What a difference 2 years can make. That’s the obvious conclusion from comparing US exports of caustic soda today, with those seen in the years to 2012. As the chart, based on Global Trade Information Services data shows:
- Net US exports fell 4% in Q1 (red column) versus 2012 (blue), and were 19% below 2013 levels
- Detailed analysis shows actual exports fell 8% versus 2013, whilst imports jumped 31%
- China’s slowdown meant US exports to Brazil and Australia for aluminium production fell 3% and 47% respectively
- Similarly, the slowdown meant imports from NEA doubled, as producers there looked for new markets
- And imports began to arrive from the Middle East for the first time, as new capacity came online
This is probably just a warning of the larger downturn that is round the corner, as the blog noted last month. Caustic soda has benefited (unintentionally) from the scandal over the role of metals warehouses. These have successfully ‘locked up’ enough aluminium to build 2 years’ worth of cars, and artificially inflated prices.
European producers have similarly benefited from the artificial boost to aluminium production. But European stocks of caustic soda stocks have been rising ominously, with March data from EuroChlor showing them up 9% versus a year ago at 284kt.
Confirmation of the slowdown comes from China itself. Its caustic exports had plateaued at 2Mt between 2011-2013. But her Q1 exports were down 13% versus 2013 levels. And Q1 also saw a 13% slowdown in her exports of the main chlorine derivative, PVC.
Caustic soda, PVC and chlorine are excellent leading indicators for the global economy. They are well established products, having been made industrially for over a century. And they are used in a very wide variety of applications. Whilst US exports are very competitive, due to its low cost position due to shale gas.
Today’s slowdown in US caustic soda exports is thus an orange warning light that the global economy is probably not as robust as we would all like to believe.
An accident waiting to happen is perhaps the best way to describe aluminium markets – the key swing outlet for caustic soda. Caustic soda is normally a late cycle product, with sales then focused on the mining industry. Industry leader Alcoa’s results confirm the disappointing trend. It lost money in Q1, whilst revenue fell 8% due to a decline in aluminium prices.
Even more worrying, as the chart above shows, based on EuroChlor data, Is that European caustic inventory is already at high levels:
- Inventory jumped 22% in February (red square) versus 2013 (green line)
- This followed an 18% jump in January, and took stocks to 296kt – equal to 2009/10 levels
- The driver was an increase in February operating rates to 81%, after an average 75% in 2012
A further problem is that aluminium stocks in warehouses remain at more than 10 million tonnes, despite a 43% fall in prices from the 2008 peak. As the blog noted in January, this is sufficient to build 2 years’ worth of cars.
Aluminium producers are thus now fighting a war on two fronts:
- Rusal has forced a postponement in the London Metal Exchange’s plan to cut warehouse delivery times
- Rusal and Alcoa have also started to cut production at high cost mines
The warehouse position is the most scandalous, with buyers forced to wait up to 570 days to obtain their own stored material – and to add insult to injury, made to pay large premiums to obtain prompt delivery of replacement supplies.
But whilst Western aluminium producers are finally starting to face up to reality, we can be fairly certain that they will do too little, too late. This is always the problem when markets are unable to operate properly, as wishful thinking rather than reality starts to dominate producer thinking.
They have thus allowed themselves to be lulled into a state of false optimism. They wanted to believe stimulus programmes would restore pre-Crisis growth levels, and they have ignored the fact that the warehouse delays kept unwanted inventory off the market.
But we all know how this story will end. Aluminium demand will continue to suffer under the influence of today’s high prices, whilst in the end the inventory will appear on the market. When this happens, it will be the innocent producers of caustic soda who will suffer just as much as the aluminium market.
Today’s rising inventory are a clear warning that major operating rate reductions are now on the horizon.
Whisper it quietly to your friends in the oil business. But oil prices are looking very vulnerable. Producers and the central banks have done a great job in creating the myth of imminent shortages – these have always been ‘just about to happen’ as a result of supply disruptions or the long-promised recovery in global growth.
But whilst the blog tips its hat to them for creativity and persistence, frankly the story is wearing a little thin.
