“Crisis brings opportunity and change” is one of the most widely used expressions in the financial world, but in the case of the Brazilian aluminum industry, it sums up the current situation perfectly. The “change” referred to would require returning to the situation of only a few years ago.
It’s not news that Brazil is enduring the worst economic depression in its history – the country’s GDP shrunk 4% in 2015 after staying flat in 2014, and is expected to fall another 3% this year. How this crisis has impacted the local aluminum demand is truly astonishing.
The recession (deepened by the political turmoil which redounded in the impeachment of Dilma Rousseff) severely harmed activity in the automotive and construction sectors, the second and third largest aluminum consuming sectors in Brazil, only behind the packaging segment.
To understand the new dynamics it is important to be aware of the past situation. It was mid-2013 when S&P Global Platts began receiving calls from market participants warning that smelters would soon start to close in Brazil due to the high smelting costs leveraged by the hike in energy prices, and that the market needed a local premium reference for primary aluminum. At that time, local P1020 production was already showing signs of weakness, imports were stabilized and Brazil has established itself as a net exporter of ingots.
A year later in 2014, soon after Platts launched the assessment, the country quickly became a net importer of primary aluminum. With domestic energy costs reaching record highs, with Novelis and Alcoa closing three smelters in total, imported metal started driving supply,while exports began drying up.
By 2015,only producers left were CBA, which reduced its output dramatically (and boosted its own-generated energy sales) and Albras, which sent half of its production to Japan owing to the contract between Hydro and the Nippon Amazon Aluminium consortium, who jointly control the plant.
By 2016, the recession had deepened causing several industry closures and reducing energy consumption. At the same time, a much stronger than expected rainy season increased the utilized capacity of domestic hydroelectric plants, which generate around 70% of the country’s energy.
Lower demand, coupled with abundance of hydroelectric power pushed electricity costs downwards, while the devaluation of the Brazilian Real following the economic crisis increased the cost competitiveness of domestic power in dollar terms. With the bulk of international trade priced in dollars, exporting domestic aluminum become more viable once more.
More than an “opportunity” or a “change”, this new scenario of devastated domestic demand and low smelting costs meant just one thing: it was time to export again. While domestic premiums remained attractive compared with those in other markets such as the US, Europe or Japan, smelters saw a benefit in selling at a low margin rather than stockpiling product, carrying the metal, and waiting for a buyer. The attractiveness of these carry trades was also reduced due to a tighter contango on the LME, which has been prevalent throughout 2016.
Since energy prices in the regular spot market have remained below $25/MWh for most of this year, it is reasonable to assume that Brazilian smelters are not really concerned about plunging premiums. However, a recent rise in power costs – with the spot market trading at around $45/MWh in September – could once again put Brazilian exports in jeopardy.
Brazil’s paradigm has once again changed, raising its export profile – and pushing imports aside as the domestic premiums offered by producers are now below import parity, making Brazil an unattractive market for international traders. The net importer label just doesn’t fit anymore in a lower power cost environment.
If energy drops again to around $25/MWh, it would make sense to think that some of the closed smelters could be reactivated next year, be it with an eye on exports, the domestic market – or a mixture of both. The situation favors smelting, and proof of this can be seen in the CBA having elevated the use of installed capacity since May, with Brazil’s output outperforming last year’s figures month on month.
As of 2009, Brazil had seven active smelters producing 1.5 million mt of primary aluminum. Compare this with 2015, when only Albras and CBA remained active in the market and with production levels at 772,000 mt — its lowest in decades, then the opportunity for changing this downtrend is open once again.