The opinions expressed in this report are those of CRU Group and are considered market commentary. They are not intended to act as investment recommendations. Full disclaimers are available at the end of this report.
As the P1020 ingot premium falls further and risks a round trip to pre-Pandemic levels it is worth recapping on the recent boom, the reasons for the fall and where it may go next.
The ingot premium in Europe exploded after Covid-19 in a way that no one anticipated. It had traded between $100 /t and $200 /t duty paid for most of the 5 years previous, only briefly crossing the $200 /t mark once in 2018. Post-pandemic, however, it went from a low of about $100 /t in 2000 to over $600 /t in Q1 this year.
The US Midwest premium also rose although less dramatically. Trading between 5 ¢/lb and 22.5 ¢/lb for most of the last 5 years, it breached 20 ¢/lb in 2018 before falling. It then rose from a pandemic low of 7.5 ¢/lb to a high of 40 ¢/lb in April 2022.
The reasons for this extraordinary rise in pricing include:
- The snap-back in demand following the Covid-19 panic of early 2020
- Record freight rates and transportation disruption blocking imported material
- Record premiums for value added products made from ingot: billet, slab, PFA etc.
- The recent trend towards regionalisation and rising trade barriers
Why did Europe’s ingot premium rise by over 300%
The demand rebound following the Covid-19 panic of early 2020 happened very quickly. Also, global logistical disruption led to higher freight rates. Local supplies were insufficient in Europe and the US and imports were unavailable. Premiums therefore rose.
Also, shortages further down the supply chain led to a boom in premiums for value added products (VAPs) made from ingot such as aluminium billets, slabs and PFA. This encouraged smelters to cut ingot production where possible and make the VAPs to capture additional downstream margins. This was given further urgency in 2021 by rising energy prices.
In late 2021 in Europe over 750 kt/y of smelter closures were announced. These producers could not improve their product mix further and cost pressures caught up with them. Smelters making only ingot could not justify staying open without the VAP premiums. Other smelters making VAPs cut their primary production and instead switched to re-melting cold metal to maintain their output. The effect of this was to further amplify the local ingot shortage by reducing local production and boosting demand at a time when ingot was already scarce.
This explains why ingot premiums rose so strongly this year, even outlasting the boom in the underlying metal price. By May 2022, the peak for European ingot, CME Group’s spot aluminium contract (ALI) had already lost about 25% in value reflecting concerns about global economic growth. The European duty paid premium rose in that time by 36% to reach its own peak of $610 /t in May.
The market begins to fall
As we know, ingot prices in Europe and the US have now cooled substantially. The European duty paid premium is down by 35% to $395 /t with most of the losses occurring in August and September. In the US, the high point for the Midwest premium came in May and since then it has fallen by 40% to 24.25 ¢/lb. However, the European premium is still 160% above its medium-term average pre-pandemic of about $150 /t. Midwest on the other hand is now only 27% above its pre-pandemic average.
The reason for the drop is the unwinding of several factors. On the demand side, concerns around the economy have begun to mount. July and August were weak months for aluminium consumption, especially in Europe. August activity was the weakest in years. September is better than August but significantly down year on year. Uncertainties around end consumer demand, interest rate rises and energy price uncertainty are cooling business activity.
Also, VAP production is now in reverse. With freight rates falling, Europe faces a potential flood of imported VAPs from the emerging markets. This has led to a sharp contraction in the premiums for VAPs. The billet premium in Europe for example is down by at least 37% from its peak and by 50% in some European markets. This is causing a switch back to ingot by smelters as the margins on VAPs in Europe no longer justifies their production.
Also, making ingot is a more typical configuration for many primary producers. Ingot is safer in some respects than some of the alternatives. It is fungible, hedgeable, easily tradeable and more easily bankable unlike many VAPs. In times of financial stress and volatility this cash-like quality can be very attractive, adding financial safety and price risk mitigation.
Also as with VAPs, ingot also faces the risk of cheaper foreign imports which becomes greater as freight rates unblock. We believe smelters in the Middle East and India for example can now sell ingot duty paid, landed in Europe today, for about $250 /t. With premiums today still at $395 /t this leaves a healthy margin for importers and room for further price contraction.
Can smelter shutdowns improve the situation?
