by Raul de Frutos on JANUARY 31, 2017

Aluminum prices started the year on a strong note, finally overcoming the $1,800 per metric ton price level that had acted as a ceiling for more than a year.

While robust demand has supported aluminum prices, investors’ eyes have recently turned to the supply side of the equation. In December, China’s share of global aluminum output was more than 56%. The giant producer’s share of supply is now facing some serious risks.

For years, Chinese cities have been choking on the smog spewing from China’s industrial production sector but things have recently gotten worse. Last month, authorities asked 23 cities in northern China to issue red alerts as inspection teams scoured the country. The scale of the red alert measure shows that the Chinese government is taking air pollution seriously… at least this time.

Investors are now speculating about capacity cuts in China as the country released a new policy document with plans to close around a third of aluminum capacity in the provinces of Shandong, Henan, Hebei and Shanxi over the winter months to help reduce emissions.

The cuts, of course, might not happen. Implementation of the document is subject to feedback and it will be normal to expect reasonable complains from both affected producers and regional governments.

Aluminum Premiums Pick Up

US aluminum premiums. Source: MetalMiner IndX.

For U.S. aluminum buyers, the all-in aluminum price consists of the aluminum price plus regional aluminum premiums. The premium is a surcharge that consumers must pay on top of prevailing prices in order to take immediate delivery of the metal from warehouses.

Not only the price of aluminum has risen, but premiums also picked up last month, trading now at $0.09/pound. The U.S. has also experienced a sharp contraction in aluminum smelting capacity over the past year. This has created a case of supply shortfall within the U.S., which now depends on aluminum imports to satisfy its rising domestic demand.

The fight against imports is getting more serious and this is something that could support domestic aluminum premiums. Recently, the U.S. launched a formal complaint against the Chinese government with the World Trade Organization over subsidies it says Beijing provides to the country’s vast aluminum industry.

In addition, U.S. customs officials seized $25 million worth of aluminum linked to a Chinese billionaire accused of stockpiling the metal across the world. The move is the most potent action yet by federal authorities probing whether U.S. companies connected to Chinese magnate Liu Zhongtian illegally avoided nearly 400% tariffs by routing the metal through other countries.

The same combination of domestic environmental and foreign trade imperatives already forced China to get serious about steel capacity closures. It is possible there could be a similar outcome in aluminum. In addition to higher aluminum prices due to supply cuts, we could see higher aluminum premiums due to the ongoing trade tensions, just as we saw the spread between domestic and international steel prices widen.