By Greg Wittbecker, Advisor, CRU Analysis
U.S. Midwest primary aluminum expressed over LME cash is 26-27 cents per pound, touted at “record levels.”
In October 2014, Midwest traded premiums reached 23 cents per pound, so on paper we have set a new high….or have we?
2014: the Era of the LME Warehouse Queues
We don’t have the time nor space to do a complete post-mortem on the factors that led to the long delivery queues in the LME in 2014. Suffice to say that financial intermediaries controlled the discretionary supply and much of it got blocked in those queues. This led to the market pricing import replacement very high.
It took radical alteration of the LME warehouse rules, a weakening of fundamental demand and higher U.S. imports to blunt that premium. By October 2015, premiums had collapsed to 8 cents/pound.
2021: End of Global Surplus is a Legitimate Driver of Higher Premiums
CRU expects the 2021 global balance to be a mere 40,000 tons. This contrasts to 2020, when we ran a surplus of 1.9 million tons. China will be in deficit of 160,000 tons and the World ex China will run a surplus of 200,000 tons. These are “rounding errors” in a market of nearly 69 million tons.
The U.S. will remain in deficit of 4.2 million tons, requiring heavy imports to meet its demand. Domestic production is flat-lined, as we reported several weeks ago .
All these numbers are very bullish…and seem to underpin why the U.S. physical premiums are strong. However, do they deserve to be 26-27 cents/pound? We argue that they do NOT, reflecting on the ongoing impact of Section 232.
Section 232: Its Distorting Effect on Real Premiums
Current LME cash prices and CIF U.S. port premiums mean that every pound of metal entering the U.S. today carries a duty of nearly 12 cents/pound. That’s a handsome return to the domestic producers, plus Canada, Argentina and Australia who enjoy exemption from that duty. We do NOT begrudge these producers their earnings. They have suffered through a decade-long drought of returns to shareholders.
However, if the goal of Section 232 was to ensure the stability of the domestic aluminum industry, we would argue that it has done little. LME prices are now well above costs for even the most inefficient of the domestic producers. Section 232 had nothing to do with that. If we stripped the 12 cents/pound of duty off current Midwest premiums, the remaining 14-15 cent/pound net premium would still be well above the historical trailing average. A very handsome return that was driven by fundamental demand recovery, nothing that Section 232 stimulated. (In fact, the anti-dumping actions of the U.S. Aluminum Associations against 18 import countries on common alloy aluminum sheet and plate probably did more to drive up premiums as domestic mills received more orders as a result).
Meanwhile, there’s no sign of any restarts coming of idled U.S. capacity. We detailed two weeks ago why we did not think restarts would come. Nothing has changed.
Despite strong LME revenue growth and a 10% “tailwind” from Section 232 on regional premiums, no domestic producer wants to boost production, so how is supply surety getting better? All we have done is put more money into the pocket of the producers while leading to this “record” premium level.
What’s Next: OEM Pressure Versus the Tariff Collection Largess
Producers aren’t the only ones enjoying these heady premiums. The physical traders have had the “long premium” trade on since 2018 and are doing very well. However, if you are long these markets, you have to be asking yourself, is it time to take money off the table?
This is a tough one to handicap.
Section 232 was a political decision. Hence it could be reversed quickly. As LME and Midwest prices continue to rise (U.S. ingot prices approaching $1.40 per pound), one has to believe that leading OEMs will get more vocal about the inflationary effects of Section 232 on their costs.
That argues for the smart trader to be exiting their long before political pressure pops this premium bubble.
The flipside is that Section 232 is a cash cow. The Congressional Research Service reported in August 2020 that the aluminum tariff took in $2.2 billion in its first two years of enforcement. That may be a drop in the bucket against the Biden administration spending agenda, but every little bit helps.
The premium trade may still have some runway, but it sure feels like time is against it.
Greg Wittbecker joined CRU in January 2018 after retiring from Alcoa, where he was Vice President of Industry Analysis and Managing Director of Alcoa Beijing Trading, based in Shanghai, China. His career spans 35 years in the aluminum industry, having also held senior commercial and management roles at Cargill, Wise Metals and Koch Supply and Trading. Greg brings perspective on the entire aluminum supply chain from bauxite to aluminum finished products and will be a regular contributor to SMU going forward. He can be reached at firstname.lastname@example.org
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