Analysts see high-flying ingot prices well into '07

Tom Stundza -- Purchasing, 4/6/2006

The world aluminum price is likely to remain high throughout the year, and probably well into 2007, given forecasts of a global aluminum market deficit of 375,000 metric tons for 2006 and uncertain production next year. The shortfall will be caused by European and North American smelters either closing or remaining shut down due to prohibitively high power costs, says analyst Mike Gambardella at J.P. Morgan Securities in New York, as well as Chinese government efforts to shut unprofitable aluminum smelters at home.

Solid global demand for aluminum, commodity fund investment interest and high raw material-input costs are the three drivers of current elevated aluminum prices, writes Jon Bergtheil, commodity metals strategist for J.P. Morgan's London office. "Global demand, whether coming from developed nations like the U.S. or emerging economies like China, remains healthy, while commodity-fund interest in metals like aluminum remains at very active levels."

The aluminum price is likely to remain above our average 2006 price forecast consensus of $1.02/lb—up from 85¢ for 2005. The consensus outlook for the 2007 LME ingot average also is $1.02/lb. While monthly London Metal Exchange (LME) aluminum prices have retreated somewhat from the highs reached in early February, they still are trending well above average prices for the last few years; indeed, the projected first quarter average cash price of $1.10/lb is running 16% ahead of the average fourth quarter price of 94¢ and 27% ahead of the average first quarter 2005 price of 86¢.

"Meanwhile," Bergtheil says, "this strong aluminum price has persisted despite the fact that LME inventories have increased by 16% year-to-date." Analyst Neil Buxton at GFMS Metal Consulting in London agrees that "in the short-term, the rise in the LME inventories may put a cap on prices." He suggests that the recent massive build in LME inventories for aluminum "now appears to be more than just 'hidden inventories'-and most likely are loan collateral being returned to the market-and reflect genuine over-supply."

Bergtheil estimates that global aluminum consumption will grow by 4.1% in 2006 and 4.5% in 2007, which sets the stage for very tight supply and demand outlook for the next two years, as he also forecasts global aluminum production to grow by 3.5% this year and 5.8% next year. However, Buxton believes that higher alumina and energy costs will constrain production below that rate. Analyst Lloyd O'Carroll at Davenport Equity Research in Richmond, Va., also agrees that "high power and alumina prices should continue to restrain primary production through 2006." He says the extreme tightness in the alumina market will ease somewhat starting in 2007, "but high power prices may be with us for a while."

It is widely agreed that the tight supply of alumina, the processed bauxite that become the key raw material for aluminum, is preventing so-called swing aluminum-smelting capacity from coming on line. "The alumina situation remains precarious," Bergtheil says, "as alumina refining utilization rates remain near 100% and any supply disruption at the refining level could push aluminum prices back towards record levels." Additional alumina refining capacity is under construction and could begin to contribute to global supplies in the second half of this year or, more probably, in 2007.

In fact, Merrill Lynch analyst Daniel Roling doesn't expect the alumina market to be balanced until the end of 2007-and doesn't expect a decrease in alumina prices until next year. The current spot alumina price is $650/metric ton, but prices should begin to decline next year as the spot price retreats closer to contract prices of $35, Roling says in a conference call with analysts.