Rio Tinto (NYSE:RIO) has announced that it is shelving its plans to construct an aluminum smelter worth $4 billion in Paraguay. The company attributed its decision to poor market conditions in the aluminum segment. The decision doesn’t come as a surprise to us, considering that only a few days back the company announced massive spending cuts, especially in the aluminum business. 
The aluminum market is currently oversupplied and prices remain depressed with no upside in sight. Despite the announcement of a massive reduction in smelting capacities by major producers such as Alcoa and Rusal, the downward price trend continues.
Why Has The Project Been Shelved?
Rio’s proposed aluminum smelter in Paraguay was supposed to be built at a cost of $4 billion. It would have been the company’s biggest aluminum smelter with a production capacity of 674,000 tonnes a year once completed in 2016. A number of factors may have driven Rio’s decision to shelve the project for now.
Aluminum prices have been on a downward trajectory for a long time now. The price has struggled to breach $1,850 per tonne on the London Metal Exchange (LME) for months. Producers like Alcoa and Rusal have announced smelting capacity cuts exceeding a million tonnes this year alone. Still, prices remain depressed due to an inventory overhang which is expected to persist for quite some time. Aluminum companies had expanded massively in the last few years on an expected increase in demand from China, but the country itself has built up substantial smelting capacities, leaving everyone else with a capacity overhang. ((LME Aluminum Prices, LME))
The weak aluminum market has been responsible for BHP Billiton’s decision to sell its 33.3% stake in Guinea Alumina, Vale’s decision to sell its 22% stake in Norsk Hydro and Chinalco’s decision to suspend its Malaysian smelter project. Rio Tinto too was looking for a buyer for its Pacific Aluminum division but was unsuccessful in getting the right price due to the weak market. It eventually decided to retain the business for the time being. ((Rio Tinto Moves Away From Paraguay, Daily Finance))
Given its failure in selling a loss-making business, it would have been shocking if Rio had gone ahead with pumping $4 billion into another aluminum smelter. After Sam Walsh took over as new CEO, the company has been very clear about letting returns to shareholders drive its business focus. To bring down its massive debt and maintain its credit rating, Rio has announced plans to cut spending dramatically over the next two years. The spending cuts will result in capital expenditures being reduced to $11 billion in 2014 and $8 billion in 2015. This represents a massive reduction from the peak spending levels of $17.6 billion in 2012. The bulk of the budgets will be spent on the iron ore and copper businesses, while cost reductions of $1 billion in the aluminum division are expected. ((Rio Tinto is delivering on its commitment to create greater value for shareholders, Rio Tinto Press Release))
Given the above, shelving the plan for a new smelter would definitely have been a foregone conclusion for the market.Notes: