Aluminum producers have been cutting production since last year in order to rebalance the market. Their measures have yielded some results as output in Europe and the Americas has fallen over the past year. However, this has been offset by higher output from China and the Middle East. As a result, aluminum prices have remained weak.
Aluminum prices under pressure despite production cuts
Weighed down by weak aluminum prices due to the supply glut, global aluminum giants such as Alcoa (NYSE:AA), Rio Tinto (NYSE:RIO), and Russia's Rusal have been cutting output since 2013. These companies expect the cut in production would lead to a fundamental balance in the aluminum market. To some extent, it has worked, as aluminum output in both Europe and the Americas has declined over the past 12 months. Also, the London Metal Exchange (LME) recently halted its plan to cut inventories at its registered facilities across the world. These factors have provided support to aluminum prices. However, prices have failed to reach $2,000 per ton, a level required for many smelters to remain profitable. So, what's keeping aluminum prices under pressure?
The reason is that despite production cuts carried out by U.S. and European companies, aluminum smelters in emerging markets, mainly the Persian Gulf and China, have been increasing production due to lower costs. As a result, aluminum production increased to 4.329 million tons in March 2013, an increment of 5% year over year, according to the International Aluminum Institute.
Rising production in China and the Middle East
Several Chinese aluminum smelters have been shuttered in the recent past because of high manufacturing costs. It is estimated that shuttering these smelters brought down the annual output by 2 million tons since 2012. However, these cuts have been more than offset by higher output from newly-made, highly efficient smelters built in the Northwest region of China. Not surprisingly, China's aluminum output jumped from 1.734 million tons in March 2013 to 1.984 million tons in March 2014, which is a record level. Interestingly, China's share in global aluminum output now stands at 46%, up from 21% a decade ago.
Earlier in January, Fitch Ratings estimated in a report that China's annual aluminum production would jump by 4 million tons, or 8%, in 2014.
Adding to this is the rising output from low-cost smelters in the Middle East. Thanks to lower energy prices, smelting costs in this region are lower compared to that of Europe and the Americas. Alcoa is expected to almost triple its raw aluminum production at its Saudi Arabia smelting facility, where it owns 25% of the joint venture. According to the company, this giant aluminum smelting facility, believed to be one of lowest-cost facilities in the world, is expected to produce 550,000 tons this year, up from 190,000 in 2013. Alcoa officials say that vast energy sources in Saudi Arabia help to keep operational costs lower, even as it closed down high-cost facilities in Tennessee and Australia.
Rio Tinto, the first western company to invest through a joint venture in Persian Gulf, owns 20% of Oman's Sohar Aluminum. The facility at Sohar, which reached a capacity of 360,000 tons a year in 2009, currently has a capacity of 372,000 tons of aluminum a year
In Qatar, Norwegian aluminum giant Norsk Hydro ASA (NASDAQOTH:NHYDY) has a 50:50 joint venture with Petroleum of Qatar in Qatar Aluminum (Qatalum). The facility has an annual capacity of 585,000 tons.
Apart from Western companies, there are several state-owned companies spread across the region increasing their output. As a result, aluminum output in the Persian Gulf climbed nearly 14% in the first quarter of the year, according to Arab News. In March the total annualized production stood at 4.5 million tons, a growth of 18% year over year.
Outlook still solid for Alcoa
Indeed, the major challenge for Alcoa and other aluminum producers is the upstream business. However, Alcoa has been taking steps to strengthen its upstream business even as it increases its focus on value-added businesses. Therefore, the outlook for the company remains optimistic.
Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.