September/October 1994
Increasing demand and production cuts hold promise to right a glutted aluminum market after a several-year distortion attributed largely to Russian exports. Having demonstrated their ability to warp the world market, where will Russian aluminum producers fit in the picture once the dust settles?
By Jeff Borsecnik
Jeff Borsecnik is an associate editor of Scrap Processing and Recycling.
When the Iron Curtain began to crumble, it raised hopes for new demand for Western World metals. Since then, however, basically the opposite has occurred: Russia and the other former Soviet republics, rather than upping their demand as many had anticipated, have instead become huge suppliers of metals-particularly aluminum-to the West.
To get an idea of how huge those Russian aluminum supplies have been, consider this: In the United States, which isn't nearly as geographically convenient a buyer as Western Europe, aluminum has been by far the largest import from Russia in terms of customs value, accounting for about half a billion dollars last year.
And the volume has grown in 1994, but change looks to be in the works.
Problems on Top of Problems
The flood of Russian aluminum to the West arrived at perhaps the worst possible time. Western aluminum producers had done some major expanding in the late 1980s in anticipation of new markets, but were soon confronted with the beginnings of a worldwide economic recession. In response, metal values plummeted, with the annual average price on the London Metal Exchange (LME) dropping from $1.18 a pound in 1988 to 75 cents in 1990.
And then came the metal from Russia. With the New Year's Day 1991 breakup of the Soviet Union, military consumption of aluminum there all but stopped and the civilian economy-and metal demand fell apart. On top of these conditions, inflation and price controls were keeping domestic metal prices extremely low--all at a time when Russian aluminum producers were desperate for cash to meet payroll and purchase raw materials, energy, and transportation services. So the producers began to seek new outlets for their materials, and found it in the already-oversupplied export market.
As a result, aluminum inventories on the LME-always a ready buyer-grew geometrically: 657 percent between the beginning of 1991 and the start of 1994, with June of this year showing the first break in the trend. "Never before has there been an almost-overnight surge on the supply side of the equivalent of 10 percent of total world capacity, primarily from a single source like Russian exports, due to such an extraordinary event as the end of the Cold War," moaned Richard G. Holder, chairman and chief executive officer of Reynolds Metals Co. (Richmond, Va.), commenting on the situation at the end of last year.
Not surprisingly, Western producers pressed for limits on Russian exports, and the Russians demurred. At the start of this year, however, Russian producers signed a "memorandum of understanding," agreeing to trim 500,000 metric tons (mt) from their production during 1994 in exchange for 1.5 million mt in cuts from the major Western producers during the same time period plus promises of technical assistance in modernizing their aged facilities. The agreement calls for additional cuts on both sides in 1995.
Stemming the Flow: The Early Results
So have the cutbacks worked? According to Russian data, the country's aluminum exports were down 22.5 percent in June 1994 compared with June 1993 or, put another way, 30-percent lower in June than the monthly average for the January-through-May period of this year, notes Stewart Spector, head of Spector Reporting (Boynton Beach, Fla.), which analyzes aluminum markets.
But this doesn't necessarily mean that Russia's promised production cuts have come through. Bruno W. Boehm, head of the metal trading department of Alusuisse-Lonza Trading (Zurich, Switzerland), estimates that the Russians had cut only 100,000 to 200,000 mt by the end of July, with much of even this likely the result of technical production problems.
In defense of the Russians, however, Boehm notes that much of their aluminum is now produced in tolling arrangements with foreign owners of alumina, and this portion of production simply cannot be cut. This is especially true, he points out, in those cases in which the alumina owners provide food and other vital material to smelter communities.
Besides, adds Peter Merner, proprietor of Merner Research (New York City), whether they've cut 100,000 or 500,000 mt, it's "'not enough to worry about" in a world market of more than 20 million mt.
On the Western side of the deal, cutbacks have also been slow in coming, according to various observers. Spector, for instance, points out that some producers have found themselves temporarily short of metal as a result of greater-than-expected recent demand, pressing them to "phase down" production rather than going forward with the immediate cuts assumed under the memorandum.
In any case, growing demand and rising prices this summer have eased the pressure on both sides, notes Christopher Stobart, director of the CRU Consultancy Group (London), which analyzes metals activities in the Commonwealth of Independent States. Plus, he adds, the memorandum of understanding is a voluntary pact with no enforcement provisions. "You can't blame [the producers] for not cutting back further if they are happy with the price," he says. "If I were in that position, I might keep producing."
Merner takes a similar point of view, noting that the urgency to cut production is gone thanks to improving consumption levels today (which he suspects are even higher than have been reported) and the "terrific outlook” for demand ahead. "Demand is at a high enough level in the West that, assuming the recovery of Western economics stays on track, people will be delighted to have a million or so tons of Russian aluminum annually for the next few years."
