Today, we will be having a guest post by Paul Adkins, Managing Director of AZ China Limited. Paul lives in Beijing and thus, has a first hand view of what is going on in China. Many of our readers appreciate the insights offered by Paul that can be found in no where else.
One issue facing China?s government as it mulls the next five-year plan: What to do about the country?s aluminium industry? While this might seem a minor matter, it symbolizes a major dilemma that faces the country, namely, how to balance concerns for economic growth with those for energy use and environmental protection.
China is now the largest single producer?and consumer?of aluminium and will make about 17 million tonnes this year, up 20 percent from last year. But that record comes at a steep price. Aluminium production not only consumes about 8% of all electric power in China, but also is responsible for large amounts of carbon dioxide (CO2) emissions. And the electricity needed to power the industry has a multiplier effect on pollution problems because 70% of China?s electricity comes from coal, a major contributor of CO2 emissions.
The China Nonferrous Industry Association (CNIA), which represents the aluminium industry, recently published a draft plan calling for aluminium capacity to be limited to 20 million tonnes in the next five-year plan. But China is already over that cap, with about 21 million tonnes right now. Given the new smelters already under construction, total capacity could reach as much as 28 million tonnes by 2012.
Beijing recently indicated it is serious about reducing energy intensity ? the amount of energy consumed per unit of GDP ? and sees aluminium as a major culprit. As an example, it takes at least 12,000 kilowatt hours (kwh) to produce one tonne of metal. But so far, the authorities have chosen to target the steel and cement sectors, and largely left aluminium untouched.
The choices now in front of the planners and politicians are profound. They could simply allow market forces to dictate the industry?s future, with the laws of supply and demand determining not only metal production, but also energy use and CO2 emissions. Then again, the China aluminium industry has not shown itself to be totally subject to such forces. Smelter capacity has run well ahead of consumption, especially in the last few years. Meanwhile, proprietors have struggled to make a decent return on the huge investment needed for a smelter, as the price of aluminium is determined on the Shanghai Futures Exchange, and may have no relation to operating costs, much less capital costs. Because of the huge capital costs, long-term contracts for electricity and other key inputs, and the cash flows involved, producers often run at full operating speed to maximise efficiency, despite apparent losses on the metal price.
Alternatively, they could put limitations on the aluminium industry, with the caveat that such efforts can have unintended repercussions. In 2003, for example, the Government decided to crack down on old inefficient smelters and ordered those with less than 50,000 tonnes of annual capacity to shut by the end of 2004. Many proprietors simply built expansions or upgraded their technology, and industry capacity shot up, not down.. Indeed, even the CNIA has admitted that it is virtually impossible for the government to control the industry. One risk is that Beijing could be left embarrassed if the industry ignores new edicts.
Even if Beijing were successful in reducing aluminium capacity, it would come with economic costs. In addition to the loss of thousands of jobs in the country?s 120 smelters, it would cause ripples in associated businesses, including raw materials suppliers, downstream factories, and the many support industries that surround a smelter. For stockholders, any limitation on capacity would cause the share price of China Aluminium (Chalco) and other publicly listed smelters to soften. Investors needed to see growth strategies, which would not be available in the Aluminium industry. (Chalco has already started alternative strategies, embarking into iron ore, copper, gold and now rare earths.) As well, such a decision could affect billions in loans outlaid for the many new projects currently under construction.
There is also a global dimension to this dilemma. Russia stands poised to sell aluminium to China in the event of supply shortages. The world?s aluminium companies source many of their raw materials from China. If Chinese smelters are constrained, the value of China’s exports of raw materials will decline.
In the end, the decision on aluminium might come down to one of the country?s scarcest commodities: energy. Aluminium is called ?frozen electricity? because of the huge amounts of electricity needed to produce it. It seems more sensible for China to import aluminium, even at the cost of lost jobs, to gain the benefits of saving energy and limiting pollution.
