What happened since 2006 in the world of Aluminum Investments

Too much stock-optionism, not enough technology.

18 months ago (July ’06), we did here a crystal ball exercise addressing the uncertainties in the aluminum industry affecting investment policies. We were right on target. This is an update.

We said: Around 2000-05, the world economy began growing faster than at any time since the post WW2 era, as a consequence of a general progress towards republican institutions (Rule of Law, Individual Rights, Limited Government, Free Trade) which originated in the 80’s. The effect is felt in Latin America (since the 80’s), in ex-Communist countries (Central Europe, and now Russia and CIS countries), in China, in India, and now even in Africa although not in all countries and not without some serious tensions. Today we can confirm that, but with a provision: The merger mania boosted by the stock-optionist craze means that too much money is spent to purchase goodwill through leveraged acquisitions and not enough is invested in long term investments, notably technology. While energy prices and costs have exploded we made, since the sixties (Pechiney cells such as P130 and AP16) no progress in smelting technology, and are still consuming some 13 to 14 MWh per tonne of metal produced while generating at least carbon dioxide, in same amounts per tonne than at the time.

We said: Economic growth means growth of energy consumption, which means more generating capacity. Building new power plants means facing political objections, the main ones being concerns about environmental impacts, others being more political objections regarding sustainable growth and even objection to so-called “globalization” of economy. This is now illustrated in full in South Africa, 20 years ago a stable “Power Island” with excess power originating from very competitive coal. Now electricity shortages are such that Eskom, the national utility, must ration it, and that all mega-projects notably in the Coega mega-industrial zone are compromised, including the Rio Tinto (Ex-Alcan, ex-Pechiney) mega greenfield.

We said: The business world begins to realize that the general resistance to so-called “globalization”, meaning in the minds of classical economists resistance to wealth creation through optimization of resources and markets according to the eternal dogma of the Market’s “Invisible Hand”, happens not because the world opinion is really turning against Adam Smith’s famous theories, but because so-called “Capitalism” is seen as degenerating into “Stock-Optionism”. Stock-Optionism being the system creating a link between the shutdown of a faraway plant, the anticipated cost reduction supposedly resulting of it, the anticipated increase in profits, and the anticipated increase in stock prices, this in turn benefiting insider trading and stock option holders who can cash in now on these cumulated anticipations. This link has a name: the strategy aiming at stockholders’ value creation as a goal in itself, instead of as a consequence of a successful competitive strategy. Whatever can be your opinion about Stock-Optionism, it triggered a resistance to Globalization which impacted on investments in energy capacity whether new capacity or refurbishing. We were right. Since then we have witnessed the cascade of acquisitions involving aluminum producers between themselves (Alcan, Alusuisse and Pechiney, Alcoa, Rusal and SUAL, and with mining groups (BHP, Rio Tinto, perhaps BHP again or CVRD…). Each acquisition wave delays investment projects, which in turn triggers higher demand and higher metal prices. Escalation of oil and energy prices contribute.

We said: Energy prices had to go up first to force public opinions to concentrate on the real issues and approve the following measures:

· We said: The world economy needs to keep growing if underdeveloped countries will achieve a decent living standard; this means more energy generation. We were right, and new energy capacity is more needed than ever.

· We said: Growth can be sustained with a more optimal use of energy; various energy savings measures will be encouraged. Energy consumption per capita, today of 20-50 GigaJoules/Year in developing countries, of 150-200 in Europe and of 350 in North America, should progress to around 150GJ throughout the world. Even such modest goals mean a total generation capacity multiplied by about 4 in 2050. We were right, but must note that meanwhile Global Warming linked to CO2 and CnHn emissions is now recognized as a scientific truth, even though global warming since the last ice age also is a fact. Atmospheric temperature increase caused by human activity represents only some 20% on top of natural long term warming (which originated some 12 millennia ago and is now coming to full cycle); but these 20% constitute the drop overflowing the vase. If you still doubt it, contact us for a bibliographic memo.

· We said: Thermal and nuclear power plants will supply the bulk of new capacity during the next 30 years. We were right, and will add today: For aluminum, it will come from coal and nuclear. Gas seems very attractive because power plants are much less capital intensive. But gas will be priced out of the aluminum market, except in the Middle East still for some time (Alba, Dubal, and Qatar, Abu Dhabi, Oman, Algeria, Saudi Arabia projects. For hydropower, note one last major greenfield project in Malaysia. Otherwise resistance to new hydropower capacity is growing worldwide. The Three Gorges project in China which displaced more than one million people to generate hopefully 4,000 MW (equivalent to 3 nukes…) may become a case study of why stay away from hydropower in the future.

