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Chinese aluminium: next set of reforms for the industry?

Many market observers were sceptical about China's ability to deal with aluminium overcapacity. But cuts at Weiqiao, the world's largest smelter, shows China's determination to deliver supply-side reforms. The market is now divided into two camps – one that believes China will cut output significantly. The other one reasons that smelters will ramp up quickly and nothing much will really change. 

If we were to predict what the authorities have in store for the aluminium industry, we only need to look back at coal and steel.

Coal and steel industry following a similar blueprint to target overcapacity and improve profits of state-owned enterprises

Widespread losses in the coal sector raised concerns about the industry's ability to service its debt. These concerns eventually resulted in government action to increase coal prices. In early 2016, the Chinese government launched a supply-side reform of the coal industry with the aim of eliminating one billion tonnes of excess capacity by 2020.

Steel also followed a similar pattern. To resolve the overcapacity problem, the State Council announced plans to close around 100-150 Mtpa of capacity by 2020. The government has maintained an unwavering focus on steel capacity closures and has publicised frequent updates on progress, which has been faster than expected.

Provincial governments were sacrificing private steelmakers and reducing the competition for SOE steelmakers. It's similar to what we are seeing in aluminium. The authorities are shutting down brand new 600kA cells belonging to private companies in Shandong and Xinjiang. In effect pushing the SHFE prices higher and allowing state-owned enterprises to benefit.

The aim in coal and steel was to improve profitability through M&A and rationalisation whereas for aluminium the narrative is more on illegality and pollution. The outcome, however, is the same – production controls!

The authorities are taking a leaf right out of the steel industry's playbook in terms of targeting private companies to ensure state owned enterprises prosper.

If the aluminium smelter sector follows a similar path to coal and steel then what does it mean for the global market balance and prices? As an alternative to our base case outlook, we show the outcome from a scenario of aggressive output cuts. What if the authorities maintain tight supervision so that illegal production cuts made this year will stay offline for most of 2018? Under the full implementation of cuts scenario, we get a global deficit that not only widens in 2017 but remains in place over the next couple of years.

Trade cases – thanks but no thanks!

In parallel the rapid rise in primary aluminium production, China has become a dominant exporter of aluminium semi-fabricated products. The displacement of domestic production across a number of countries affected by Chinese exports has not gone unnoticed. China is a target of various trade cases. In the event of a range of anti-dumping duties materialising, there is little room for Chinese exports to be redirected to other countries. We estimate the risk of loss of export markets by China during the next 12-24 months to be at least 500 ktpa.

Game plan to reduce 4 Mt of Chinese semi-fabricated exports

Chinese pseudo semis exports to Malaysia and Vietnam also brought into focus how Chinese exporters were exploiting the VAT rebate system. If the authorities plan to keep all the illegal production lines offline they also need to ensure that primary metal and semis are diverted to the domestic market first and not exported. We believe the government will gradually reduce the export rebates on aluminium semi-fabricated products.

Global market balance – a moving target

Wrapping it all up into what an aggressive cuts scenario coupled with ongoing trade cases means for the global balance.

Prices will remain volatile in the short-term. Encouraged by the Shandong cuts, market participants now expect more cuts in other provinces. The 15th October deadline for illegal capacity clean up is two months away so expect more action until then.

Producers and state-owned enterprises, in particular, have reported good results recently but the price rally could lose steam if the authorities rebrand previously labelled illegal production lines as 'legal' in the near future.