The facts of the matter are that prices have hardly moved since the blog suggested last September that the bulls seemed to be running out of ideas to help keep prices at the $100/bbl level:
- The maximum weekly average price has been no higher than $112/bbl
- $105/bbl has been the minimum weekly average – creating a very narrow trading range
And the fundamental rule of purchasing is that when prices are not rising, they are on the way down. No wonder the normally bullish analysts and traders in the investment banks have gone rather quiet. They will face job cuts rather than bonuses if this calm continues.
Most likely, however, this is the calm before the storm. The market has traced out, as the chart shows, probably the most extended triangle shape of all time. And triangle shapes normally end with a bang, not a whimper. Either the bears give up, and allow prices to rocket higher. Or the reverse happens, and prices collapse.
Copper markets may provide a guide to what may happen next. Nicknamed ‘Dr Copper’ for its ability to act as a leading indicator for the global economy:
- Copper prices trebled from $1.4/lb in December 2008 to peak at $4.50/lb in February 2011
- They then collapsed to $3.60/lb in October before stabilising
- But in recent weeks, they have begun another collapse, falling to $3.0/lb last week
There are many reasons for copper’s fall, and most of them also apply to oil. Players have been happy to build inventory in the belief that prices would always recover. Whilst central banks have maintained the flow of easy money at low interest rates. In the absence of real growth, this money had to go into speculation instead.
Copper prices are now at their lowest levels for 4 years, and its decline has been followed by other metals including aluminium, lead, nickel and zinc.
So oil prices may be about to follow. Certainly it seems one major support for them may be about to disappear. As the blog noted last June, Brent has been a broken benchmark for many years. It trades only 1mb/d, yet sets the price for 2/3rds of the market.
Of course, this has been very convenient for everyone involved. But now the ICE futures exchange is starting to discuss adding more grades to the benchmark. And Vitol CEO Ian Taylor has argued it should include oil from W Africa, Kazakhstan and Algeria, as well as Russia and the US.
The key to the short-term outlook is probably China. The market still expects another stimulus package, and is holding on to its cargoes in hope. But if the new leadership continues with its current policies, then in the absence of major global hostilities, prices probably have only one way to go.
When was the last time you told your customers that they would have to wait 570 days for delivery of material for which they have already paid?
You’ve never done this? Well, you need to take lessons from those super-smart people who own the aluminium warehouses, such as Goldman Sachs (pictured above by Reuters). As the blog has noted before, they have created a situation where warehouse stocks now represent enough metal to build 2 years’ supply of cars.
Finally, however, the world’s largest buyer, Novelis, has gone public with its complaints to the Financial Times. They argue that the shortage is “temporary and artificial”, and that the market remains in large surplus with 10m – 15m tonnes of metal stored in warehouses around the world.
They are also upset by a second tactic now common in the market. If you want to obtain prompt material to use today, and you can’t obtain your own material from the warehouse until the end of 2015, you instead have to pay a “prompt premium”. And this isn’t small change. Last week, buyers were paying about $450/t in premium, 26% above the supposed ‘cash price’ at the London Metal Exchange.
Clearly, ‘enough is now enough’ for Novelis. As their chief supply officer, Nick Madden, notes:
“There is more than enough metal to meet the higher consumption levels, but it continues to be held off-market by those who benefit from financing deals and the appreciation in premiums. This increase in costs ultimately does flow down through the supply chain to the end consumer.”
Aluminium is thus another market, like crude oil, where the market is completely failing in its primary role of price discovery. There have been no shortages in either market since 2009 to justify today’s high prices. And the short-sighted greed of those creating these high prices is clearly having major negative effects on those of us who live in the real world:
- Aluminium is used in a wide range of applications, from beverage cans to car bodies
- Its higher prices therefore have to be passed on to consumers
- Equally, caustic soda demand has been artificially inflated by the aluminium stock build-up
- When finally the bubble bursts, chloralkali producers will be the innocent victims as demand disappears
This moment may now be approaching quite quickly. Demand for new cars has begun falling in major markets, as the blog discussed yesterday. And this could well be the trigger for a price collapse, if it continues.
In the meantime, the moral of the aluminium story is clear. As in virtually every area impacted by the Crisis, most regulators and policymakers have let down the people they were supposed to protect.
We all know that strange things have been happening in global commodity markets in the past 5 years. Central banks have been pumping out free cash, which has been used to fund speculative trading by many of the major investment banks. In turn this has taken many prices to new records. And this was all happening when demand growth was weak, whilst supply was increasing rapidly due to the higher prices.
