When will aluminium flood end?

The aluminium market has been waiting a long time now for the momentous day that China turns to net importer of the light metal.

As both the world's largest producer and consumer it will mark a seismic shift in aluminium's global fundamental dynamics.

So far, however, the waiting has been in vain. The much-heralded turnaround has been a mirage, hovering tantalisingly on the short-term horizon but ever receding.

It's not been for want of trying by the Chinese authorities.

They have long targeted the export of aluminium as a wasteful use of the country's stretched energy resources, slapping a 15-percent export duty on the metal as long ago as November 2006.

However, Chinese exporters have proved adept at modifying primary metal just enough to pass it through customs under different export categories, particularly those still qualifying for export tax rebates. This game of cat-and-mouse has taken various forms...often literally.

First it was aluminium bar and rod. Then it was aluminium tube. Most recently it has been aluminium alloy. Each time the authorities have responded by eliminating rebates on the offending export code and bringing it into line with primary aluminium's 15-percent tax rate.

The most recent attempt to plug the leaking tariff system was the Aug 20 change of tax treatment for alloy with the important exception of that produced from secondary sources, in other words authentic alloy.

Net exports of "alloy" surged to 397,100 tonnes in the first seven months of 2008 from 105,500 in the same period of 2007.

That more than compensated for China's apparent shift to net importer of primary metal to the tune of 31,000 tonnes in the Jan-July 2008 period.

The big question is whether the latest change of tariff code will do the trick of stemming the flood of Chinese metal into the international market-place.

The steady harmonization of export tax treatment across the aluminium category spectrum is an undoubted positive, simply because wily exporters must be running out of options to escape the 15-percent tax.

However, there are two reasons for caution.

Firstly, the most recent customs figures for August show that net exports of aluminium product remained strong at 130,400 tonnes despite the alignment of the export tax on bar/rod and tube with that on primary metal.

This may simply reflect the country's rising semi-fabricated products capacity but it leaves the suspicion that primary metal is still leaking through the customs net in another, as yet unidentified, form.

Secondly, China is not yet ready to turn to net importer because despite one of the fastest consumption growth rates in the world, the local market remains in palpable supply-demand surplus.

Net exports of unwrought primary aluminium and aluminium alloy combined totalled 438,200 tonnes in the first eight months of 2008. Net exports of "product", using the term loosely, totalled 891,250 tonnes over the same period. All that metal was evidently surplus to domestic requirements.

Moreover, visible surplus in the form of stocks held by the Shanghai Futures Exchange (SHFE) has been rising. At 193,201 tonnes SHFE stocks are up by 104,086 tonnes on the start of January and just shy of the multi-year highs of early August. Invisible surplus, in the form of off-market stocks, is also building.

Reuters last week quoted local smelter officials as saying that unsold inventory in eastern and southern consuming areas could be at least as large as that held by the Shanghai exchange.

China bulls can point to the fact that domestic primary aluminium production growth has slowed sharply from 34.3 percent in 2007 to 11.3 percent in the first seven months of 2008.

That in theory brings it below anticipated consumption growth this year, implying dwindling surplus and a gradual shift to net importer status.

However, much of that production growth slowdown has been due to unscheduled power shortages, first in January/February and again over the summer months, when seasonal peak usage was compounded by prioritisation of power supply for the Olympics.

A July producer pact to cut output seems, as ever with such agreements in China, to have been little more than political gloss on what was already de facto reality.

As power availability improves over the coming months, production growth could reaccelerate, possibly very sharply indeed.

Reuters reported earlier this month that some 1.5 million tonnes of production capacity, around half of the total increase expected this year, is poised to be activated in the fourth quarter. This surge of new production could not come at a worse time.

Consumption slowed more than usual this summer, again because of the Games, and it should recover from this month onwards. But by how much is highly uncertain, given weakening export markets and signs of slowdown in China itself.

SHFE spot aluminium prices have already fallen by 8.8 percent over the course of 2008 and are at three-year lows. The domestic market outlook over the remainder of this year is less than promising. That means more pressure on already squeezed margins in parts of the smelter sector, particularly those smelters without captive power.

How long higher-cost smelters can hold out remains to be seen, but while they do, China looks set to remain in surplus and the incentive to export will remain high.

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