LONDON (Reuters) – Global aluminium production rose by 2.1% over the first three months of this year, according to the latest figures from the International Aluminium Institute.A roll of aluminium is seen at the start of the can making process on the production line at Ball Corporation, Wakefield, Britain, October 18, 2019. REUTERS/Andrew Yates

This is a disaster for the world’s aluminium producers. Amid all the uncertainty generated by COVID-19, one thing is for sure. Aluminium usage hasn’t risen by anything close to that rate. It’s rather a question of how hard it has fallen.

Given the lockdown of much of the world’s auto manufacturing capacity, a key end-use sector for aluminium, the intuitive answer is very hard indeed.

In the opaque aluminium market the truest signal is price and that on the London Metal Exchange hit a four-year low of $1,455 per tonne earlier this month. It is currently trading around $1,490.

At least aluminium isn’t going to “go negative” like the WTI oil contract. Storage space isn’t going to run out. But that’s part of aluminium’s problem.

MINIMAL LOCKDOWN IMPACT

Other industrial metals are experiencing a supply shock which is partly mitigating the coronavirus demand shock as mines around the world are forced to stop operations due to lockdowns in key producer countries such as Peru.

However, for the most part aluminium smelters even in countries with the most severe lockdowns such as South Africa have been designated critical industries and allowed to continue operating.

The biggest lockdown hit has been experienced by Argentina’s Aluar, which has temporarily shuttered 50% of its 460,000-tonne per year Puerto Madryn plant to comply with the government’s emergency quarantine measures.

Elsewhere, Rio Tinto has idled one of four potlines at its Tiwai Point smelter in New Zealand and Hydro has pushed back the restart of a 95,000-tonne line at its Husnes plant in Norway. Ironically, the line is being revived after being mothballed during the last aluminium price crisis in 2009.

The Tiwai Point plant was already under long-term review due to low prices. So too is Rio’s ISAL smelter in Iceland, which is running at 85% of its 230,000-tonne per year capacity under what the company calls its “value over volume” policy.

That underlines the slow price response time of the global aluminium industry. Most producers are still reacting to last year’s low prices rather than the current demand shock.

Moreover, the minimal curtailments seen so far are being overshadowed by new and restarted capacity.

An 11% year-on-year jump in first-quarter production in the Gulf, for example, reflects the ramp-up of a new 540,000-tonne per year line at Aluminium Bahrain.

Higher output in Latin America is down to the return to full capacity of Hydro’s Albras plant in Brazil after a government-mandated part closure of the alumina refinery which feeds the smelter. The restart is still work in progress with Albras closing 25% of capacity again after a March fire.

It’s a similar story in North America, where a 4.1% rise in output is largely due to the return of the Becancour smelter in Canada after a crippling 18-month strike that ended in July last year.

Then, of course, there is China, the world’s largest producing country, where smelters managed to lift output by 2.2% over the first three months of this year despite Beijing’s tough quarantine measures and despite a collapse in first-use demand from product manufacturers.

SLOW-FUSE INDUSTRY

Aluminium is a notoriously slow-fuse industry when it comes to responding to price signals.

It takes time and money to close and restart capacity without damaging a smelter’s production equipment. Aluminium smelters use a lot of electricity and many have long-term power contracts with penalty clauses for sudden changes in usage.

Moreover, this is an industry that is battle-hardened by years of low pricing since the last demand shock of the Global Financial Crisis (GFC).

Smelters still operating are by definition survivors and often insulated against low pricing by long-dated hedging programmes.

Norway’s Hydro, for example, had hedged 50% of its primary metal output for the first quarter of this year at an average price of $1,750 per tonne, according to its Q4 2019 financial accounts.

All of which helps explain why the collective reaction time to demand and price shocks can be glacial.

The aluminium price dropped to a nadir of $1,275 in February 2009, when the GFC storms were most intense. It wasn’t until 2011-2012, however, that a collective shuttering of capacity started building momentum.

STOCKS RELEASE

The consequence of excess production relative to demand in 2008-2009 was inventory build. LME stocks surged from 1.17 to 4.6 million tonnes between August 2008 and August 2009.

Aluminium, unlike oil, is easy to store. During the worst of the GFC demand shock traders were even trying to lease disused airfields to stockpile metal. All you really need is a hard enough concrete surface.

And the market itself provided the mechanism for holding all that unsold metal in the form of a super-contango. As long as the forward price is trading at a sufficient premium to the cash price to cover the cost of money, storage and insurance, stocks financiers can make a tidy profit from letting the metal sit in deep freeze in a warehouse.

Aluminium has been living with the consequences of those high stocks ever since in the form of low pricing and persistent margin compression for producers.

There are already indications that this new crisis is going to run to the same script as the old one.

LME stocks have increased sharply since the middle of March with just over 400,000 tonnes of metal hitting registered warehouses.

This may be the tip of the iceberg, though, since a shadow LME warehouse system has grown over the last decade. Excess metal will be absorbed by such “near-market” storage first before it shows up as LME-warranted metal.

LME spreads, meanwhile, have noticeably loosened with the cash-to-threes period flexing out to a contango of around $40 per tonne in recent days. That’s not quite a return of the super-contango of 2009 but it’s the widest the structure has been in four years.

In short, the aluminium market shows every sign of repeating the mistakes of crisis past.

Aluminium producers could break this vicious repeat cycle by biting the collective bullet and shuttering capacity.