LONDON (Reuters) - The Chinese aluminum machine is once again cranking up.
The country produced 2.75 million tonnes of the stuff in September, the second-highest monthly tally ever, exceeded only in June 2015.
Annualized run rates have accelerated by 2.16 million tonnes to 33.48 million over the last two months and China accounted for 55.7 percent of global output in September.
These figures, supplied to the International Aluminum Institute by China’s Nonferrous Metals Industry Association, come with a health warning, prone as they are to bouts of alarming monthly volatility.
But the trend is firmly upwards and appears to bear out a broad analyst consensus that a period of rare self-discipline by Chinese smelters was doomed to end sooner or later.
The reason that smelters are now turning the taps back on is largely one of price.
Shanghai aluminum prices have been on a tear since troughing below 9,000 yuan per tonne in November 2015.
The most actively traded contract on the Shanghai Futures Exchange (ShFE) has this week hit a near two-year high of 13,300 yuan.
It has comfortably outperformed the London price since the start of the year but there are grounds for caution about what is driving this supercharged rally.
It might yet all end in tears. And given Chinese exports of aluminum products are rising again, it may not just be local smelters who face a potential sudden reversal of fortunes.
FROM BUST TO BOOM
It’s hard to believe but this time last year many of China’s aluminum producers were struggling to survive.
The price was imploding and smelters were pushing the government for state assistance in the form of loans to create a “strategic” stockpile of unsold metal.
It’s still uncertain whether that plan ever got off the ground or whether smelters delivered on their side of the bargain in the form of production cuts.
But what is certain is that Chinese production of aluminum slumped by an annualized 7 million tonnes over the October 2015-February 2016 period.
Fast forward a year and even a high-cost operator such as Chalco is back in the black, posting a net profit of 107.9 million yuan ($16 million) in the January-September period, compared with a net loss of 974.6 million yuan a year earlier.
Industry consultants AZ China estimate 1.8 million tonnes of capacity has now been restarted. Another 2.5 million tonnes of new capacity, much of it ultra-low-cost, is also expected to be activated by the end of the year.
The pace of both restarts and greenfield additions is expected to accelerate into the year-end.
Consumption, alas, is not expected to accelerate over the same time-frame as the cycle of government stimulus turns to government clampdown on overheating property markets.
An early warning sign of a potential return to oversupply is the pick-up in exports of semi-fabricated aluminum products.
Earlier this year when production was being curtailed, the export flow was down as much as 10 percent on year-earlier levels. As of September that gap had closed to just 1.7 percent.
Graphic on Shanghai aluminum price, stocks and open interest: tmsnrt.rs/2eCpcZO
NO METAL IN SHANGHAI
None of which is obvious, looking at the Shanghai market.
Prices are booming and stocks are chronically low. Total registered ShFE inventory is just 84,981 tonnes.
It has fallen by 212,000 tonnes this year and the headline figure has over the last few weeks hit lows not seen since September 2011.
Although partly due to production restraint in the first part of 2016, there are other factors at work here.
Firstly, a change in trucking regulations caused a temporary seizure in the country’s haulage sector, most pertinently in a sharp slowdown in movements of aluminum from smelters in distant Xinjiang province to depleted sheds in Shanghai.
After the initial chaos, the situation is now normalizing as road hauliers seem to have been successful in passing on the extra costs to customers.
But the second issue is structural, namely the increasing preference within China for transporting aluminum in liquid form rather than in the solid-state ingot form deliverable against the ShFE’s aluminum contract.
Paul Adkins, managing director of AZ China, suggests around 70 percent of all Chinese movement of aluminum is now in liquid form and that the practice is becoming “institutionalized” with new industrial parks being designed for manufacturers to receive molten metal.
The shortage of metal in Shanghai, in other words, is artificial and primarily a function of the exchange’s own delivery criteria moving increasingly out of synch with the local aluminum supply chain.
SPECULATORS RULE, OK?
Just don’t tell the speculators who appear to have been drawn increasingly into the ShFE aluminum market by the appearance of shortfall and resulting tightness.
Something changed in the Shanghai aluminum market in the fourth quarter of last year.
Volumes and market open interest experienced a step-change in what was previously a contract shunned by local investors in favor of hotter metallic markets such as copper or steel rebar.
Whether it was the original price collapse or the subsequent recovery that caught the eye of Chinese speculators is impossible to know but they have stayed in the Shanghai aluminum market ever since.
The ShFE’s aluminum contract has seen trading volumes almost quadruple so far this year. Market open interest of 608,362 lots at the end of September was up 56 percent on last year.
And it’s still rising, currently totaling 713,530 lots. Coming in tandem with rising prices it seems that ever-increasing amounts of hot money are chasing the Shanghai metal shortage story.
The problem is that there is a shortage of aluminum only in a specific form (ingot) and in a specific location (Shanghai).
China is not short of aluminum and as production cranks back up, the chances of a harsh reality check on the Shanghai contract loom ever closer.
The London aluminum price has also risen this year but only to the tune of 13 percent, compared with the 30-percent gain in Shanghai.
Capping London’s performance have been waves of forward selling as producers look to protect themselves against a price fall.
Chinese smelters may want to take note.
(The opinions expressed here are those of the author, a columnist for Reuters)
Editing by Dale Hudson
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