by Raul de Frutos on OCTOBER 20, 2016

Aluminum prices have risen this year, but not as much as other base metals. Aluminum continues to struggle near $1,700/mt, a level that prevented prices from rising three times this year.

Three-month LME aluminum near stiff resistance levels. Source: MetalMiner analysis of Fastmarkets.com data.

Many analysts argue that this year’s rally is limited because they expect Chinese smelters to restart capacity in the fourth quarter. The argument is that now that aluminum prices are higher than at the beginning of the year, smelters making aluminum will be more profitable.

Some capacity has already been restarted, but the numbers are running short of analysts’ expectations. Despite all fears, it’s possible that aluminum output in China will not increase as most analysts are predicting. Why? Let’s look at the cost curve:

Energy Prices Rise

It takes a lot of energy to smelt aluminum. Indeed, energy accounts for around half of the cost for Chinese smelters to produce aluminum. While aluminum prices have increased 13% this year, thermal coal prices have surged near 70% this year. As energy prices increase, Chinese smelters are getting squeezed, making it tougher for them to expand production.

Oil prices near stiff resistance levels. Source: MetalMiner analysis of Fastmarkets.com data.

For this reason, it’s not a surprise that oil prices, the main benchmark for energy prices, look very similar to aluminum. Oil prices are currently at a stiff resistance level near $50/barrel.

What This Means For Metal Buyers

Most analysts expect capacity restarts to weigh on aluminum prices. However, higher energy prices could prevent Chinese smelters from restarting capacity. Oil prices are now trading near a key level. If oil prices manage to trade above $50/barrel, we would expect aluminum to finally break above $1,700/mt.