Jun 03, 2023

Why history provides a cautionary tale for aluminium

High energy costs have been the downfall of aluminium smelting capacity on and off over the years in the United States, and they led to its elimination in Japan.

Now a fresh energy crisis is threatening to unravel what is left of aluminium production capacity in Europe at a time when the world is working to decarbonize and needs more of the low-carbon, infinitely recyclable metal, not less.

It is a pattern long recognized by Dick Evans, who recently retired as chairman of downstream producer Constellium and who spent decades at Kaiser Aluminum before joining Alcan and leading it through its acquisition by Rio Tinto.

"Over my 55 years in the industry, there's been one steady long-term trend, which is aluminium production capacity moving away from developed areas to the areas that have the low cost, long-term, secure power sources," he told Fastmarkets in an interview.

The energy-intensive nature of producing aluminium means that regions with low-cost hydroelectric power or natural gas have an advantage.

"It's not a straight line as there are crises cyclically, which is when you get the capacity shake-out and then the industry is stable until the next shake-out. That's when the real curtailments happen. But if you look long-term, and look through the noise, that's been a continuous trend," he said.

Although the cause of the current energy shock - Russia's invasion of Ukraine - is different compared to past cycles, Evans noted that the market impact is the same in that oil and gas prices have gone through the roof, followed by power, just as they did in the four prior decades.

"As with previous cycles, the most vulnerable aluminium smelters are eventually permanently closed, while the more modern ones are often curtailed to likely reopen for a few years until the next cycle," he added.

That was the pattern in the US, which has seen the slow but steady eradication of its aluminium smelting industry over the past several decades.

The data says it all. According to the International Aluminium Institute, world production of primary metal in 1973 was 12 million tonnes, of which the lion's share came from North America with 5.03 million tonnes. China, the Middle East, and Russia did not produce aluminium at that time.

Fast forward to 2021, and world primary production had grown to 67.2 million tonnes, of which almost 39 million tonnes was produced in China, 5.9 million tonnes came from the Middle East, and over 4 million tonnes was produced in Russia and Eastern Europe. Over that same period, North American production had dropped to 3.8 million tonnes, even despite the addition of hydropower-based smelting capacity in Canada, which accounts for over 3.0 million tonnes.

The last smelter to be constructed in the US was in 1980, when aluminium producer Alumax and Clarendon, a unit of Marc Rich, built the Mt Holly plant in South Carolina. That plant, one of the few left in the country, is now owned by Century Aluminum and operating at 75% of its 229,000-tonne-per-year capacity.

In the 1980s, 10 US smelters located across the states of Alabama, Arkansas, Louisiana, Texas and Tennessee closed. More followed the next decade, cutting the number of smelting operations to 23 plants by 1998. Now just two - Alcoa's Massena West and Century Aluminum's Sebree - are running at full capacity and the remaining five – which are Mt Holly, plus Hawesville, Intalco, Warwick and New Madrid - are either fully curtailed or have seen capacity cuts.

It is a trend that is now accelerating in Europe, where Brussels, Belgium-based industry association European Aluminium estimates that in under a year, Europe's aluminium industry had to idle over 900,000 tonnes of its primary production due to soaring energy costs.

In its heyday, US smelting capacity was clustered around the country's Pacific Northwest region, a relic of the growth spurt seen during World War II when the metal was considered strategic for the fabrication of military aircraft.

When the war ended, there was a big push in the following two decades to find new demand sources – and so flourished the aluminium can, as well as foil, skis, tennis racquets and wheels made from the metal. That is, until the oil shocks of the 1970s and 1980s started to spoil the party.

The two most serious oil supply and price shocks began in 1973 and 1979, triggered by the Fourth Arab-Israeli War and the Iranian Revolution respectively. The impacts of these energy crises were felt by aluminium producers around the world, and it was then that the first real shift away from fossil-fuels began, particularly by operators in the US and Japan.

"Although those with long-term energy contracts could ride the crisis out, the US aluminium industry started to look for new production locations outside the country. It was looking for long-term, contractual energy supplies, and Canada, Africa and the Middle East were key locations under consideration," Evans recalled.

