Alcoa To Close Italian Smelter In Order To Lower Costs

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Alcoa (NYSE:AA) has announced its intention to permanently close its Portovesme primary aluminum smelter in Italy. [1] The smelter had already been idled in November 2012. The move to permanently shut down the Potovesme smelter is a part of the company’s efforts to lower costs in order to make its primary aluminum business segment more competitive in an uncertain aluminum pricing environment. The company is giving greater emphasis to its value-added businesses going forward and reducing its dependence on its commodity businesses.

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Aluminum Prices

Aluminum has diverse applications in industry. It is an important input in the packaging, aerospace, automotive, construction, commercial transportation, power generation, capital goods and consumer durables industries. Thus, demand for aluminum is broadly correlated with industrial growth. The European debt crisis and slowing Chinese growth have contributed to weakness in aluminum demand over the last few quarters.

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On the supply side, production capacity was not reduced corresponding to the fall in demand over the last few quarters. Persistently high aluminum inventory levels relative to demand have kept London Metal Exchange (LME) aluminum prices depressed. [2] This inventory has been built up partially as a result of aluminum being tied up in financing deals, which were made possible due to low interest rates. ((Aluminum Price Premiums: Disconnect Between LME and Reality Continues, Metal Miner)) Despite inventories being at fairly high levels, market forces failed to rationalize supply through the shutdown of smelting capacity. Though global aluminum majors like Alcoa and Rusal announced smelting capacity cuts, the same cannot be said of Chinese aluminum producers. This is primarily due to state intervention in the form of provision of subsidies or renegotiated power contracts to smelters, which serve as a disincentive to cut production. China accounts for more than 40% of the world’s aluminum production and the expansion in production by Chinese producers more than made up for capacity cuts by global majors. [3]

Aluminum prices have recovered somewhat lately, driven by a fall in LME aluminum inventory levels and the impact of global capacity cuts. [4] However, in view of the uncertainty regarding aluminum prices over the previous quarters, Aloca has curtailed smelting capacity and sought to reduce its dependence on its commodity businesses.

Smelting Capacity Cuts

The closure of the Portovesme smelter will reduce Alcoa’s base smelting capacity by 150,000 tons to 3.6 million tons per year. [1] The company has shut down high cost smelters in response to an uncertain aluminum pricing environment over the past few years. The company had earlier reduced its base smelting capacity from 4.23 million tons per year at end of 2012 to 4.04 million tons per year at the end of 2013. ((Alcoa’s 2013 10-K, SEC)) As a result of the curtailment and closure of high-cost smelting capacity, Aloca’s average production cost per metric ton of aluminum has fallen from $2,287 in 2012 to $2,201 in 2013, and further to $2,196 in the first half of 2014. [5]

The company has stated that its intends to further lower its average cost of producing both aluminum and alumina in the years to come. [6] Thus, more curtailments and closure of high-cost smelting capacity could happen, particularly if aluminum prices remain subdued for an extended period of time. In tandem with its cost reduction initiatives for its commodity businesses, the company has laid emphasis on its value-added businesses, driven by the aerospace segment. Alcoa’s shift towards value-added products is reflected in its revenue figures. The percentage contribution of value-added products to the company’s total revenues has steadily increased. This figure stood at 52.1%, 54.4%, 55.7% and 58% in 2011, 2012, 2013 and the first half of 2014, respectively. ((Alcoa’s Q2 2014 10-Q, SEC)) In calculating these figures, we have only considered third-party sales. Value-added businesses will drive Alcoa’s results in the near future, with cost reduction expected to keep its commodity businesses competitive.

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Notes:
  1. Alcoa to Close Portovesme Smelter in Italy, Alcoa News Release [] []
  2. LME Aluminum Prices, LME []
  3. Alcoa, Rusal’s Aluminum Production Cuts Not Enough With China Smelting, Metal Miner []
  4. Aluminium prices hit 17-month highs, Financial Times []
  5. Alcoa’s Q2 2014 10-Q, SEC []
  6. Alcoa’s Transformation Is Accelerating, Alcoa Company Presentation []