"The rapid shift in the structure of iron ore pricing, and the acrimony accompanying it, has been grabbing most of the media attention but it is only in recent weeks that a similar change occurring in the pricing of bauxite and alumina has started to become visible.
For several decades alumina has been priced in relation to aluminium, using a fixed percentage of the LME price for the metal. That is largely, it appears, as a consequence of the integrated and low-growth nature of the sector throughout most of its history.
Alumina prices have generally been set in low teens as a percentage of the aluminium price, although the price recently rose from around 13 per cent of the metal price last year to between 14 and 15 per cent this year. The price is incorporated into multi-year contracts.
The system has started to break down with the emergence of non-integrated aluminium smelters in China and the Middle East buying alumina and bauxite in excess of the needs of the integrated players, which in turn has created spot and short-term contract markets for alumina estimated at roughly a third of the overall market.
Not surprisingly, given the rather arbitrary nature of the pre-existing pricing structure, the spot price has increasingly diverged from contract prices. Equally unsurprisingly, the producers who are long alumina and bauxite BHP Billiton, Vale, UC Rusal and Alcoa are increasingly agitating for a change and a shift towards more market-related pricing.
While the campaign is being led by BHP, which waged and won a long campaign to modernise iron ore pricing, most of the big producers have rapidly fallen in behind it.
Apart from the amount of profit that has been left on the table as the paths of the aluminium and traded alumina prices have diverged over the past five years, there isnt sound logic in pricing alumina off aluminium. The economics of aluminium are driven primarily off the cost of its power, while the economics of an alumina refinery are dictated by the quality of the bauxite reserves that feed it.
With Chinas demand for bauxite and alumina soaring, and its own industry tending not to be integrated, the industry dynamics are somewhat different to those in iron ore, where the Chinese mills had a clear common interest in resisting changes to the pricing structure at a time of rebounding demand and prices.
The more fragmented nature of the aluminium industry and Chinas role in it would make it even more difficult to frustrate the introduction of a new market-related pricing of alumina.
China now forms about a third of the global alumina market and about a third of Chinas bauxite needs are now imported. Alumina prices are increasingly set by the marginal Chinese refinery and as a consequence average refining costs are rising steadily.
Aluminium prices are starting to rise, despite significant idled capacity and historically high levels of inventory. If alumina could be de-linked from aluminium pricing, the combination of market pricing and a rising industry cost base would have a leveraged effect on the margins and profitability of those producers with the lowest cost bases who produce more alumina than they consume in their own smelters.
Among the major players, Rio Tinto, after its Alcan play, probably has the most balanced position and while it would benefit significantly from higher aluminium prices it probably wouldnt be a big net winner in the short term from higher alumina prices. It does, however, have its foot on a lot of bauxite and therefore would have the option of creating a long position.
The group with probably the most leveraged exposure to the changes because it is almost a pure play on alumina is the locally-listed Alumina Ltd., through its 40 per cent interest in the alumina-focused Alcoa Worldwide Alumina and Chemicals joint venture with Alcoa. Most of the other big players are integrated and/or have multi-commodity portfolios.
Iron ore and coal are already well on their way to market-related pricing. Now, it seems, alumina is also shifting.
The new pricing structures will, when demand is strong and supply tight, transfer significant value towards the big low-cost producers. They will, however, increase the potential volatility of the big resource groups cash flows as the bulk of their key commodities moves from settled annual prices to short-term market-driven pricing."
From business spectator
AWC Price at posting:
$1.70 Sentiment: LT Buy Disclosure: Held
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