"Japan meanwhile was dependent on oil for electrical power, and the crisis pushed the industry into a period of catharsis that killed its aluminium smelting industry. The country made a strategic decision to shut its smelters and go overseas – to Australia, Venezuela, Africa - and use technology to develop its footprint," he said.

Comparisons between the energy crisis of the 1970s and the current day situation are inevitable. But while there are many similarities between the periods, there are also important differences.

For sure, oil prices are high, supplies are tight, and inflationary pressures are continually ratcheting up. But tighter oil supplies are in part a response to the move away from fossil fuels and a decision by the West to partially embargo Russian oil imports, while inflation today is still significantly lower than it was 50 years ago.

But the energy crises of the 1970s did set in motion a wave of temporary curtailments and occasionally permanent closures, beginning a seesaw pattern of cuts and restarts for smelters that has only worsened since.

"From the 1980s onwards, when you had a smelter that was losing or renegotiating its power contract or had made a decision to sell its energy supply source, it triggered a capacity shutdown, which in turn triggered the further migration of capacity outside the United States," Evans said.

"Smelters across the United States faced the same situation; they curtailed during low aluminium prices and/or high energy costs and reopened for a period of time during high metal prices and/or low energy costs," he added.

The pattern continued into the 1990s, when the collapse of the Soviet Union and the flood of 10% of world aluminium into the market led prices to fall precariously close to $1,000 per tonne, once again putting pressure on marginal smelters.

This triggered the 1994 Memorandum of Understanding, an inter-governmental agreement signed by the European Union, Russia, Australia, Canada and the US to cut aluminium capacity. Anti-trust laws mean this unprecedented move is unlikely to ever be repeated, but its success in breathing life into the ailing mid-90s aluminium industry is indisputable.

Following the agreement's signing at the European Commission in Brussels, most of the major aluminium producers announced a series of production cuts, though only Russia committed to an actual quota, of 500,000 tonnes per year. Energy costs were not addressed in the agreement however, meaning it failed to tackle an issue at the heart of the sector's woes.

And so aluminium industry limped on, facing another cycle of closures in 2000-2002 and then again in 2009-10 at the end of the commodities super cycle.

These were particularly devastating in the US Pacific Northwest, where capacity had been struggling for years. An unprecedented 15-fold increase in spot electricity prices in that region - after long-term power contracts expired - led to the curtailment of another 10 aluminium smelters in 2000 and 2001.

The shakeout in 2009-10 was different, coming as demand for aluminium collapsed during the global financial crisis. Again, energy played an important role, this time in terms of the US expansion of fracking oil and gas, an unexpected scenario which lowered energy costs for some years but failed to provide any long-term support to smelters.

"There were a number of attempts to either build or restart a smelter and tie it to long-term natural gas prices as they were so low. But no-one successfully put that together as gas producers wouldn't go beyond seven- to ten-year contracts with smelters," Evans told Fastmarkets.

Over the past several decades, Europe was always typically somewhat less impacted, even partially insulated, by volatile energy prices because of government involvement, longer-term energy contracts and a focus on the social considerations of unemployment. But as energy prices have risen across the region over the last several years, the region has lost its relative immunity to the problems of its neighbors across the Atlantic.

As Evans pointed out, when European energy prices ultimately caught up and aluminium prices slumped due to rapid production in China, it became a huge drag to smelters in Europe.

"In China, coal is cheap and many power plants and smelters are owned by local governments who have a big interest in maintaining output. The country continued to produce even when it didn't make sense economically, from a capital standpoint," he said.

This has resulted in a period of structural overexpansion in China, although there are now cuts for environmental reasons with capacity switching away from coal.

Many industry participants fear the current round of high energy prices could spell the permanent death knell for some of the capacity shuttered in Europe.

To date, capacity curtailments across the region include in the Netherlands by Adel, in Spain by Alcoa, in Romania by Alro, in France by Aluminium Dunkerque, in Slovenia by Talem, in Germany by Trimet and in Slovakia by Slovalco.

Unless something dramatically changes, Europe's aluminium smelters will likely go the same way as those in the US, with capacity remaining at the whim of energy prices and temporary curtailments and closures eventually becoming permanent.

This makes access to affordable, decarbonized electricity even more essential, although unlikely to materialize in the immediate term.