Is the growth run coming to an end?

Purchasing improved this year but there's no certainty that demand expansion will continue in 2006

By Tom Stundza -- Purchasing, 11/3/2005

Purchasing of extruded aluminum products through August was 7% ahead of the year-ago pace, but durable goods manufacturing activity slowed in late summer and early autumn and that lowered extrusion-buying activity. Purchasing managers don't foresee a major near-term drop-off in buying patterns, based on latest monthly surveys of light metal business activity. And such analysts as Jeffrey Largey at J.P. Morgan Securities wrote off the decline in bookings as "a typical seasonal pattern of softening orders during July and August when end-use customers take manufacturing shutdowns."

However, the mills are very concerned about future demand trends outside the aerospace and construction markets, and neither buyers nor market researchers can agree whether purchasing activity will stay flat, rebound briskly or grow only moderately as the weather gets cooler. At present, the consensus forecast by metals distribution executives is full-year demand growth of less than 5%—indicating weakened purchasing activity this winter and well into 2006.

"The good news is that, obviously, there is a great demand out there for our products," says Alain Belda, chief executive of Pittsburgh-based Alcoa in a recent speech. "The bad news is that, rather than it happening in our backyard, it is happening far away in the so-called 'BRIC' countries (Brazil, Russia, India, and China) and, more recently, Eastern Europe and Latin America." And that trend has occurred not just in sheet products but also in extruded parts, bars and tubes.

Extrusions are made by forcing liquefied aluminum through a shaped opening in a die. The extruded part of product emerges as an elongated piece of light metal with the same profile as the die opening. Led by groups such as the Aluminum Extruders Council in Wauconda, Ill., new applications for extruded metal are being developed all the time. Recently, members of the council began supplying mission-critical extruded aluminum components to Boeing's truss design and procurement team that are supplying the astronaut crews who have been constructing the International Space Station.

Extruded aluminum framing of grades 6061 and 6063, for example, are now being supplied by council-member firms to Aluminum Chambered Boats of Bellingham, Wash., to make new-generation aluminum-hulled boats. The vessels now are being used by the Coast Guard, Border Patrol and other water-rescue and coastline-protection units of the Department of Homeland Security. The key to extruded aluminum use is its durability, light weight, high strength, and corrosion resistance.

However, it appears that construction activity has been—and remains—the biggest factor in expanded purchasing and use of aluminum extrusions. Aluminum extrusions tend to perform second only to structural steel in terms of tensile strength. Typically, the extrusions have less attention-grabbing applications than those fast boats for law enforcement—from windows and doors to contractor's products, from metal ladders to ceiling tracks. This has been important to extrusion makers in recent months since annualized 2005 construction spending of $1.1 trillion (through August) is a 7% gain over full-year 2004 expenditures.

Another big market for extrusions is trucks and trailers, which is expanding this year at a 2.5% rate. Analysts explain that the medium and heavy truck, freight car, and truck trailer markets are in the midst of a strong recovery to replace older fleet units and expand capacity. The demand for new equipment is expected to remain strong through 2006.

So, it is mostly the traditional types of uses that resulted in 4.2 billion pounds of aluminum extrusions being used in the U.S. last year, a four-year high. After using 4.4 billion pounds of extrusions in 2000, the domestic market consumed an average 3.8 million for the following three years.

"The U.S. economy is in reasonably good shape," says economist Lloyd O'Carroll at BB&T Capital Markets in Richmond, Va. So, he and other aluminum market researchers reckon that North America demand growth for extrusions will remain relatively healthy—if not explosive—for the next several years.

"The aluminum market's current demand isn't as strong as the overall economy," he says, but pins that on "too much inventory in the warehouses of downstream manufacturers since the second quarter." He believes that tonnage will be eliminated over the winter. And that fits with the consensus view that post-hurricane-season rebuilding of the Gulf Coast region will expand use of extruded light-metal parts and tubing—even if that will result in only a gradual growth in purchasing that starts to happen early in 2006.

In the meantime, "the rate of near-term consumption growth for aluminum products now seems weaker than earlier in 2005," says analyst John Mothersole at Global Insight's offices in Washington, D.C. "North American markets look as if they have peaked heading into the fourth quarter," he says, "based on downgraded expectations for both GDP growth and, more importantly, slower growth in industrial production." Upshot: Early forecasts that end-user consumption of extrusions would increase by 5-7% have been downgraded to the 3-5 % range.

