Low European Al demand masks supply fears

European aluminium demand has remained muted in 2023, masking supply upheaval after the curtailment of around 1mn t/yr of capacity that resulted from spiking energy prices and consumers' self-sanctioning of Russian metal.

While some analysts now say demand is unlikely to return in force before the second half of the year, markets will be vulnerable when it does because even a modest lift in demand could expose supply-chain shortages and lead to a rapid increase in prices and premiums.

It is increasingly clear that there is much less pent-up demand than some market participants were expecting to manifest through rising orders in the first quarter.

Construction markets remain subdued because of the war in Ukraine and high interest rates, while the wider construction market is also retracing to long-term averages following a spike last year. Automotive production continues to fall in Europe, despite growth in electric vehicle output, and even packaging markets are stuttering.

While few would call market conditions strong, they could pave the way for the type of supply side changes that might have been expected to have a much bigger impact in a high-demand environment.

Russia's invasion of Ukraine has led to wide-ranging sanctions — but until recently none directly applied to Russian aluminium. That changed just over a week ago, when the US marked the anniversary of the invasion with a new package of sanctions, trade tariffs and export controls, including hiking tariffs on aluminium smelted or cast in Russia.

The London Metal Exchange (LME) swiftly followed with its own ban on Russian metal being warranted in its US warehouses, confirming that the LME's position regarding the viability of Russian metal is to follow the lead of governments.

But there is no Russian aluminium in the LME's US warehouses, just as there are no deals taking Russian metal to US buyers — the market self-sanctioned long before any concrete government or industry action. This has also happened to a large extent in Europe, with little Russian metal finding its way to the continent this year and only being warranted in LME warehouses by third parties.

This has been possible because of soft demand, allowing the industry to turn away from a significant source of material without fully replacing it and not experiencing wrenching price movements as a result.

"The supply reshuffle is happening at a very good time," one analyst said. "Demand is poor, and you don't see marginal Russian metal making an impact right now. Europe can do without Russian metal without seeing a big increase in prices."

But any improvement in demand will probably lead to a far more reactive environment, with prices and premiums vulnerable amid tight supply.

The realities of this situation have been shown with P0610 — a higher-purity grade of aluminium than the standard LME-deliverable P1020. A small number of European producers of high-purity aluminium had problems in late 2022 that caused supply to fall, and the differential in premiums between P0610 and P1020 grew quickly as a result.

"One or two sources of metal in Europe were facing issues and the whole P0610 market was shaken," a trader said. "The moment we see a real increase in demand [for standard-grade aluminium] we will really be facing the situation where 1mn t/yr has been cut from European capacity."

The solution to replacing lost supply could lie in rising imports of Chinese metal in the form of so-called ‘fake semis' — aluminium semi-products that count as downstream processed aluminium, but are destined to be simply remelted back into primary aluminium units. But tariffs and duties on Chinese aluminium exports mean this trade will only be viable at much higher prices.

"There is no longer a free flow of imported aluminium into China and exported semi-products, as there are only a few markets left that China can export to tariff-free," the analyst said. "Potentially, subject to demand, China could export fake semis [to Europe]."

But the reality for now is that European aluminium supply is still constrained by a lack of Russian metal and cuts to domestic capacity, and there is unlikely to be any relief from additional units without a significant upward price correction.

"With Russian metal no longer going to Europe, any change in demand levels could prove to be a real stress test for the European aluminium industry," another trader said.

By Jethro Wookey