Posts Tagged ‘energy’

China’s Aluminum Industry – where to from here?

Sunday, October 17th, 2010

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.

Tags: , , , , ,
Posted in Market Observations | 2 Comments »

Fighting for resources in the Caucasus

Thursday, August 14th, 2008

As we know, on the day of the Beijing Olympics 2008 opening ceremony, a war was brewing between Georgia and Russia. We do not know what the quarrel between Georgia, Russia and the disputed provinces of South Ossetia and Abkhazia was all about. Claims of genocide by Georgia on South Ossetia were made by the Russia, while Georgia claimed that Russia was trying to bully its tiny neighbour. Who is in the right?

We do not know.

But as we said before in Are we in a long-term inflationary environment?,

The implication is extremely unpalatable: some nations will have to rise at the expense of the others, which may result in armed conflicts (touch wood, heaven forbid!).

We believe the conflict was at the root about jostling and pushing for the influence and control of natural resources. Russia is an energy rich nation- much of Europe is dependent on Russia for its gas supplies. It also has abundant reserves of oil too. And disturbingly, Russia has shown to have no qualms in using energy to bully its neighbours and settle disputes.

In terms of natural resources, the Caucasus is a very strategic region. As this map in the Wikipedia shows,

Detailed map of the Caucasus region (1994), including locations of economicaly important energy and mineral resources: South Ossetia has reserves of lead and zinc, Abkhazia has coal, and Georgia has oil, gold, copper, manganese, and coal.

In terms of oil, this article from The Age explains,

While Georgia does not produce oil itself, US and European energy firms have counted on the pro-Western country – sandwiched between Russia and Iran further south – to host a conduit for oil and gas exports from Azerbaijan.

…

Since President Mikheil Saakashvili took power in 2004 two new pipes have been built, and the explosion of violence between Georgia and huge northern neighbour is threatening those, notably the Baku-Tbilisi-Ceyhan (BTC) pipeline.

…

Transporting oil through the Caucasus is designed to make the West less dependent on supplies from Russia, which has shown worrying willingness to close the taps in disputes with other ex-Soviet states in recent years.

Make no mistake about this: in the years to come, countries that own and control energy reserves (and natural resources in general) will be the ones calling the shots. As we said before in The Problem that can throw us back into the age of horse-drawn carriages,

… supplying environmentally sustainable energy indefinitely at a rate fast enough is a colossal global problem that must be solved. If not, the latter generations will not live better than the current generation.

Many of the oil fields located in US-friendly oil producing nations are in decline. The implication is that as the years goes by, more and more of the world’s energy are produced in nations that are not so receptive to the US and its Western allies.

It is no coincidence that we are seeing conflicts in such regions of the world.

Tags: , , , , , , ,
Posted in Geopolitics & Politics, Oil | 10 Comments »

Can rising oil prices undermine the benefits of globalisation?

Tuesday, June 3rd, 2008

Right now, there is much talk about price inflation. As you read the news media headlines, you will get to see a lot of talk about the soaring oil and food prices. There are rumours that the Fed is going to raise interest rates to fight inflation. Some people are comparing today with the infamous stagflation of the 1970s. We have heard of inflation in the Middle East, China, Singapore, South Korea and even Japan. It seems that the world is infected with the inflation bug.

Today, we read a news article, China, Starbucks and inflation, of which one of its paragraphs caught our attention:

“In many rural economies, you have farmers who go in their trucks with the produce they grow to the market to trade it,” said Lawrence Eagles, head of the International Energy Agency’s oil industry and market division. “But if it no longer becomes profitable because of the cost of gas, they’re going to simply return to subsistence farming, which would be a significant development.”

It is obvious that if most of these rural farmers return to subsistence farming, the price of food will rise, thanks to the rising price of oil. This led us to mull about the inflation problem.

Nowadays, we live in the modern age of globalisation. One of the characteristics of globalisation is specialisation. Countries specialise in producing things that they are particularly skilled at or can do so at a relatively lower cost than the others (see the theory of comparative advantage). Individually, our jobs are becoming more and more specialised. We see more and more experts at narrower and narrower fields of discipline.

No doubt, globalisation can bring about a lot of prosperity and wealth (and a lot of other negative side effects as well). For example, we have a case whereby Australia grows macadamia nuts (because it has a comparative advantage), ships them to China for packing (where the low cost of labour allows packing to be done at a much lower cost) and them ships them back to Australia for sale. Producing and packing macadamia nuts in either country alone will result in higher costs. But thanks to the globalisation, we can enjoy lower prices than otherwise.