Spector also foresees a time in the more distant future when, combining Western World economic growth with coincident growth in China, Eastern Europe, and perhaps the Middle East, "the West will be begging for Russian metal, which we may not be able to get."
But back to today--and the huge quantities of aluminum still held in LME warehouses. Don't these stocks--which were hovering around 2.5 million mt in early August--keep the need for cutbacks going? Fred Lonner, principal of Fred Lonner & Co. Inc. (New York City), thinks so. Despite the apparent turnaround in consumption, he says, "For the sake of the industry, it's important that LME stocks be reduced before production is turned up."
Merner agrees these stocks are large, but he notes on the other hand that producer inventories "are adequate but nothing more" in light of current demand. Furthermore, he figures, LME holdings could fall by as much as 2 million mt by the end of next year.
Opinions vary on the likelihood of such a dramatic stock reduction. Stobart, for one, calls the prediction "extreme." Boehm, on the other hand, says that significant cuts in LME inventories are possible if economic growth is sustained and the producers are disciplined about sticking with pledged production cuts.
If worldwide aluminum consumption grows at a pace of 3 or 4 percent through the end of 1995, for example, inventories could drop by 1.5 million mt, he says, adding the caveat that aluminum exports from former Eastern Bloc nations (mostly Russia) would have to be limited to 1.2 million mt and Western production held at the levels envisioned by the memorandum of understanding. Still, he calls this picture "optimistic" and suggests a more likely scenario shows Eastern exports at 1.5 million to 1.6 million mt and Western production up some, resulting in an LME stock reduction of perhaps 1 million to 1.2 million mt by the end of next year.
The Domestic Consumption Factor
Another possible key to the future balance of world aluminum supply and demand lies in the revival of domestic aluminum consumption in Russia. This, however, is no near nor sure thing.
The Russian economy is troubled, at best. To put it statistically, the country's gross domestic product fell about 15 percent between 1992 and 1993, according to the U.S. Department of Commerce. Inflation, though down to 8 percent per month in June, has raged much worse over the last few years. And industrial production reportedly fell about 25 percent during the first third of this year compared with the same period of 1993. More importantly, fundamental systems of supply, payment, and distribution have been disrupted.
Nevertheless, there are signs of improvement in various sectors, including those that consume aluminum, according to firsthand reports. "If you go to Russia now, the private-sector economy is very robust," says Spector. "A year ago, domestic fabricators had no cash to buy ingot, but now they're looking for aluminum." The problem is, says Merner, consumer markets for aluminum there are underdeveloped and the quality of many manufactured goods is considered low, so the Russians are likely to import any consumer goods they can. Thus, Russia's best hope of rising aluminum consumption could come from increased exports to the West of semifinished products, as former defense factories try to find ways to keep workers employed, notes Boehm.
Still, if world aluminum prices continue to improve, while it should boost Russia's foreign exchange earnings, it also could slow growth in domestic consumption in markets where aluminum competes with materials like wood and steel, notes Boehm. In fact, he says, aluminum may be "too expensive for Russia" should prices reach the $1,600 to $1,800 per mt he expects in the next couple years.
Put it all together, and it could take about I 0 years before there is a resurgence of "significant" Russian consumption, Boehm predicts. Others agree it will take time, though perhaps not as much as a decade. Says Randolph N. Reynolds, chief executive officer of the international division of Reynolds Metals Co.: "I think you'll see substantial changes in the next three to five years."
Forces to Contend With
Russian aluminum makers face many troubles beyond collapse of their traditional markets and Western reprobation over their exports. Here's a look at variables that may determine how well they can compete in the long run.
Energy. Russian producers are struggling with rising prices for energy-among other inputs and services. "Energy costs in Russia seem to be going up and getting closer to world averages," says Pat Plunkert, aluminum specialist with the U.S. Bureau of Mines. For some of Russia's older, smaller aluminum smelters, especially those located in western Russia, this could be their death knell.
Siberian smelters, on the other hand, which Boehm estimates account for about 80 percent of the country's 3.2 million-mt capacity, benefit from cheap hydroelectric power. Indeed, he suggests, the key to competitiveness in the world aluminum market in the long ten-n will be "the energy price in the West vs. the energy price in Russia." Boehm points out that, in contrast to most of the industrialized West, the "opportunity cost of power in Siberia is zero."
Raw Materials. "Getting bauxite and alumina is a problem for the Russians, and I think it will be a growing one," says an aluminum industry consultant active in Russia, noting the country currently imports about 65 percent of its alumina not only from its neighbors Kazakhstan and Ukraine, but also from Western countries such as Australia and Ireland. Russia's own alumina plants are becoming "highly uncompetitive in the world as energy prices rise," according to the Department of Commerce, which predicts that these facilities will never be able to compete with the West if they must pay full energy costs. Still, for the time being at least, tolling arrangements have helped guarantee alumina supplies.
