Rio Tinto Refines Its Aluminum Business

The weakened state of the aluminum market continues to take its toll, as Rio Tinto (NYSE: RIO  ) announced it was closing its Gove refinery in Australia, a move that will cost 1,500 jobs. It's possible the refinery could have remained operational even in the new low-demand environment, but after the government scuttled a deal to provide the refinery with lower cost natural gas there really was little choice available to the miner.

Source: www.facebook.com/pages/Rio-Tinto-Alcan-Gove

This is a scenario we're seeing played out all across the industry, as miners find themselves forced to cut expenses and non-core projects get the axe. Vale (NYSE: VALE  ) recently divested itself of its 22% stake in aluminum producer Norsk Hydro  (NASDAQOTH: NHYDY  ) for $1.8 billion, while Chinalco (NYSE: ACH  ) suspended work on a $1.6 billion aluminum smelter project in Malaysia. Rio Tinto itself shed its position in aluminum products company Constellium for $330 million.

The automotive industry, though, has been a particularly bright spot for aluminum, even if October's seasonally adjusted sales rate dipped below trend. Carmakers are still on track to sell 15.1 million vehicles this year, one of the best results the industry has had in years, and industry executives themselves are much more upbeat about what next year will bring, even if there are pockets of gloom for other heavy aluminum users, including beverage cans, electronics, housing, and semiconductors.

Auto sales are roundly expected to top 16 million next year, and some analysts anticipate metalcutting to hit $7.4 billion, a 20% increase to the expected levels for 2013. From aerospace to consumer medical products there's a general expectation of strong growth, even among those industries that are otherwise seen as stagnant. They might not be robust, but they remain solid nevertheless.

At the same time there's a growing production deficit in metal. Russian giant Rusal says global aluminum usage should hit 51.2 million tons this year, but production is estimated to be 50.9 million tons, and the company is cutting its own production levels this year and next. Overall output is down 5.8% over the first three quarters of 2013 to 2.95 million tons even as demand is expected to rise 10% this year. At the same time, China's push towards aluminum self-sufficiency has continued to flood the market with too much of the metal. 

There may be some additional short-term pressure on pricing as new London Metal Exchange rules push more inventory to market faster. Alcoa (NYSE: AA  ) is using the opportunity to further its position by switching to niche specialty markets that should provide higher margins.

For Rio Tinto, though, its problems lay in smelting's nature as an energy intensive operation, which is why it had found hope in the agreement it struck with Australia's Northern Territory providing it with 300 petajoules of gas over the next 12 years. That would have significantly cut its energy costs, but in July the government reneged, saying it would instead provide 195 petajoules of gas over 15 years in a dual-fuel deal that would include heavy fuel. Rio Tinto, though, said it only needed the gas because it could source its own heavy fuel.

With the deal in tatters, China's push toward self-sufficiency, and Russian markets effectively closed (Rusal has a virtual domestic supply monopoly on aluminum), Rio Tinto faces unacceptably high expenses that it needs to reduce or eliminate. The Gove refinery had to go. Yet for those companies that have figured a way to profit from the changing dynamics of the industry, and I'm thinking specifically of Alcoa here, 2014 and beyond should be a period of growth.

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