Alcoa Announces Sale Of Stake In Alumina Refining Joint Venture As Part Of Cost Reduction Efforts

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Alcoa (NYSE:AA) has announced the signing of a definitive agreement that will result in the company selling its its ownership stake in the Jamalco bauxite mining and alumina refining joint venture to the Noble Group for $140 million. ((Alcoa to Sell Stake in Jamalco to Noble, Alcoa News Release)) The Jamalco joint venture is 55% owned by Alcoa Minerals of Jamaica (AMJ) and 45 percent owned by Clarendon Alumina Production Ltd. AMJ is part of the Alcoa World Alumina and Chemicals (AWAC) joint venture, owned 60% by Alcoa and 40% by Alumina Limited. ((Alcoa to Sell Stake in Jamalco to Noble, Alcoa News Release))

The move to sell its stake in Jamalco is a part of the company’s efforts to lower the cost base of its upstream alumina and primary aluminum businesses, in order to make them 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 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 the weakness in aluminum demand, and consequently prices over the last few quarters. [1]

On the supply side, production capacity was not reduced corresponding to the subdued demand conditions over the last few quarters. Persistently high aluminum inventory levels relative to demand have kept LME aluminum prices depressed. This inventory was 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 a record high, market forces failed to rationalize supply through the shutdown of smelting capacity. Though global aluminum majors like Alcoa and Rusal did make significant smelting capacity cuts, the same was not true of Chinese companies. This was 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 accounted for around 45% of the world’s aluminum production in 2013, and the expansion in production by Chinese producers more than made up for capacity cuts by global majors. [2] ((Alcoa, Rusal’s Aluminum Production Cuts Not Enough With China Smelting, Metal Miner)) This oversupply situation kept aluminum prices depressed over the last few quarters.

Aluminum prices have rebounded recently. Global smelting capacity cuts in response to low prices have finally taken effect. LME warehouse stocks of aluminum were down around 10% in July, since the start of the year. [3] In view of the global smelting capacity cuts, as per a poll conducted by Reuters in July, the market for aluminum is expected to move from an oversupply of 235,500 tons in 2014 to a deficit of 4,444 tons in 2015. [4] LME aluminum prices averaged roughly $1,800 per ton over the course of the third quarter in 2013. These prices have averaged close to $2,000 per ton in the third quarter this year. [1] However, global smelting capacity restarts in response to higher aluminum prices are expected to lower or eliminate the extent of the deficit next year. In addition, the trajectory of Chinese economic growth will influence aluminum prices to a large extent. With slowing Chinese growth, there is unlikely to be any significant upside to aluminum prices. A significant proportion of Alcoa’s alumina pricing contracts are based on LME aluminum prices. Thus, the uncertainty in aluminum prices affects Alcoa’s Alumina business segment as well. In view of the uncertainty regarding aluminum prices, Aloca has sought to reduce its dependence on its commodity businesses.

Closure of High-Cost Upstream Capacity

Alcoa’s stake in Jamalco accounted for around 4.6% of Alcoa’s consolidated alumina refining capacity of 18.1 million tons per year. [5] The company had announced the closure of the Portovesme smelter earlier on in the year, which reduced Alcoa’s base smelting capacity by 150,000 tons to 3.6 million tons per year. [6] The company has shut down high-cost smelters in response to an uncertain aluminum pricing environment over the past few years. The company’s base smelting capacity stood at 4.23 million tons per year at end of 2012. ((Alcoa’s 2013 10-K, SEC)) The company has stated that its intends to further lower its average cost of producing both aluminum and alumina in the years to come. [7] 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 57.1% in 2011, 2012, 2013 and the first nine months of 2014, respectively. ((Alcoa’s 2013 10-K, 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. LME Aluminum Prices, LME [] []
  2. U.S. Geological Survey Mineral Commodity Summary-Aluminum, 2014 []
  3. Aluminium prices hit 17-month highs, Financial Times []
  4. Aluminium smelter restarts seen undermining global deficit outlook, Reuters []
  5. Alcoa’s 2013 10-K, SEC []
  6. Alcoa to Close Portovesme Smelter in Italy, Alcoa News Release []
  7. Alcoa’s Transformation Is Accelerating, Alcoa Company Presentation []