Aluminum market dislocation temporarily distorts trade flows
By Wenyu Yao
The Russian-Ukrainian war exacerbated the market dislocation between London and Shanghai. As we previously highlighted, the Chinese market has been on the soft side after the Chinese New Year due to weaker seasonal demand, and more recently the Covid outbreaks have forced some traders to maintain a wait-and-see approach, which weighed on prices on the Shanghai market. On the flip side, however, the war continues to disrupt the supply chain, as self-sanctioning by supply chain players from banks to shippers has further tightened physical liquidity in more than an already tight market. Subsequently, the world market, excluding China, continued to tighten, reflected by the increase in the physical premium from Europe to North American markets.
The market dislocation has temporarily reshaped the trade landscape that previously viewed China as a primary aluminum importer. The latest trade data for the first two months of this year testifies to this. Reversing the strong imports of the past two years, China’s primary aluminum exports jumped to more than 30kt in the first two months from just 1.6kt in the same period of 2021.
China’s primary aluminum exports jump in February (tons)
However, the exported primary aluminum is likely due to opportunistic sales, and it is not homemade Chinese aluminum. This aluminum would consist of pre-imported ingots stored in Chinese bonded warehouses, which are exempt from Chinese export tax when leaving the bonded areas. Therefore, instead of waiting for the opportunity to enter the Chinese domestic market, they are now incentivized to take advantage of physical reverse arbitrage in other markets.
As for the domestic primary metal, it would need an additional incentive to boost exports, given the 15% export tax on top of the price. In other words, it would require the London Metal Exchange (LME) market to further outperform the Shanghai Futures Exchange (SHFE), or physical premia to rise further.
For now, the base case scenario here is that Chinese imports could remain subdued, but massive domestic bullion exports seem less likely. However, if Russian aluminum were to be further disrupted due to self-sanction or cutback at Rusal due to raw material shortages, it could result in up to four million tonnes of supply being cut. and spur market dislocation, thereby attracting some Chinese exports to fill the void.
At the same time, we believe that the current market dynamics should encourage Chinese exports of semi-finished products and aluminum, thereby supporting domestic demand.
China net alumina imports/exports (tonnes)
The commodity market is also full of uncertainties. We noted earlier that the liquidity of alumina in the physical market has started to decline. The risks increased further after Australia banned exports to Russia, leaving Rusal little leeway in finding an alternative alumina supply to fill the void. Such a ban only increases the risks of reduced production in Russia. Alumina exports from China are possible, as seen in 2018, but any potential export spike is unlikely to be sustained. As Chinese smelters look to restart steadily to take advantage of decent margins at the moment, their demand for alumina is poised to pick up, supporting the price of the raw material in the onshore market.
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