November/December 2009
Aluminum scrap consumers face serious setbacks in their key markets, persistent overcapacity in their sector, and ongoing competition from global scrap buyers. Is there any cause for optimism? Yes, they say, but not in the short term.
By Kent Kiser
How would North American aluminum scrap melters rank the first half of this year's aluminum market on a scale of 1 to 10? Jim Butkus of secondary aluminum producer Audubon Metals (Henderson, Ky.) charitably rates it below a 5. It was "a very bad time to be in our business," he says. Or as Stephen Moss, of aluminum scrap brokerage firm Stanton A. Moss (Bryn Mawr, Pa.) puts it, "The first half of the year was about as bad as it can get."
Fortunately, the second half of 2009 has brought some recovery, prompting aluminum scrap consumers to give recent months a higher rating—maybe a 6. "The last couple of months have been very good," Butkus says. "They will get us out of what was going to be our worst year. We'll salvage at least a mediocre year." Stanton Moss of Stanton A. Moss concurs. "If we could end the year and break even or make a little profit, we'd be happy. I think that's what the whole industry is feeling."
"Mediocre" and "break even" are a far cry from the previous five years, when many aluminum scrap melters enjoyed some of their best years ever. From 2004 to 2008, "we were on somewhat of a roll," Butkus says, likening the market's rise to the steady climb at the start of a roller coaster. What market participants didn't know was when and how steep the descent would be. The end of 2008 brought a harrowing plunge: Secondary aluminum production fell from 4.1 million mt in 2007 to 3.4 million mt in 2008, according to industry estimates (see Table 1), and analysts expect 2009 production to be even lower. That's why most melters would be happy with "mediocre" at this point. With the economic outlook murky, melters are uncertain of what twists and turns are still to come. Will there be another dip? Another climb? A flat stretch? Much of the answer hinges on the two largest markets for secondary aluminum—automotive and housing.
Market Meltdowns
The truth about the automotive market is that it was showing signs of decline years before the recent meltdown. North American light vehicle production reached its peak in 2002 and has been slipping ever since (see Table 2). From 2002 through 2008, production fell 23 percent, from 16.4 million vehicles to 12.7 million vehicles. In 2009, estimates are that North American automakers will produce 10.3 million vehicles, which would represent a 37-percent decline from the 2002 peak, according to J.D. Power and Associates. Most of this decline has occurred in the past two years, with production slipping 16 percent in 2008 and a projected 19 percent this year.
Aluminum scrap consumers agree that the Car Allowance Rebate System ("Cash for Clunkers") program boosted auto sales in August, bringing them some much-needed demand. "The program worked down car inventories in the market, so we saw a substantial rush to build new product," Butkus notes. "We've seen a pretty good turnaround since July." The problem, of course, is that the program was just a temporary measure, one that could hurt auto sales in 2010. "All it did was move buyers from next year into this year," a buyer for a Midwest smelter says.
Some aluminum scrap melters don't expect North American annual auto production to ever surpass the 16-million mark again. "That's going to be an impossibility," the smelter rep says. Others are more optimistic, though they concede that it all depends on the U.S. unemployment situation. "If you get people working, we can get back to 16 million cars," Stanton Moss asserts. "Until this country can get back to low unemployment, I don't think you'll see cars being bought or sold."
The housing market is another significant destination for secondary aluminum in products ranging from light housings to gas meters to siding. Based on U.S. housing starts (see Table 2), the market peaked in 2005 at 24.9 million units, but it has declined precipitously in recent years due to the subprime mortgage crisis. In fact, the market's decline has picked up speed in each of the past three years, dropping 13 percent in 2006, 26 percent in 2007, and 33 percent in 2008. Based on figures through August, the U.S. market is on track to end this year with about 6.6 million housing starts, which would be a 39-percent year-on-year decline.
Even as residential construction seeks a bottom, aluminum melters worry about the other shoe dropping—the commercial real estate market. If such a decline happens, one bright spot could be demolition projects resulting in greater scrap generation, notes Stephen Moss, though such work might not lead to any new construction, "just new parking lots or empty fields for now."
The same story has played out in U.S. shipments of major appliances (see Table 2), which include aluminum in motor housings and other components. From their peak in 2005, shipments declined 15 percent, to 39.8 million units, in 2008, and they have continued that slide in 2009. Through August, U.S. shipments were 18 percent lower than the comparable period in 2008. This downtrend could slow or reverse, however, if the federal government's new Cash for Clunkers-type program for appliances has the desired effect. In the Energy Efficient Appliance Rebate Program, participating states will offer $300 million in federally funded rebates to consumers who purchase new energy-efficient appliances.
