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Primary aluminum producer Rio Tinto Alcan struggles amid triple threat

In summer 2007, Rio Tinto outbid rival American aluminum producer Alcoa Inc. to acquire Alcan Inc., Canada’s largest aluminum producer, for $38.1bn in a friendly takeover deal. The high price was paid with the belief aluminium prices would continue to rise, and China would eventually open up to foreign aluminium imports.

However the acquisition soon turned sour. Sealed less than a month before the financial crisis came to the fore, aluminum prices plummeted from a 35 year high, falling 36.9% by 2009 from 2007’s peak. Relying on China as a growth market proved to be a mistake as the Chinese government encouraged self-sufficiency in aluminum production, closing the Chinese market to foreign trade.

Adding further to the company’s woes, rising energy costs contributed to the company’s decision to start selling assets and close smelters. By January 2013, the $38.1bn takeover had had over half of its assets written down to the tune of $20bn.

Why did low aluminium prices and rising energy costs affect Rio Tinto in this way? A multi-stage process, primary aluminum smelting is highly energy intensive. The first stage involves the mining of bauxite, the bauxite is then refined into alumina. The final stage of production, aluminum smelting, is the most costly in regards to energy. Alumina is smelted into aluminum via an electrolytic process known as the Hall-Héroult Process, whereby a low voltage direct current (DC) at a very high current of around 150,000 amperes is used. It takes four tons of bauxite to produce just one ton of aluminum, and between 13-14 kWh of electricity to produce 1 kg of aluminum.

In use since 1886, in the last 100 years the Hall-Héroult Process for aluminum smelting has seen a 70% reduction in electricity consumed per unit of aluminum produced. Despite this, it remains an energy intensive process with smelters being situated close to energy sources, often operating their own power plant.

With almost 65% of energy purchased from suppliers rather than auto-generated, a majority of aluminum producers are going to find their production costs under pressure amid rising energy costs.

Power consumption has continued to grow due to on-going increases in production in spite of a growing global aluminum glut. Primarily due to China’s increasing aluminum production capacity, the effects of the country’s production activities can be seen on power consumption as coal overtook hydroelectric as the main energy provider for aluminum production in 2005, a result of China’s development of large scale coal mines.

A two-fold problem, the global aluminum glut is the result of the lingering effects of the financial crisis, and increased production outstripping demand. China is primarily responsible for increased production as its production for 2012 increased 52.3% over its 2008 levels, whilst Europe and North America recorded declines across the same period.

With the Chinese government subsidizing unprofitable smelters, growth in production has continued despite aluminum inventories in China’s main trading regions hitting record levels in 2013. The resulting glut has impacted on aluminum prices, and many non-Chinese aluminum producers have suffered as a result.

Weak aluminum prices, coupled with rising energy costs and Rio Tinto Alcan’s cheap long term energy contracts creeping ever closer to expiry, mean the company is looking at a situation that is going to see it absorb substantial losses. With the potential growth markets of China and Russia closed to Rio (Russian producer Rusal has a domestic production monopoly); the company is in an extraordinarily difficult situation, as is the rest of the primary aluminium production industry.

Expect further asset sales and smelter closures as Rio Tinto Alcan, and its rivals, attempt to ride out the perfect storm of weak aluminium commodity prices, rising energy costs and no access to the largest growth markets.

For more information, read Marketline’s Case Study on the struggles for Rio Tinto Alcan.

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