One key development in metals markets was the purchase from 2010 of warehouse capacity by companies such as Goldman Sachs and JP Morgan. They found a loophole in the rules for the London Metal Exchange (LME), whereby they only had to actually deliver product to buyers after a long wait. This provided them with sharply higher income from storage charges, as buyers often had to wait over a year for the product. And it also meant the product could be tied up in futures contracts, forcing market prices higher.
Aluminium has been an excellent example of this trend in action. It is critically important to the chloralkali industry as an outlet for caustic soda, and the blog thus keeps a careful eye on developments:
- As the chart shows, recent price levels have been very different from the spikes in the 1988 and 2007-8 booms
- Both previous spikes were caused by credit bubbles, which temporarily increased demand whilst supply was slow to respond
- But since 2009, prices have risen as buyers faced year-long waits for delivery of their own material from the warehouses
- Buyers have instead been forced to go into the market and purchase extra product at higher prices
The LME rules are now changing, but the profitability of this game has been so large that it seems the major players are reluctant to admit defeat. 5 companies now own 75% of the LME’s warehouses, and they all now own shadow warehouses as well.
Between them, they have created a paradigm shift in stock levels. Stocks were at normal levels of 1.5MT in early 2008, but now seem to be around 10 times higher:
- A year ago, LME stocks had hit a record 5.1MT, with similar volumes in the shadow warehouses – enough to build over a year’s supply of new cars
- An excellent new analysis by the Wall Street Journal suggests LME stocks are now 5.5 million tonnes, whilst stocks outside the LME may be up to 10 million tonnes
- In other words, stocks may now be 25% of total world demand, as the LME stocks were already 10% of demand
- We don’t, of course, have official data on the shadow stocks as the firms are able to keep this private
- It does seem likely, however that current stocks are enough to build 2 years’ supply of new cars
This explosion in stocks has created strong demand for caustic soda in the short-term. But in the end, this supply will have to come back on the market.
And as the WSJ notes, the lack of transparency over inventories means the market is no longer performing its role of price discovery. Instead, prices have remained firm whilst stock levels increased.
Thus the risk of a price crash must be rising day by day.
The blog was with the mining industry last week, when giving the keynote speech on The Impact of the ‘Demographic Cliff’ on Demand Patterns at the annual Metal-Pages conference. Mining is seeing similar demand patterns to those in chemicals, whilst the price performance of aluminium shows very similar influences to those at work in oil markets, as the above chart of developments in the LME aluminium price since 1993 shows:
• Prices ranged between $1000 – $2000/t from 1993 until 2005, just as oil prices ranged between $10 – $30/bbl
• They then shot up to peak at $3000/t in 2008, whilst oil rocketed to $145/bbl
• After collapsing in Q4 2008, both have recovered to trade above historical levels
Aluminium is, of course, of great interest in its own right, and as a critical use for caustic soda.
There have been 2 key developments in aluminium markets since 2009. The first was the expansion of China’s demand until 2011. The second has been the enormous growth in the role of financial players. The former is well understood, but the latter is quite remarkable:
• Bloomberg report that stocks are now at record levels and are expected to keep rising in 2013 to reach 8.67m tonnes. This is enough to build 62m cars (total annual world volume)
• Production is expanding rapidly due to the high prices, and is well ahead of demand
• The reason is that 80% of all aluminium stocks are locked into speculative financial contracts, and so are unavailable for use by genuine consumers
• This volume has overwhelmed warehousing operations at the major exchanges such as the London Metals Exchange. Buyers usually wait a year to obtain supplies
• Reuters has reported that the wait is deliberate, as the major warehouses are owned by companies such as Goldman Sachs and Glencore – who profit from high storage fees
All this is, of course, completely legal within the LME’s rules.
Aluminium is thus another example of the way in which global financial markets have totally lost their true role in enabling price discovery. Instead, they have become a speculative tool for those with access to low-cost central bank liquidity.
The situation can clearly not continue forever. But for the moment, end-consumers have no choice but to pay today’s high prices. Similarly, when the party does eventually come to an end, companies (including chloralkali producers) will suffer major losses on inventory values. Whilst operating rates may well crash until the stock overhang is worked down.