Will Alcoa Be Tarnished by Falling Prices?

As rising costs and lower prices pressure aluminum producers, Alcoa (NYSE: AA  ) said it is shuttering two more smelting operations in Brazil, which follows its closure of a smelter in Australia last month and others in the U.S., Canada, and Italy last year.


Alumar smelting facility, Sao Luis, Brasil. Source: Alcoa.

All across the industry, producers are reducing capacity to account for depressed pricing despite heightened demand. The world's largest aluminum producer, Rusal, has also been closing smelters and announced it was cutting production, saying output will likely fall to 3.5 million tons this year, down from 3.9 million tons in 2013. Similarly, Rio Tinto (NYSE: RIO  ) said in December it was closing its Australian smelting operation and shelving plans for an aluminum plant in Paraguay.

Last May, Alcoa put some 460,000 metric tons of smelting capacity under review, but its pullback has actually been more severe, as this latest announcement means capacity will be reduced by 800,000 metric tons, or some 21% of the total, when the shutdown is finished in May. After hitting a high of around $2,800 per metric tonne in 2011, alumina pricing has tumbled sharply and now trades for around $1,682 per metric tonne, its lowest level in four years, as an inventory glut maintains downward pressure.

5 Year Aluminum Prices-Aluminum Price Chart

Source: InfoMine.com.

Alcoa says its actions are consistent with its stated goal of lowering its position on the world aluminum production cost curve to the 38th percentile and the alumina cost curve to the 21st percentile by 2016. In comparison, Rio Tinto says it has an industry-leading cost position for aluminum smelting and is moving into the second quartile of the cost curve for alumina refining.

Still, China's smelters are delaying taking shipments and cutting spot imports as banks there crack down on lending to industries from aluminum to steel by as much as 20%, while also cutting production. The country is awash in alumina, and the moves are seen as a means of stabilizing the domestic industry, but top Chinese aluminium producer China Hongqiao Group says at least 30% of capacity will need to be taken from the market over the next three years. That's going to rebound on global producers such as Alcoa and BHP Billiton (NYSE: BHP  ) , which reported in January that alumina production over the previous six months improved 8% to a record 2.6 million tonnes.

Despite the reductions Alcoa is making, it's still pushing ahead with plans for building a low-cost smelter in Saudi Arabia, which is expected to have capacity of 1.8 million metric tonnes per year. So perhaps we should take all these production and capacity cuts the miner is announcing with a grain of salt. Even though they've made steep reductions at certain facilities around the world, capacity elsewhere is still expanding.

It seems much faith is still being placed on having China come to the rescue, but with its economy slowing faster than analysts expected, Alcoa may need to curtail expansion everywhere instead of in the piecemeal fashion it's currently doing.

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