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As coal and crude oil prices continue to decline, the cost structure for electrolytic aluminum is gradually shifting downward. This trend is expected to trigger a wave of inventory reduction in the aluminum smelting sector during the second quarter. While many companies are reluctant to cut production, prolonged losses have pushed some firms to their breaking point. The bottoming out of aluminum prices is likely to be a slow and painful process, with no quick fix in sight.
According to recent reports, some domestic aluminum producers started experiencing losses at the end of 2011. After nearly 18 months of sustained pressure, aluminum prices continued to fall, forcing more smelters into the red. Currently, several companies are facing extended cash flow deficits, with losses growing as prices keep declining. Our analysis suggests that since March, the forward price of Shanghai Aluminum has dropped to around 14,250 yuan. Due to these low levels, many grid-powered smelters in Henan, Shanxi, Guangxi, and Yunnan are suffering cash flow losses of over 500 to 1,000 yuan per ton.
In response, the Nonferrous Metals Industry Association has brought together major domestic aluminum producers to discuss measures for addressing excess capacity and exploring the possibility of production cuts. However, due to varying operational costs across different companies, consensus on specific production reduction plans remains elusive.
Although large aluminum producers have not yet reached an agreement on cutting output, this development signals that many firms are now at a critical juncture. Production cuts may be the only viable option moving forward. We maintain our earlier view that a significant reduction in domestic aluminum smelting capacity is highly likely to occur in the late second or early third quarter. Based on this expectation, we believe that the drop in Shanghai Aluminum prices in May may be limited. However, if production cuts fail to gain momentum, the downward trend in aluminum prices is likely to persist.