Transportation. The painful switch to a market economy has caused a "tremendous increase" in transportation costs, which is a big concern considering Russia's reliance on imported alumina and the vastness of its own borders, says Boehm. Furthermore, the country is said to have a limited supply of railcars.
Pollution problems. The Russian smelters face significant environmental problems and most, if not all, would be forced to close if existing environmental standards-reportedly among the toughest in the world-would be enforced, according to the Department of Commerce.
Technology. Most Russian smelters employ dated technology and will require substantial investments in order to improve the quality of their output, limit environmental degradation, and, perhaps, just maintain production. In fact, Horst Peters of the German aluminum maker VAW estimated several years ago that necessary upgrades to Russia's four biggest smelters alone would cost $6.6 billion. Still, as Boehm puts it, "the Russians will continue to produce until their smelters fall apart," and their engineers have proven themselves "very able people."
Capital. Underlying many of these other factors is the simple need for cash, the prospects of which look better in light of recent aluminum demand and prices. If consumption and prices keep improving, says Spector, "the Russians are going to make an awful lot of money." But, he adds, there's always the question of whether that cash will be put back into the smelters. (Some suspect substantial amounts of cash harvested from the initial outpouring of Russian metal never made it home.)
Still, even if the Russian producers begin turning a real profit, many believe their success in the long run relies on outside financial assistance. To date, however, while several Western producers have undertaken technology-transfer projects with their Russian counterparts, little Western capital has been pledged to aluminum projects there. And CRU's Stobart suggests this situation isn't likely to change, as most Western producers are likely to favor less-risky investments in other parts of the world.
To deal with this predicament, Russia is making various efforts to attract foreign investors, including a program called the Defense Enterprise Fund sponsored by the U.S. Department of Defense and supported by the Russian government to help convert Russian defense-related facilities to consumer product manufacturing plants. The Russian government is also considering various incentives to encourage foreign investment, such as tax holidays and the ability to purchase land outright.
If Western producers don't take advantage of these programs, Asian participants might, potentially stepping in with substantial capital for Russian producers, suggests one observer.
Political issues. Perhaps the ultimate factor determining the future role of Russian aluminum will be political developments. Although the country’s political stability appears to be improving and many assume the evolution toward a market economy will continue, this is not assured.
A Significant Player?
While the immediate disruptive effects of Russian exports may be on the wane, they won't be forgotten anytime soon. The explosion of Russian aluminum clearly taught the world that the metal is a global commodity and even domestic events in one country can have broad repercussions.
It also revealed that although Russia doesn't promise to be a major consumer of Western World aluminum products anytime soon, the former Soviet republic will continue to be a major force in aluminum. "The Russian aluminum industry will be a very significant player indefinitely," says Merner. "The producers there have some infrastructure problems to deal with, but if you are an optimist about Russia, you should be optimistic about Russian aluminum."
Blame It on the Welfare System
Politics and economics weren’t the only forces behind Russia’s aluminum export surge. And they aren’t the only forces Russian metal producers must continue to struggle with in their transition to a market economy. The producers’ social responsibilities to their “company towns” are equally important.
Russian aluminum companies, explains Alusuisse-Lonza’s Bruno Boehm, act much like a city mayor in the West, providing all-encompassing social services to their communities. “The company have people in charge of providing food for company-owned shops, warehousing people looking for the coal to heat houses, plus the whole housing structure,” he says, noting the teachers, doctors, and bus drivers are also on the company payroll.
A related issue the Russians must contend with is supporting large work forces even as their production drops and costs rise. Certainly the political pressure to keep even facilities that don’t make economic sense operating for the sake of the workers and the larger community of dependents has been and continues to be strong. For a Western analogy, suggests one analyst, consider the opposition from local communities in the United States to closings of unnecessary military bases.
Though they might wish they could crawl out from under these obligations, in most cases there is no alternative to the company social support network for the local community. “They don’t have the tax structure to turn over social obligations to the cities,” notes Randolph Reynolds of Reynolds International, “so it’s going to be a slow process.”
Part of the answer may be found “as the country develops a service sector--which is nonexistent--that’s going to provide a lot of jobs,” says another aluminum analyst. This will, however, entail large-scale “economic displacement” and a sort of historic reversal of the population movement during industrialization under Stalin, he suggests.•
Increasing demand and production cuts hold promise to right a glutted aluminum market after a several-year distortion attributed largely to Russian exports. Having demonstrated their ability to warp the world market, where will Russian aluminum producers fit in the picture once the dust settles?