It also appears that the supply of such aluminum goods as extrusions "is more than adequate to meet current North American economic and aluminum consumption growth estimates," says Largey at J.P. Morgan. That's evident by recent market surveys which show that delivery leadtimes of extruded shapes and tube is off this year's peak (7.9 weeks in March) and averaging 6.5 weeks in August and September. Reason: In contrast to other nonferrous metals, which are in tight supply this year, North American aluminum has shown improved availability since January.

Alcoa, the world's largest supplier, has ramped up production at its Massena, N.Y., and Wenatchee, Wash., smelters, and full production has been reached at the Becancour smelter in Quebec. Upshot: Producer inventory has climbed steadily throughout 2005, with the July data showing the highest stock levels in two years. And, this might even create a pricing problem for mills if the summertime slippage in new-order bookings continues through autumn.

Several analysts now believe that the downside risk on the price of aluminum outweighs further upside. As analyst Mike Gambardella at J.P. Morgan notes, "It is hard to decipher compelling aluminum fundamentals that would justify the recent run-up in the aluminum price. We believe that power-related smelter closure announcements back in July were the initial drivers of the aluminum ingot price rally; but on the whole, there is more aluminum capacity coming online than slated to be closed."

That's why U.S. Midwest-delivery premiums on aluminum extrusions have softened substantially. Purchasingdata.com surveys show that the average price of 6061-grade extruded bars now is about 3% cheaper than it was in the first. And, since extrusions follow ingot pricing, the anticipated future slippage in primary metal prices will reduce extrusion prices further.

Fritz Gilbert, director of metals planning for aluminum sheet mill Novelis in Atlanta, tells the Institute of Scrap Recycling Industries (ISRI) meeting in Chicago that London Metal Exchange (LME) aluminum primary ingot should average 84¢ or 85¢/lb in 2005 and stay around there in 2006. However, London-based investment banker Calyon Financial expects a fall-off in the ingot price average next year by 10¢/lb to around 74¢. And that could drop extruded rod to $1.50/lb or lower in the U.S. from its current price average of $1.60.

The reasoning in the Calyon Financial report is that the U.S. aluminum market outlook is a bit mixed through next year with high energy prices expected to weigh heavy on both sides of the market-lowering industrial activity by end users and raising operating and chemical additive costs for the smelters and mill products producers.

"We're also cautious on the outlook for aluminum in the short term," agrees analyst David Martin at Deutsche Bank Securities in New York.

Aluminum consumption will lag production next year for the first time since 2003 as higher energy prices slow economic expansion, forecasts Carmine Nappi, director of industry analysis for Montreal-based Alcan, the world's second-largest producer. Demand will grow as much as 4.6% next year to 33.5 million metric tons worldwide, he says, compared with a 5% increase in 2005. But, there will be enough production to create a "slight surplus" of price-depressing aluminum in 2006. "That surplus will become much more significant if demand drops sooner than expected because of high power costs,'' Nappi tells a Metal Bulletin-sponsored International Aluminium Conference.

Analyst Uday Patel of CRU Consultants in London tells the ISRI gathering that "although we expect solid growth" the prospects for 2006 "have become clouded" by such possible problems as a global economic slowdown, increased interest rates, loss of consumer and investor confidence and more inventory destocking than expected. Patel expects the world economy to grow by 3.1% in 2005 and 2006, close to long-term trends. However, he sees "increasing nervousness" over 2006 prospects and expects consumer/industrial spending to weaken and persistently high energy prices to feed inflationary pressures.

Speaking at a recent Aluminum Extruders Council meeting, Stephen Johnston, Alcan's senior analyst, points to several reasons for demand and price slippage ahead. He says that oil prices are near record highs in real terms and threaten economic growth; the price of competing materials, such as steel, are declining; current high aluminum prices encourage startup of idled Chinese smelting capacity; and alumina prices are likely to ease over the next few years. Also remember, he says, that automotive—another substantial sales target for aluminum products—is staggering through a period of reduced demand (even with employee-pricing incentives for buyers).

China may become an even bigger factor in the world aluminum supply/demand balance equation, and therefore global pricing scenarios, suggests the Calyon Financial report. There is a lack of reliable statistics on Chinese production and consumption: "If we take the stats available at face value, then China is now consuming around 22% of world aluminum," says the Calyon Financial report. "This is a large and dynamic chunk of business that essentially has to be analyzed by gut instinct."

But, it is known that China has continued its expansion of aluminum smelting and has become an exporter of aluminum ingot and various products—all of which could become price—depressants in 2006. "We remain concerned about the escalating aluminum production levels from China against the backdrop of slowing global consumption levels," says a report by Christopher Olin, an analyst with Longbow Research.