Ingot sunset. Will it rise in Japan?
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
