London 21/10/2014 - Forecasts for an-ever wider global supply deficits for aluminium ingots in 2015 and beyond ignore one crucial factor: Chinese production.
China, which accounts for around 47 percent of the world's aluminium output, continues to produce more than it needs for domestic consumption. It exported 380,000 tonnes of aluminium in secondary and unfinished products in July this year, 390,000 tonnes in August and perhaps more than 400,000 tonnes in September, according to the country's General Administration of Customs.
While these large year-on-year increases came when the price of aluminium on the LME was recovering strongly - crossing $2,000 per tonne in July and remaining above that level for most of August - the numbers challenge the long-perceived notion of China as a bubble market for aluminium and for the rest of the world to record a deficit in 2015.
With aluminium premiums rising unabated, China may well continue to export semis to compete in the global market or it could enable exports of primary material, both of which would lower the all-in price.
CHINA'S EXPORT LOOPHOLE
Although China has a 15-percent tax on primary aluminium ingot exports, there is no tax for semi-finished or finished products. The country even offers a refund on part of the 17-percent value-added tax (VAT) on exports of some products, making it more competitive in foreign markets.
The volatility in arbitrage possibilities usually makes it too risky to export aluminium from China. But some exporters get around this and the export tax by producing semi-finished products such as billets with LME standard P1020 ingot purity specifications (99.7 percent aluminium purity), which also qualify for a tax rebate.
These are then melted down and recast as ingots overseas, several sources have confirmed. A Chinese company has reportedly built up 650,000-850,000 tonnes of stocks in Mexico by exporting primary metal under the guise of tax-free billets and profiles, for instance.
To do this, certain factors have to be aligned, such as an export arbitrage sufficient to cover logistical costs. The SHFE-LME arbitrage window is sometimes open only for a short time, in which case there is little to be gained by exporting aluminium at levels that could potentially be achieved domestically a few days later.
This year, the SHFE-LME arbitrage has been negative nearly all the time and was negative enough in June and July this year to prompt higher exports from China but it is currently too narrow to guarantee a profit. The ratio even turned positive for a day or two in September, prompting some imports into mainland China.
With aluminium destined for ingot production leaving China under the guise of billets, t-bars, sows or other shapes, official data could be misleading.
China produced an estimated 250,000 tonnes of aluminium in August, the International Aluminium Institute estimated, almost as much as in South America and Africa combined. This figure is not included the IAI's reported global production figure of 2.027 million tonnes for that month.
LEAPFROGGING THE VALUE CHAIN
But while supply of primary aluminium may be lacking, end-users outside China in certain sectors may not feel the pinch so much due to the increase in exports of semi-finished aluminium.
Of August exports at 320,000 tonnes of semi-finished products, around 165,000 tonnes were plate, sheet and strip. Another 78,000 tonnes were aluminium foil.
Exports of semi-finished aluminium products were up 7.4 percent in January-August on the same eight months of last year, customs data shows. This trend is likely to continue - Chinese semis production is expected to more than double between 2010 and 2018, leaving China in a substantial and growing surplus.
"It is very profitable to export aluminium semis and products from China," Andreas Hommert, head of research at hedge fund Citrine Capital Management, said. "These exports will likely fill the deficit that has opened up in the world ex-China."
The premium over the domestic price that can be earned by exporting is now $200-400 per tonne, a level that has traditionally resulted in a massive trade response, Hommert noted, also pointing to weakening domestic demand growth.
While this is encouraging for end-users who need mainly flat rolled aluminium products, it causes complications for those who rely on ingots or primary sources of aluminium. If material continues to be shipped out of China at present rates, it is unlikely to be primary product.
"Chinese producers will be more incentivised to export downstream products," JP Morgan Chase said in a September research bulletin.
But with global aluminium ingot premiums continuing to climb into record territory, increased low-cost capacity in China coming online towards the end of 2015 and weakening demand for domestically produced aluminium for financing purposes after the Qingdao scandal, primary aluminium exports from the country could become profitable.
REMOVAL OF EXPORT TAX WOULD ENCOURAGE PRIMARY IMPORTS
Beijing might also ease the restrictions on aluminium exports if domestic consumption cannot support its smelters.
"If the aluminium market remains strong it only makes sense to me for China to export more. It's a global market and if the global market is in shortage, countries that overproduce should look to fill that gap," Robin Bhar, head of metals research at Société Générale, said.
"China is part of the WTO and I think in the long term you're not really allowed to have import and export barriers like this; it should be a level playing field," he said.
Even without flicking the switch on primary exports and discounting that some semi-finished products are de facto ingots, the volume of semi-finished aluminium products being exported at current rates should make a significant dent into what has been predicted to be a substantial deficit.
Estimated exports of 2.2 million tonnes so far this year is around the volume "taken out of the West, so they are offsetting the deficit assuming the semis is the surplus", INTL FC Stone analyst Edward Meir said, seeing exports reaching 3.5 million tonnes by the end of 2014.
"People are realising that the deficit is not appearing in the fundamentals in the way that was expected," he added.
(Editing by Mark Shaw)