It is well-known that high energy prices could mean further smelter closures are on the cards in Europe and the US. Would this have the same tightening effect on ingot supplies as the previous closures in Europe did in late 2021?
In Europe we believe it would not, but in the US it may have some impact. Our analysis suggests that 20% or 720 kt/y of operating capacity may be at risk in Europe but of that total only 9% makes ingot. In the US on the other hand and as much as 69% or 550 kt/y may be at risk of which 47% makes ingot. Therefore, the European shutdowns would do little to support the ingot premium but in the US they may do so.
Figure 1: Capacity at risk is not primarily concentrated on ingots
An upturn in freight rates could also support the market
A major factor contributing to the fall in premiums has been declining freight rates. The fall began in mid-2021 and in recent weeks has been accelerating. Shanghai to Rotterdam container rates are down by 59% from their peak in October 2021 for forty-foot containers. Shanghai to Los Angeles is off by 70% and Shanghai to New York is down by 52%. In the last 3 weeks alone Drewry’s World Container Index has fallen by over 10%.
Nevertheless, global logistics conditions do remain far from normalised. China continues to lock down parts of major cities including Shanghai, Chengdu, Shenzhen, Wuhan and Daqing an this policy looks set to continue at least in the short term. Also, there are reports of substantial port congestion in hubs like Rotterdam, New York and Houston. Stevedore and trucker trike risk is elevated, and overland freight remains expensive. Hence, there is some potential for a stabilisation in freight rates which could support premiums.
Figure 2: The fall in freight rates has accelerated in recent weeks
Downside potential greater in Europe, less in the US
We believe that European premiums are more exposed than the Midwest since they remain well above historical averages and low-cost imports are now flowing into this market. We see ferocious competition in VAPs and do not expect a revival in VAP premiums in the short term. We see continued switching away from VAPs by smelters and increasing ingot supply. Shutdowns, if they happen, would likely not fundamentally change this picture.
On the other hand, US premiums are now closer to their historical average and we see less scope for downside. Among other factors, we believe the US premium is below the replacement rate. This is the price at which equivalent offshore material could be imported and implies a short-term under-pricing in the US market. However, it should be noted that the replacement rate itself is falling as freight rates come down. One possible explanation for this could be the level of cheaper Russian ingot imports now entering the US. If a US smelter shut down this could improve the picture however it would depend on the production not being replaced immediately by imported metal. Nevertheless, to Europe however we see more scope for flattening in this market instead of further falls
Three relevant contracts are traded at CME Group: the European duty paid ingot premium is a futures contract traded under the name EDP. European duty unpaid is traded under the name AEP and the Midwest ingot premium is under AUP. Forward prices can be checked either directly on the CME Group website or through a Bloomberg terminal.
Japan’s time to shine?
The market where there may be cause for optimism based on underlying demand is in fact Japan. The reason for this is its exposure to the automotive sector. Weaker global economic growth is improving the availability of semiconductors and is showing signs of easing supply chain issues. This has held back global automotive production since Covid-19 began and now can have important countercyclical benefits for the automotive OEMs.
This theory remains to be proven however and recent reports of supply chain issues affecting the Ford Motor Company in Q3 and Volkswagen give us pause for thought. Nevertheless, we do see potential for improvement, unlike in other markets. In addition, Asian consumers are on average likely to keep buying over the winter period and this should be supported to some degree by Chinese stimulus measures. By contrast in Europe demand is more in question. Accordingly, we would highlight the potential for gains in the MJP ingot premium. This is not yet reflected in price activity although there have been brief but significant spikes in recent weeks with gains of up to 22%. We therefore ask: can Japan be a ray of light?
Figure 3: The MJP futures contract is showing signs of bottoming
The opinions and statements contained in this communication do not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs. This content has been produced by CRU Group. CME Group has not had any input into the content and neither CME Group nor its affiliates shall be responsible or liable for the same.
CME GROUP DOES NOT REPRESENT THAT ANY MATERIAL OR INFORMATION CONTAINED HEREIN IS APPROPRIATE FOR USE OR PERMITTED IN ANY JURISDICTION OR COUNTRY WHERE SUCH USE OR DISTRIBUTION WOULD BE CONTRARY TO ANY APPLICABLE LAW OR REGULATION.
Subscribe for more information
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.