War pushes fragile aluminium markets to the brink of disaster

Six months ago, US investment bank Citi warned that aluminium markets were “sleepwalking into the biggest deficit in 20 years” as China fast approached its self-imposed annual production cap of 45 million tonnes.

The mandate has been a ticking time bomb since it was introduced in 2017 to curb overcapacity and cut emissions. China first hit that production ceiling last year, which raised questions about whether the rest of the world could step in to meet demand for the metal that is used in everything from aircraft and cars to food packaging and solar panels.

Fast-forward to March and traders are now bracing for a full-blown crisis that could push prices to record levels after Iran attacked two of the biggest aluminium smelters in the Middle East, a region that accounts for 9 per cent of global output.

The weekend strikes on two sites in Bahrain and the United Arab Emirates pushed futures on the London Metal Exchange to a four-year high of $US3492 a tonne on Monday. Prices are rapidly approaching the record of $US4073 a tonne reached in March 2022 after Russia’s invasion of Ukraine.

Before the strikes, the Middle East conflict and Iran’s effective blockade of the Straight of Hormuz had already pushed aluminium markets to the brink because smelters in the Persian Gulf had been unable to ship out the metal or bring in key raw materials such as alumina and bauxite.

“The closure has been forcing consumers to dip into inventories, which are now largely eroded,” said ANZ senior commodities strategist Daniel Hynes. “This has left the market with little buffer to cushion any supply shocks.”

Aluminium is the most widely used metal after steel and is made by mining bauxite, which is then refined into alumina powder before being smelted into metal.

Smelters typically keep enough of those raw materials to cover about a month’s production. So as the war enters its fifth week, more operators are expected to cut output to keep their plants running because shutting down and restarting an aluminium smelter is a lengthy and costly task.

Qatar’s Qatalum was the first smelter to go offline on March 3 and is now operating at 60 per cent of its capacity – a safe, full restart is expected to take up to 12 months. Aluminium Bahrain has shut down about 19 per cent of its capacity.

Supply chain carnage

Other aluminium producers in the UAE are facing logistical difficulties because of the risk of missile and drone attacks. While Saudi Arabia and Aluminium Bahrain are shipping the metal through Jeddah port on the Red Sea to avoid the Strait of Hormuz, it is costing them more money.

The ongoing conflict is also threatening the expansion plans of major companies in the region, with several projects in Saudi Arabia at various stages of development. Strategists warn that there are now higher risks of delays or abandonment of these projects from the conflict, which is escalating by the day.

“The latest attacks increase the probability of a prolonged disruption scenario, where supply losses could persist even if geopolitical tensions ease,” said ING commodities strategist Ewa Manthey.

“Any prolonged outages would further tighten the market, especially given the region’s limited raw material inventories and dependence on uninterrupted shipping through the Strait of Hormuz.”

The conflict has also highlighted the vulnerability of aluminium’s supply chain, with the Gulf emerging as a pivotal production and export hub over the past decade.

The smelting process is energy intensive, so operators have benefited from the abundance of cheap gas in the Middle East. Aluminium output in the region has more than doubled since 2010 and exports now meet 18 per cent of global demand outside of China.

A sustained spike in the price of the metal is expected to heap further pressure on manufacturers already grappling with surging energy costs.

Western carmakers are reportedly struggling to secure supplies, which has sparked “panic buying”, with many manufacturers drawing on inventories. Japanese automotive suppliers have warned of production cuts within four months if supply remains disrupted.

The increase in prices has boosted the few major ASX-listed aluminium stocks over the past week. Alcoa has rallied 19 per cent, while Rio Tinto and South32 have both jumped about 10 per cent each.

“We expect that aluminum will be one of the commodities most significantly affected by ongoing conflict in the Middle East,” said UBS analyst Lachlan Shaw.

UBS noted that Alcoa offers the greatest leverage to aluminium prices given it is a pure-play producer, with facilities outside the Persian Gulf. The broker forecast a 10 per cent rise in aluminium prices would result in a 23 per cent increase in the stock’s fair value.

However, UBS said South32 offered “the most compelling upside” in the sector due to the miner’s attractive copper exposure.

Reporting by Alex Gluyas for Financial Review

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