Capacity and Credit
In addition to the sobering dynamics of secondary aluminum's key markets, the smelting sector continues to be plagued by overcapacity. "It has always been our worst enemy," Butkus says. "Everybody's sitting on excess capacity." Many smelters have extra, idle furnaces that they can fire up whenever the market dictates. Though some operators have closed their doors in recent years—including Arkansas Aluminum Alloys (Hot Springs, Ark.) and Joseph Behr & Sons (Rockford, Ill.)—they didn't remove enough tonnage to balance the market. Equally exasperating, it's common for a smelting operation to go out of business, only for a new owner to revive it, thus perpetuating the glut, Stanton Moss points out.
In addition to paring some capacity, the recent market downturn has sent other reverberations up and down the aluminum supply chain. One significant repercussion was Aleris International's Chapter 11 bankruptcy filing in February. The Beachwood, Ohio-based company is among the largest players in the aluminum niche. Though the company is still alive and reorganizing, its bankruptcy was "a big scare for everybody," Stanton Moss says. Several die-cast suppliers to the automotive industry also went bankrupt this year, removing some significant buyers of secondary aluminum alloy products from the market.
Many customers' shaky financial status has forced aluminum scrap melters to reassess their credit policies and reduce their exposure by deciding which customers are worthy risks going forward. "It's a huge issue," Stephen Moss says. Butkus agrees: "It's as big a problem as we have today." The Midwest smelter rep says his company has responded by being "very, very, very conservative in terms of whom we give credit to." In fact, his firm has stopped selling to some customers due to their perceived financial instability. His company expects its sales to be down about 25 percent this year, he says, and about 10 percent of that decrease is tied to its choice not to sell to certain customers.
Compounding these financial problems for melters is the increasing difficulty in finding credit insurance. The result is that many melters "will be forced to do business without protected receivables," Butkus says. "If you can't get credit insurance, you're substantially naked with your customers." That makes melters vulnerable if certain customers go bankrupt. "As things get more dog-eat-dog, I think you'll see more people get hurt," he says. Melters can respond, in part, by making sure their terms and pricing reflect the rising risks. Also, Butkus advises, "Always do business with the leaders of the industry. That has served us well."
Exports and Other Challenges
Given the steep drop in the generation of and demand for aluminum scrap due to lower manufacturing activity, it isn't surprising that scrap availability is "still generally very tight," Stephen Moss says. "The volume of scrap has shrunk along with demand. It's not readily available everywhere."
Since 2005, scrap availability has been tight for another big reason—China, which significantly ratcheted up the competition for U.S. aluminum scrap. "Scrap availability and prices are often a function of what China is doing," the Midwest smelter rep says. China has driven the trend of steadily increasing U.S. aluminum scrap exports (see Table 3), which rose 243 percent between 2000 and 2008. China's purchases of U.S. aluminum scrap grew 523 percent from 2000 to 2008, boosting its market share from 28 percent in 2000 to 50 percent in 2008. Its purchases reached their peak in 2006, when it claimed 62 percent of U.S. aluminum scrap exports. Particularly notable for U.S. aluminum scrap consumers is that China has focused its purchases on secondary smelting grades of aluminum scrap, not on beverage cans or remelt secondary ingot. "China started out buying the low end of scrap, but then it started competing on the more mainstream smelting grades," Stephen Moss notes. China's imports of smelting grades jumped 354 percent from 2000 to 2008, giving North American scrap consumers stiff competition for such feedstock.
Though China is the biggest influence on the U.S. aluminum scrap export market, it isn't the only factor. Two other Asian nations—Taiwan and South Korea—also have increased their consumption significantly since the start of the new millennium. Taiwan increased its imports of U.S. aluminum scrap 961 percent, from about 30,278 mt in 2000 to 321,136 mt in 2008. South Korea boosted its imports more than sixfold in the same period, from 34,085 mt in 2000 to 222,742 mt in 2008. Together, China, Taiwan, and South Korea purchased 73 percent of all U.S. aluminum scrap exported in 2008—more than double their combined share of 34 percent in 2000. Several other Asian nations, including Thailand, Japan, India, and Vietnam, likewise have increased their U.S. aluminum scrap purchases hundreds, even thousands, of percent since 2000.
The trends are obvious: More U.S. aluminum scrap is heading offshore every year, and more of it is ending up in Asia. For scrap sellers, this is a positive trend because it keeps both scrap demand and scrap prices up. For North American aluminum scrap consumers, the trend has forced them to compete on price with Asian buyers and/or seek out scrap grades that are less interesting to international buyers.
