlook for aluminium prices is positive as alumina production is now falling below previous planned levels in several markets while market conditions improve.

The broker notes smelter closures in Europe and the US remain a possibility given higher electricity prices, while it continues to forecast a demand revival for later this year or early next year. SB Citigroup is also bullish on both alumina and aluminium as it continues to forecast reduced production from Chinese smelters, in part because of the ongoing impact of power shortages.

The broker discounts recent speculation China could soon experience an electricity-generating surplus, suggesting 125GW of unapproved capacity already under construction has been halted, 50GW of which has been permanently sidelined.

This is significant, as the additional capacity would have allowed aluminium production to increase, which would have been a negative for prices.

Like Macquarie, SB Citigroup is bullish given the likely closure of European smelters, as well as its expectations of strong demand growth. Macquarie estimates the global aluminium market will have a deficit this year of about 400,000t.

The broker expects aluminium prices to average about US$1,985/t (US90c/lb) in 2006, while alumina prices similarly are expected to remain stronger for longer.

SB Citigroup forecasts aluminium to average US$84c/lb this year, US$85c in 2006 and US$75c for the two following calendar years. Alumina is forecast to average US$370/t, US$340, US$260 and US$205 respectively.