China’s Influence Over Aluminum is Growing

We are used to China having a pivotal impact on a range of commodities due to its sheer size and vast consumption.  Aluminium is no different with China both the world’s biggest producer and consumer.

But as China rebalances away from an investment-led economy, markets want to know if its prodigious commodity appetite will abate. This could also see China’s dominance as a growth driver fade.

Aluminium, however, looks set to ride out any China headwinds.

Considered a metal of the future due to its increased use in high-tech manufacturing and transportation, aluminum’s demand is expected to outstrip other base metals in the years ahead.  The latest forecast from the World Bureau of Metal Statistics said aluminum demand is expected to grow by about 6 percent this year.

Aluminum is also less likely to be exposed to the fallout from China’s economic model transition. Heavy industries will more likely bear the brunt than demand for consumer goods like automobiles, appliances and electronics, which remains strong as the economy continue to mature.

The International Monetary Fund (IMF) in a recent report noted at this stage of China’s development, demand for aluminum should be increasing. The fund said it expects Chinese demand for high-grade metals like aluminum used in consumer durables such as automobiles and dishwashers to likely prove more resilient in years ahead.

In addition, it was worth noting in the same report the IMF also downplayed expectations of a tail-off in China’s commodity consumption.  When it compared the growth trajectories in China, South Korea and Japan, the fund found that China’s per capita gross domestic product would need to double before that started to happen. (GDP per capita stood at $6,600 in 2013, the IMF estimates.)

 

Surging Output

On the supply side, aluminum’s fundamentals appear to be picking up, thanks to a reduction of demand supply imbalance, albeit due to production cuts outside China.  Companies such as Alcoa, Rusal and Rio Tinto have been reducing supply over the past two years in an effort to tackle oversupply.

Surging output in China has more than offset these cuts, however. China is continuing to expand production rapidly, although it has been focusing on rationalization and higher quality growth.

This includes consolidation, building larger smelters and new technology. The trend has continued of constructing new smelters utilizing cheaper power in western provinces including Xinjiang, Gansu, Qinghai and Inner Mongolia.

New supply has offset any impact from closures of less efficient smelters. Aluminum production rose to a record 1.984m tonnes last month from 1.734m tonnes in March 2013. China now accounts for 46 percent of global aluminum output, compared with 21 percent a decade ago.

During 2013, Chinese output reached 21.9m tonnes, a gain of 11 percent year on year. China’s annual capacity is still expected to increase to 40m tonnes by the end of 2016 according to Societe Generale Securities.

 

Internationalization Ahead

Apart from this outsized appetite for aluminum and huge production, another reason China’s development needs to be closely monitored is the impact of its financial market liberalization.

Going forward China’s influence on international markets for aluminum should only increase as it internationalizes its capital account and allows cross border capital flows.  Given the scale of its dominance in the industry, there is a view China also wants to have a direct say in how the metal is transacted.

Many interpret the move by Hong Kong Exchange and Clearings (HKEx) to purchase London Metals Exchange in 2012 as a clear sign of intent in this direction.  China will at some stage allow its companies and citizens freedom to trade commodities on international markets.

Due to the regulatory changes and constant variables in supply and demand in different markets, these regional premium prices are becoming more important. The market currently does not have a good solution to mitigate risks on this premium portion which is reaching over 20 percent of the entire aluminum cost.

Given these developments, the launch of CME Group’s new “all-in” aluminium contract looks to be extremely timely. The contract will benefit from being tradable across CME’s global platform and is also physically deliverable.

We expect this will increase transparency and improve price discovery as it will provide the industry an ability to hedge premium portions of the contract. This will also create a new arbitrage opportunity for traders looking at different benchmark prices including SHFE and LME. It is a simple futures model, it’s easy to execute on screen and cheaper to trade.

It will also be tradable in Asia and give market participants greater choice at a time when China is about to become a much bigger player on international markets.

 

Youngjin Chang is executive director of metals products and global head of metals at CME Group.

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