But we see a weak point in globalisation. In the above example, it only works if the cost of shipping things is not prohibitive. As oil prices rises, the cost of shipping increases. As shipping cost increases, the benefits of specialisation and comparative advantage cannot be exploited just as easily.

Using the quote from the above-mentioned news article, we can imagine that with specialisation and comparative advantage, the farmers specialise in growing food for the city dwellers, while the city dwellers specialise in producing white goods in the factories for the farmers. Both benefits. But as the price of transport shoot up, this cosy arrangement can potentially break down.

So, as we can all see, this is another example of to show that much of the prosperity and comforts of modern life depends cheap and abundant energy. Take that away, and the good life as we know will be under threat.

Tags: , , , ,
Posted in Economics/Finance, Oil | 8 Comments »

Why are the poor suffering from food shortages?

Tuesday, April 15th, 2008

Recently, there are a lot of news headlines about rising food prices and food-related riots and unrest. As this news article, Food inflation, riots stir concern reported,

Finance ministers meeting in the US to grapple with the global financial crisis have also struggled with a problem that has plagued the world periodically since before the time of the Pharaohs: food shortages.

Surging commodity prices have pushed global food prices up 83 per cent in the past three years, according to the World Bank – putting huge stress on some of the world’s poorest nations.

Is this a fairly recent phenomenon? In February and July last year, we touched on this looming food crisis in Corn as food or as fuel? and Prepare for more food price inflation respectively. Finally, in October last year, we had identified three macro-themes about this looming food crisis in Why are food prices rising?. So, you can see that this food problem has been in the makings for quite a long time already. It is only recently that it has received great attention in the media.

We have been thinking about this food problem for quite a long time, wondering whether there is a root reason for this slow-motioned tragedy. As we read the news media about this problem, the reasons seemed to be quite fragmented. Somehow, our intuition tells us that there must be an underlying force behind all these reasons. So today, we will attempt to come out with a theory to explain how it comes about, while hoping that we do not fall into the narrative fallacy that we talked about in Mental pitfall: Narrative Fallacy.

Today’s journey will begin in China. At the end of 2006, China’s rural population stood at around 737 million. From 1990 till today, we estimated around 230 million rural peasant Chinese migrated from the countryside to the cities (source: China’s rural population shrinks to 56% of total). Our guess is that the majority of the rural migrants are males. Over the past couple of decades, it is this mass migration that provided the vast quantity of labour to propel China’s rise as a major economic power. It is China’s economic power in manufacturing that enabled the debt-induced over-consumption and low inflation of the West, especially in the English-speaking nations (look at the US’s mighty trade deficits). Compared to Western standards, China’s peasant farming is not as efficient and productive per capita. Now, if around 230 million rural peasant Chinese (mostly males, and the males do most of the farming) migrated to the cities’ manufacturing related jobs, it is clear that Chinese farm output has to fall significantly. Also, China as a whole is getting wealthier than before and as a result, consumes more meat, which in turn consume grains for livestock, thus competing against the demand for human-consumed food. Therefore, to feed China’s vast population with significantly reduced farm output, food imports have to rise significantly, which puts upward pressure on the world’s food prices.

Next, China’s rise over the decades raises the consumption of commodities greatly, including energy. As we said before in The Problem that can throw us back into the age of horse-drawn carriages,

In summary, supplying environmentally sustainable energy indefinitely at a rate fast enough is a colossal global problem that must be solved. If not, the latter generations will not live better than the current generation.

With rising energy costs, the US embarked on a foolhardy ethanol program in the name of energy ‘independence’ (see Prepare for more food price inflation). This program resulted in even more diversion of more food production resources into fuel making, reducing the food supply even more.

In the more affluent Western nations, food production takes on a more capital-intensive form. These capitals requires energy. With rising energy costs, food prices have to rise because of the increasing cost of production and distribution.

To make matters even worse, food is tend to be much less income and price elastic, especially for the poor. That is, no matter what, people have to eat even if their income falls or if the price rises. This is unlike the more discretionary items like clothing whereby people can reduce demand in response to falling income or rising prices. As a result, any increase in the cost of producing food is easily passed on to the consumers in the form of higher prices.

When the effects of climate change and drought get thrown in, the situation becomes even more serious.

The more we look at it, the more we feel that the global economic growth of the past decade is not sustainable without serious environmental, food, energy and commodities repercussions. That is why we see that a severe global recession is a necessary evil. Otherwise, more sufferings and permanent damage will occur even for the future generations.

Tags: , ,
Posted in Commodities, Economics/Finance, Food, Market Observations | 8 Comments »