Aluminum Faces a Decade of Dilemmas

September/October 1991

Jay Sirdeshpande is a Montreal-based consultant in nonferrous metals as well as in cross-cultural management. He previously was director of trading and global metal management for Alcan Aluminium Ltd. (Montreal).

The aluminum industry is confronting some major dilemmas through the 1990s:

Although there's recognition that aluminum may be on the threshold of a spectacular increase in use in automobiles, the industry needs substantial capital and proof that this is the right direction to take before it can commit to long-term development of this market.

The aluminum industry realizes there are unrivaled benefits to recycling, but its commitment to secondary products can make the supply side less flexible in adapting to changes in demand, especially during periods of low demand.

The industry sees the potential for making more and more products from recycled metal, but has not followed suit in developing products that take advantage of primary aluminum's unique purity value.

While pricing based on the London Metal Exchange (LME) for aluminum mill products as well as for ingots seems inevitable, the industry appears unable to protect itself from the swings in earnings resulting from such a pricing system.

There is good news: The aluminum industry is capable of resolving these dilemmas, just like it was able to overcome difficulties--even to make some large strides--in the last three decades.

Following the metal's unprecedented growth in the 1960s came the energy crisis of the early 1970s, which forced the industry to put more emphasis on energy efficiency as well as general cost-consciousness. In response, new pot designs and casting methods were developed and resulted in a 15- to 20-percent improvement in energy efficiency.

When the 1980s are entered onto the pages of aluminum industry history, they will likely be seen as the years of both consolidation and development. During the early part of the decade, some old smelters were shut down or replaced and producers trimmed their workforces. In more recent years, output has been remarkably free of major strikes and technical or political problems. Furthermore, the late 1980s saw new smelters come on-line and ushered in an era of developing new products, such as automotive parts, and improving existing products, such as beverage cans that can be made with thinner aluminum.

Industry observers are hopeful that the 1990s will be growth years, with continued cost reductions and product developments. Many look forward to a generally less volatile global economy compared to the last decade, pointing to reduced political tension between the East and the West, the weakening of the cartels, lower and steadier oil prices, and lower inflation rates as signs of a promising decade. Furthermore, the cohesiveness and quick response of central bankers throughout the world likely will keep currency fluctuations within a manageable range, and inter- and intraregional free trade is expected to improve productivity and efficiency. AR of this is good news for the aluminum industry.

Can Auto Demands Be Met?

Despite the promise of a prosperous future, however, investors within the industry apparently doubt aluminum's ability to capitalize on its opportunities, which will require significant investment to be fully realized. For example, with automakers indicating that they could triple their use of aluminum as part of the effort to reduce vehicle weights, there is a need for expansion-and financing. Although most of the additional aluminum that could be needed could eventually be supplied from a secondary stream, increased primary capacity would be required until the secondary pipeline was full. The vast sums of capital needed for such an undertaking may not be available unless the economy quickly rebounds from its current lows. Furthermore, if aluminum were substituted for some steel in the manufacture of auto body parts and other sheet products, rolling capacity would have to be increased, again necessitating significant capital expenditures.

At least part of the explanation for this investment hesitancy is that there is still considerable debate over which material will best serve automakers' needs: aluminum, magnesium, plastic, or steel. And regardless of how the contest is decided in the short term, all industries know that no material is home free forever in any automotive application.

While the competing materials are vying for a solid position with the auto industry, the onus is put on automakers to choose. Not surprisingly, the aluminum industry would like the auto industry to make the clear choice before it makes any financial commitments. The auto industry, on the other hand, is expecting aluminum producers to prove themselves and earn a position as preferred material suppliers.

The continued "slugging it out" between steel and aluminum for a better position with the auto industry likely will simply delay the automakers' decision. Conversely, a strategic alliance between the steel and aluminum industries--not out of the realm of possibilities in this era in which Detroit's "big three" are shifting gears toward cooperation and Alcoa and Kobe Steel ink an agreement--could speed up the process.

Their common purpose is clear: to satisfy the needs of their customer, the auto industry. The common denominator is the process (rolling or casting) rather than the material. In other words, the alliance could propose to the auto industry an optimum steel/aluminum combination on the basis of rolling characteristics.

While the industry ponders its position in the automotive world, it's also facing oversupply, which may be traced in part to a “competition” between secondary and primary aluminum during recessionary periods. In most cases, secondary metal has a lower fixed cost but a relatively higher variable cost than primary metal--a condition that, during times of negative cash flow and under strict economic analysis, would call for reducing production at (or even closing down) secondary facilities. Paradoxically, during recessionary periods, the price of scrap drops, diminishing the rationale behind reducing secondary production. Socioeconomic and environmental issues add to the equation Producers must examine in deciding what capacity to close.

Together, these factors have made the industry increasingly less flexible m adjusting production to changing demand, which, naturally, results in inventory buildup and pushes prices further downward.

A related problem of balance between aluminum supply and demand requires close scrutiny. By the mid-1990s, the Americas are expected to have close to 10.7 million tons of primary capacity, with total consumption of primary and recycled aluminum predicted to be around the same level. During the same period, European primary capacity is expected to be approximately 4.4 million tons, while total demand should be about 7.7 million tons. This implies that primary and/or recycled metal from the Americas will be sent across the Atlantic to make up for the European supply shortfall. And as long as the European Community's duty on primary aluminum exists, the scrap will have a cost advantage.

The big question: Does it make sense to ship secondary metal to Europe , secondary metal American industry has worked so hard to capture?

Growth in the aluminum recycling industry has also led to increased sophistication in production processes, which have enabled secondary producers to offer products whose quality is as good as that of products from primary smelters.

More than 60 percent of all aluminum products used today, in fact, can be produced from scrap, although only 25 percent of the total supply is in secondary form. In other words, a considerable amount of p metal is used in products that could be made with recycled metal. Furthermore, primary smelters are increasingly simply becoming suppliers of remelt ingot. This is not only demotivating to the smelter managers and employees, but has socioeconomic implications since the primary smelters are being labeled as suppliers of non-value-added products and are, therefore, employing fewer and fewer people.

The challenge for the primary aluminum industry, therefore, is to take advantage of the unique purity value in prime. It's time for the industry to develop products that make full use of the purity of primary aluminum and command the right price.

The final dilemma confronting aluminum is that, despite its diversified markets, energy efficiency, and reduced costs, the industry has been unable to protect its earnings from price swings. While no one argues that boom conditions in the economy last forever, the fact is that an industry whose principal product commands volatile prices at various stages in the economic cycle is a high-risk investment. Many in the industry blame the LME pricing structure for this; indeed, many in the investment community seem to believe it.

The simple fact is that the LME is here to stay and the industry must find a way to protect its earnings by influencing prices through a better balance of supply and demand throughout business cycles.

How will the industry overcome these challenges? The quandaries are complicated, so there are no easy solutions. What is required is a thorough and impartial analysis of the present situation and future prospects, from the point of view of both the aluminum producers and the users. From this, the industry should be able to formulate a long-term action plan to resolve its dilemmas.•

There are four major challenges currently confronting the aluminum industry, but none is insurmountable and all hold promise for future opportunities.