· We said: Natural gas, a noble form of energy that can be and is more and more used as motor fuel as well, generates half less CO2 than coal. It is getting cheaper to ship. It will be favored, but for these very reasons its market prices will increase further.

· We said: CO2 emissions do impact on global warming, and they must be controlled, eventually eliminated; this will trigger higher energy costs. World emissions reached 7.8 Gigatonnes of carbon in 2002. If nothing is done they will reach 12 Gt by 2030 which may not yet provoke major climate changes, but would mean that unavoidable future growth will lead to such a situation. A reasonable plan in the context of the Kyoto Protocol aims at a peak of 11.5 by 2025, then a downtrend leading to a figure of 9 Gt by 2050. Massive reforestation will be pursued, which will both help solve the CO2 problem (trees and some high-fiber plants consume CO2 to generate cellulose through the chlorophyllian photosynthesis conversion), help the pulp & paper industry and reclaim soil in arid lands. We were right, but we add: for reforestation to consume CO2 and avoid generating CnHn, the forest must be managed. The Amazonian rainforest needs to be preserved for other reasons (as an extremely complex, huge ecosystem which impacts on a whole climate) but its contribution to CO2 adsorption and stocking is questionable. Too many of its trees and plants are naturally rotting.

· We said: The share of electrical energy in total energy consumed by industry and consumers has been growing and will continue to grow, from 18% in 2002 to around 50% in 2050. We confirm that, and mention that Sweden, a highly developed country, demonstrates best that an economy can grow while its energy consumption actually goes down… But Sweden is not an ideal location for a smelter.

· We said: Renewable energies (wind, solar, biomass, photovoltaic, others) will take a bigger share in capacity (perhaps 50% in 2050) but conventional energies will keep growing in capacity in absolute terms if only to reach the above goals. They will all represent high-cost energy, even when subsidized; not suitable for aluminum smelting. We can definitely confirm that, but will mention that CO2 confinement in coal fired power plants will gradually become mandatory. This trend will roughly double the cost of kWh, which is why we will see more nukes linked to smelters: Costs of nuclear energy will go down as coal-fired energy costs go up. But none of theses trends means that renewable energy sources may compete in aluminum smelting.

· We said: Consumers and industry must prepare for generally higher energy prices. Since then oil prices have hit $100 per barrel so we can certainly confirm that and add that it will take quite some time before we reach a new equilibrium of energy prices.

· We said: On top of that, political considerations impact on energy markets: The Middle-East is part of the Arab World, considered more and more as hostile to the United States, to other “Anglo-Saxon” countries and to many European countries. It also controls some 40% of world oil production, which in theory constitutes a political risk. War situations in the Middle East have, since 1948 onwards, put growing pressure on oil availability and prices. There is a stronger incentive for the US, and also for Japan and Europe, to encourage self sufficiency in energy generation. This remains true.

We said: Aluminum producers must adapt therefore, not only to a general increase of energy prices and to a gradual vanishing of “Power Islands” offering excess energy at discounted prices, but also to a higher differential between long term energy costs and energy prices. However since aluminum prices and demand are increasing, all this should constitute a generally favorable context for aluminum investment. And it is. Yet, one can wonder why so many large greenfields keep being delayed. One can also wonder why supposedly obsolete Soderbergs are now revamped and extended, when everyone knows that they pollute more and they are less efficient; and why many older, smaller prebakes do the same. Since then, nothing has changed. Even Alcan’s Kitimat extension project in British Columbia, which we thought should have been well underway by now, is still on hold.

We gave the following reasons, and they haven’t changed:

a) The bigger the greenfield, the bigger is the 10-year energy contract to negotiate. Energy suppliers do not have excess capacity anymore. They prefer smaller contracts, easier to handle in case of big shifts in demand.

b) The bigger the greenfield, the more it will be dependent on export sales to faraway destinations of ingots, billets or sows. Also bigger will be the energy lost in casting, then shipping and remelting the metal. That factor was negligible when energy costs were low. Now it is not.

c) The bigger the greenfield, the higher is the risk of capital cost over run.

d) Capital costs per tpy in a revamping or extension are roughly half the ones in any greenfield.

e) There are more and more opportunities for an older, smaller smelter, to invest in the casthouse to move into high added value semi-products for a local market.

f) Shifting to Lithium Bath, thus increasing conductivity and reducing temperature, means often the fastest way to increase the bottom line for a minimal investment.

Since then, we are glad to notice that we were right again in foreseeing more power plant-smelter integrations. Alumina travels well. Electricity doesn’t. An IPP investor who owns a smelter consuming part of the energy he generates finds out that he has considerably reduced investment risks and that his project as a greenfield is much easier to sell to politicians, media and the public.