Aluminum Supply Tightening as Brazil Output Plunges: Commodities

Aug 15, 2014 3:20 pm ET

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Aug. 15 (Bloomberg) -- Producing aluminum in Brazil got so expensive as electricity prices surged to records this year that Alcoa Inc. idled its Pocos de Caldas smelter and now sells the facility’s power instead of metal.

The worst drought in decades drained reservoirs used to run hydroelectric generators that supply power to extract aluminum, boosting costs already inflated by more spending on labor and transportation. Cities may be forced to ration water, and last week the government cut taxes on imported aluminum to help ease shortages as demand grows for beverage cans.

While the country has the world’s third-largest ore reserves, it is importing more refined metal than it ships after output in July fell to the lowest on records going back to 1996, data show. Aluminum prices this week reached the highest in 17 months as Brazil adds to output cuts that Goldman Sachs Group Inc. said will mean global deficits through at least 2017.

“It’s not economical anymore,” said Milton Rego, executive president of the Sao Paulo-based Brazilian Aluminum Association, known as ABAL, which represents the $18 billion domestic industry. “Its the chronicle of a death foretold.”

Aluminum smelters are electricity guzzlers, with power accounting for as much as half the cost of producing refined metal. Hydro-electric generators that supply about 70 percent of Brazil’s electricity were limited during the drought, sending spot power prices on Jan. 31, the peak of the Southern Hemisphere summer, to the maximum allowed by the government, or 822 reais ($362) per megawatt hour.

Water Risk

Sao Paulo, the largest Brazilian city, has struggled to maintain water supplies. Federal prosecutors warned the municipal utility on July 29 to start rationing or risk having its biggest reservoir run out of drinking water in 100 days. Southeast reservoirs were 33.6 percent full as of Aug. 10, according to ONS, the local regulator. The last time the country faced widespread rationing was in 2001, when dam levels were 20.6 percent to 34.5 percent.

Rising costs, including electricity, and “challenging global market conditions,” as aluminum prices reached a four- year low in February, prompted New York-based Alcoa to shutter 147,000 metric tons of capacity in Brazil this year, the company said in an e-mailed response to questions.

Alcoa, which has been closing high-cost plants around the world, said March 28 it would shut a smelter at Pocos de Caldas in Minas Gerais, where it had been refining for four decades. It also cut output by 97,000 tons at the Sao Luis smelter in Maranhao that is 40 percent-owned by BHP Billiton Ltd.

Selling Power

As a result, Alcoa was able to sell the unused electricity from the Brazilian plants, generating $40 million in the second quarter, Chief Financial Officer William Oplinger told investors during a conference call July 8. The company says it has reduced smelting capacity by 1.2 million tons, or 28 percent, since 2007.

The aluminum industry has closed or curbed output at more than 50 smelters outside of China since 2009, according to Goldman, which estimates global demand will exceed output by 579,000 tons this year and 619,000 tons in 2015.

Prices entered a bull market on the London Metal Exchange last month, reaching a 17-month high of $2,056 a ton on Aug. 12. Aluminum has rallied as much as 23 percent since Feb. 23, when it touched $1,671.25, the lowest since July 2009. Today, metal for delivery in three months rose 0.2 percent to $2,000.

“Production is declining and will continue to decline,” said Jorge Vazquez, managing director of Harbor Intelligence, an industry researcher in Austin, Texas. “There are high odds that maybe more production curtailments could take place.”

Price Incentive

The recent surge in prices may encourage some producers to reopen shuttered plants.

“It was made quite categorically clear that some of those Brazilian cutbacks were just price related, and these smelters would come back,” David Wilson, an analyst at Citigroup Inc. in London, said by telephone on July 31. “These are not permanent closures.”

Even with the shutdowns, Brazil still has more than 500,000 tons of idle capacity, according to industry data. Alcoa and Saudi Arabian Mining Co. plan to start commercial production at their Maaden Aluminum joint venture on Sept. 1. In China, the biggest user, higher domestic prices and government subsidies have resulted in a “notable rise” in output from smelters, Citigroup said in a July 16 report.

Slowing Economy

The slowing growth of the Brazilian economy, Latin America’s largest, also may hurt demand for the metal, Wilson said. Expansion will slow to 1.2 percent this year from 2.49 percent in 2013, according to the mean estimate of 37 economists in a Bloomberg survey.

Domestic demand for aluminum used in cans and airplanes is slowing since the World Cup soccer tournament was held in Brazil during June and July. More than 2 billion cans of beer and soda were sold in the country during tournament, according to Atlanta-based Novelis Inc., a fabricator that is the world’s biggest aluminum consumer. While the company’s sales of beverage packaging rose as much as 25 percent in the second quarter, demand in other areas including transportation was weaker.

So far, prices haven’t encouraged more supply in Brazil, where production in July slumped to 70,400 tons, down 36 percent from a year earlier, according to ABAL. For the year, the country is poised to produce less than 1 million tons for the first time since 1990, compared with 1.3 million in 2013 and 1.66 million in 2008.

Net Importer

With output dropping, the country has imported 117,425 tons of aluminum in the first half of 2014, an almost ninefold increase from a year earlier, according to data from the country’s Ministry of Development, Industry and Foreign Trade. Imports of aluminum alloys tripled to 60,937 tons, bringing total purchases to 178,362 tons. At the same time, exports of primary aluminum totaled 167,401 during the period, down 29 percent. ABAL estimates that next year, the domestic industry will become a net importer for the first time since 1982.

Brazil imported 2,301 tons more than it exported in the first five months of the year, compared with a trade surplus of 182,878 tons in the same period a year earlier, according to World Bureau of Metal Statistics data. In May alone, the deficit was 14,517 tons.

As aluminum production declines, mines have almost doubled output since 2005 of bauxite, the ore that is refined into alumina and then aluminum. It takes about four tons of ore to make one ton of refined metal. The country also has expanded output of other minerals including iron ore, and it is the world’s biggest source of sugar, coffee and oranges, the biggest exporter of soybeans and cattle.

Cut Tax

Brazil’s aluminum trade deficit forced the government on Aug. 6 to eliminate taxes on imports of up to 300,000 tons in 12 months. The change will help avoid shortages, said Renault Castro, executive director of Brazil’s association of can manufacturers, known as Abralatas.

“It’s quite an unpleasant situation,” said Tadeu Nardocci, head of South American operations at Novelis in Sao Paulo. “There will be a bigger gap between what you consume and what you produce in Brazil.”

Premiums added to LME prices to secure metal climbed to a record $455 a ton in Europe, while in the U.S., it gained 69 percent in the past year to 20 cents a pound, according to Metal Bulletin data. The Brazilian surcharge is $575 a ton, according to the London-based metals data provider, which started to track the local price in May. Premiums are up as output dropped and metal was tied up in financing deals that extend wait times for deliveries from LME-monitored warehouses.

Those gains may not be sufficient to spur more supply.

“Prices are up, but it’s nowhere nearly high enough in order to maintain production at current levels,” Lloyd O’Carroll, a Richmond, Virginia-based analyst at Northcoast Research Holdings LLP, said by telephone on Aug. 12. “Unless the price increases, we are likely to see additional production shutdowns, and Brazil and Australia are prime candidates.”

--With assistance from Sonja Elmquist in New York and Isis Almeida in London.