The People’s Bank of China allowed the renminbi to fall by 4.6% against the US dollar between Tuesday and Thursday, but it has since strengthened marginally.
Commodity Online
Following China's devaluation of its currency this week, aluminium prices that have already fallen steadily this year while regional premiums have collapsed on oversupply, are more likely to fall further, according to a report by Moody's.
The People’s Bank of China allowed the renminbi to fall by 4.6% against the US dollar between Tuesday and Thursday, but it has since strengthened marginally.
Further falls in aluminium prices would be credit negative for producers. Primary aluminium producers, particularly in Europe and the US such as Norsk Hydro ASA (“Hydro” Baa2 stable) and Century Aluminum Company (B2 stable), will face greater potential falls in earnings compared with peers that have larger exposures to mid-stream and downstream aluminium markets, such as Alcoa Inc (NYSE:AA). (Ba1 positive) or those with more diverse commodity exposure such as Rio Tinto (LONDON:RIO) plc (A3, stable) and South32 Limited (Baa1 stable) .
Aluminium prices have been under pressure this year on concerns of slowing economic growth in China. At the same time, continued growth in Chinese aluminium production – up about 18% year-on-year through June 30, 2015 to an estimated 15.6 million metric tons (mt) has maintained overcapacity in the global aluminium market despite cuts by producers in other countries.
The excess Chinese production has gone into the export markets and, according to Hydro2 , in the first half of the year monthly export volumes were at a high level of around 300,000 mt despite a narrowing of the price differential between Chinese and European/US producers.
This resulted from the high exports from China, as well as Russia, India and the Middle East increasing the supply of the metal in other markets and causing the collapse of regional premiums, which had reached historical highs. Consequently, arbitrage opportunities for Chinese producers have reduced, making Chinese exports close to unprofitable by the end of the second quarter.
However, a weaker renminbi will boost the profitability of Chinese aluminium exports, maintaining pressure on prices in the globally over-supplied market and reduce earnings of European and US primary aluminium producers.
While aluminium producers will benefit from lower energy costs, and earnings for producers with operations in countries with depreciating currencies relative to the US dollar have been supported by weaker currencies (the Norwegian Krone and euro have depreciated by 30% and 16% respectively in the last 12 months), earnings for the rest of 2015 and 2016 will be hit by a larger decline in aluminium prices.
“We expect a more noticeable decline in the third and fourth quarter of 2015 from the collapse in premiums, given the lag effect of premium pricing. Lower primary metal prices will slow our projected 2015/2016 improvement in the performance of Hydro, underpinned by higher volumes, better commercial realisations in its bauxite and alumina divisions and cost improvements in the primary aluminium segments.”
Hydro has strong liquidity and high cash balances, so has sufficient financial flexibility to withstand weaker market conditions in 2016.
Alcoa’s growing diversification in its mid and downstream segments provides a more stable earnings source compared with Hydro, which relies more on its upstream activities. Nonetheless while Alcoa has aggressively rationalized its smelter system, made productivity savings and moved down the cost curve, the lower realized price environment will also hurt performance in the company’s primary metals segment.
However, Alcoa continues to transform itself to a lightweight value-added metals company and its focus on products to the automotive and aerospace industries will contribute to good earnings growth in its mid-stream and downstream segments.
Alcoa also has strong liquidity and good cash flows. "We do not expect aluminium prices and premiums to improve substantially in the next 12-18 months, as the market faces downside risks due to uncertain and slow global economic recovery and particularly the slowing growth rates in China. "
The industry's supply-side dynamics remain challenging, given excess capacity in China and a reluctance to close high-cost plants due to local political and social considerations, and new capacity coming on line especially in the Middle East.
While demand excluding China remains acceptable, the ramp-up of new smelters, continued excess production in China and the overhang of inventories in financing transactions will continue to limit the ability for prices to move upward and keep premiums low.