Aluminum melters also must contend with consolidation among domestic scrap dealers. In the past, the Midwest smelter rep observes, "I was talking to 200 dealers at any point. Now it's down to substantially less than that." As fewer scrap firms gain control of more and more tonnage, they could exert greater pricing power and market control that could reduce the scrap options for buyers.
Many aluminum melters also have mixed feelings about the North American Special Aluminum Alloy Contract, or NASAAC, which the London Metal Exchange introduced in 2002. On the plus side, the contract gives market participants the opportunity to hedge their price risk on an internationally accepted metal exchange. It also gives smelters a transparent price reference and a market of last resort—that is, a place to sell their metal during challenging times. That warehousing feature also can be a drawback in that end users can buy metal from the LME for physical delivery. "There has been a pretty significant drawdown in NASAAC material this year," Butkus says. "That's a serious competitor, and we smelters need to recognize it as such." NASAAC stocks declined 22 percent in the January-September period, from 245,420 mt to 191,380 mt, according to LME figures. Other smelters assert that the NASAAC contract is simply a financial tool for hedge-fund traders, one that doesn't reflect the market's supply-and-demand fundamentals. In addition, Butkus maintains that the NASAAC price "doesn't accurately reflect the price to produce a pound of 380 metal." Die casters that contract to sell their products based on a formula related to NASAAC "usually have a very difficult time performing profitably to that formula," he points out.
Finding Some Silver Linings
Faced with the recent market challenges, can smelters point to anything positive? At least one economic factor has improved markedly for them in 2009: energy prices, specifically for natural gas, which many melters use to power their furnaces. "Three years ago, gas was $15 to $17 per million Btus; now it's $3," the Midwest smelter rep notes. "That's a huge gain for us." At Audubon Metals, gas prices have dropped 60 percent since the start of the year, Butkus says. Melters now can buy cheaper gas on the spot market or lock in lower prices for the coming year, both of which help their bottom line.
Even the recent painful adjustments of laying off employees and downsizing have turned out to have their positives for aluminum scrap consumers. "We've learned how to do more with less," Butkus says, noting that his smelter was able to produce almost as much as last year in the recent busy months with "substantially fewer people." He sees similar results at other smelters. "People have learned how to acclimate and adjust," he says. "The ones who come out of this will be able to run their operations in a much leaner, more proficient manner." The Midwest smelter rep adds, "If you've got a low-cost operation, you're going to be more secure than others. The other key ingredient is having the systems and people that can manage change quickly."
Some smelters—such as Heartland Aluminum (Warren, Ind.)—have found innovative ways to turn the tough times to their advantage. The company reportedly paid pennies on the dollar to buy a pair of reverberatory furnaces that will triple its capacity. The firm is erecting a new building to house the furnaces and adding state-of-the-art equipment to feed them efficiently. Heartland also is "actively investing in research and development in making new products out of aluminum," says Michael Haggerty, the firm's president.
Hoping for a Seven
Heartland's R&D efforts aside, most smelters see no big market innovation on the horizon for secondary aluminum, though the ongoing lightweighting and "greening" of cars could boost demand for the metal. Looking ahead, the consensus view is that the melting market won't return to the lows seen in the first half of 2009, but it won't return to the highs of 2008, either. "It's just going to be a blend of mediocrity, unfortunately," Butkus says, "and we'll still have to focus on cost-cutting."
Melters' hopes rest substantially on the return of the automotive and housing markets and a reduction in the unemployment rate. "The reality is that people have to start spending money again," Butkus says. "Maybe statistically the recession is over, but our psyches have not changed. People are still worried about their jobs."
Haggerty is more optimistic. "Once this is all over with, I think there's going to be a lot of opportunity for the people who are left. There are going to be fewer competitors in the field." Stanton Moss also sees a "good" 2010, though he concedes that he doesn't expect any notable improvement until "maybe the second half of next year." So, on a scale of 1 to 10, what will 2010 be like? It will be better than 2009, Moss says, "but I don't see any 8's or 9's. If we can get to a 7, I think we'll be happy. I think we have a chance of getting there." •
Kent Kiser is publisher and editor-in-chief of Scrap. Marc Hequet, a Minneapolis-based writer, contributed to this article.
Aluminum scrap consumers face serious setbacks in their key markets, persistent overcapacity in their sector, and ongoing competition from global scrap buyers. Is there any cause for optimism? Yes, they say, but not in the short term.