January 19 (Business Standard-India) - All the base metals on the London Metal Exchange continue to rise higher and higher, aided principally by the growing investor support, improving global economic sentiment and inflation in smelter operational costs. At this point, with investors deciding to pin their faith on positives like good showing by China and India; and Euro zone breaking out of recession and not to be bothered by still wobbling US economy, copper is bid at $7,454 a tonne and aluminium at $2,293 a tonne, for ready delivery.
Interestingly, in spite of copper inventories being at a six-year high and of aluminium inching towards 5 million tonnes, investor interest remains unfazed. The rally may, therefore, continue for some more time. With the price ratio between the two base metals at more than 20-year high, these seem to have crossed the inflexion point. A point of interest for aluminium producers as also of the market is what degree of substitution from copper into aluminium will happen on the back of this kind of uncommon price differential between the two metals.
That the aluminium industry will be too welcoming of any shift of copper use into its domain is understandable in view of the prospect of capacity idled earlier when the metal sank to a low of $1,250 a tonne early last year coming back into production stream and very large capacity in the pipeline or under active consideration. As of now, 10 new smelters of combined capacity of 2.8 million tonnes are under construction. But 40 smelters of a total capacity of 18.2 million tonnes also remain at advanced stages of planning and financial closure. How well aluminium will fare at any given time will depend on the demand generation from user segments such as construction, automobiles and electricity. At the same time, there also remains the possibility of aluminium meeting with some incremental demand depending on the relative prices of other metals, particularly copper.
Consultancy firm CRU International says, "Our analysis indicates that price ratios between 2.5:1 and 3:1 could trigger substitution away from copper into primary aluminium. The higher the ratio is, the bigger the incentive to substitute from copper to aluminium." Moreover, on price volatility account, aluminium being more sedate of the two base metals, it will be the winner in this substitution game.
The inflexion point, according to CRU, comes as the price ratio approaches 2.5:1 when the most vulnerable copper market segments are impacted. But now as the ratio is at a much higher level, substitution automatically gets a fillip with investments going into R&D to "design out copper" for use in certain other products. When copper stays this high, the tendency among many users, depending on application, is to make do with scrap instead of refined copper. The generation and supply of copper scrap is linked to the working of the world economy, specially in developed countries where scrap generation and collection is maximum.
Since the world economy sank into a deep recession in the latter half of 2008 reminding people of the Great Depression of 1930s and we are now only seeing mild recovery, scrap generation is down in sync. This, according to CRU, will "lead to genuine substitution from copper to primary aluminium." Any substitution will call for investment in R&D. In many cases such investments pay for themselves quickly with minimum risks involved. But there remain areas where big R&D costs along with high risk quotient could "slowdown the migration process from one material to another."
The world is moving into times where energy efficiency regulations will become tighter more on environment considerations than fuel costs. CRU identifies heating, ventilation, air conditioning and refrigeration (HVACR) as the areas where aluminium is found to be more efficient in transferring heat. Costs to be saved in the process of migration from copper and the changes in refrigerant types further facilitating the application of aluminium in HVACR should trigger replacement of copper.
On cost consideration and also for the fact that this country has a vibrant aluminium industry, a good portion of the production of the base metal here goes into the making of cables and wires. CRU says the price perspective being what it is, the world could see substitution of copper by aluminium in cables and wires, specially in places like Brazil and China where space is not a constraint. Besides offering overwhelming price advantage over copper, aluminium being comparatively light, there is also some cost saving in building electricity pylons to hold transmission lines.
Aluminium is, however, not the only material which stands to gain at the cost copper. In the plumbing sector, copper's loss will be gain for PVC. CRU estimates the potential substitution of copper by aluminium at 150,000 to 200,000 tonnes a year, provided the price ratio remains at the current level.