Christmas has come early for aluminum bulls.
In London the price of aluminum for three-months delivery hit a five-year high of $2,199.00 per ton on Thursday.
In Shanghai the most active contract went one better, hitting a six-year high of 17,250 yuan per ton.
Speculators are piling into both markets.
Market open interest on the Shanghai Futures Exchange aluminum contract is currently at an all-time high of 1.09 million contracts with volumes elevated since the middle of August.
On the London Metal Exchange (LME), according to LME broker Marex Spectron, aluminum “exhibits the largest speculative long of the complex at 23 percent of open interest.”
Why all the excitement?
Well, it’s not exactly Christmas, but in China winter has come early with the first aluminum smelters now powering down ahead of the mandated cuts over the “winter heating season”.
China’s “Air Pollution Control” regulation, formally approved in February, requires industrial sectors in the four provinces around Beijing to cut output over the November-March period.
The winter cuts are part and parcel of Beijing’s war on smog, which can be particularly acute over the winter months.
In the case of aluminum, smelters, alumina refineries and anode plants will all be affected to varying degrees.
Smelters and alumina refineries are mandated to take cuts of at least 30 percent, implying a collective metal production hit in excess of a million tonnes.
At least a couple of aluminum operators have started powering down early in Jiaozuo city in the province of Henan, according to local industry website SMM, citing a notice from the municipal environmental protection office.
Chalco’s Zhongzhou alumina refinery and the Jiaozuo Wanfang smelter are the names in the frame. Details remain frustratingly sketchy but there are already rumors of more plants taking early action in coordination with environmental authorities.
There are two key points here.
First, the winter cuts are actually going to happen. Despite the clear statement of intent by Beijing policy-makers, there was a good degree of market scepticism as to whether they would.
These winter restrictions represent a second wave of curtailments after Beijing’s drive to close “illegal” aluminum capacity over the last few months.
Second, this whole process is going to be characterized by a lack of transparency with rumors and speculation proliferating in the absence of official confirmation.
For graphic on Chinese aluminum production, click tmsnrt.rs/2xT2pWK
Given the lack of visibility on what is happening in key aluminum provinces, it’s natural for the market to fall back on the “hard” national production figures.
These come from the China Nonferrous Metals Industry Association (CNIA) and are transmitted by the International Aluminium Institute (IAI) as part of its global monthly production report.
The latest figures for August look encouraging for aluminum bulls.
China’s national output was 2.64 million tonnes last month, the lowest headline figure since February and, expressed as average production per day, the lowest run rate since March last year.
Indeed, Chinese production growth turned negative in August for the first time in over a year.
Here, it seems, is the statistical evidence that China’s giant aluminum machine was already slowing due to the closure of “illegal” capacity.
Now, with smelters starting to shutter lines early ahead of the winter heating season, it can only fall further, right?
Just one thing, though. What if the official figures are wrong?
Industry consultant AZ China, for example, claims that “we know the real number (for August) is 3.14 million tonnes.”
That’s a 500,000-ton difference, equivalent to a massive six million tons per year.
It’s a lot of aluminum to go missing.
The problem is not last month’s production figure, which was down by 542,000 tons annualized on July. Rather, it was the 4.0-million drop in annualized production in July itself that set alarm bells ringing.
There remains a strong suspicion that CNIA, a government institution, simply removed all capacity designated as “illegal” from its July numbers, irrespective of the capacity’s actual status.
If AZ China is right, national output isn’t falling at all but has been rising sharply.
It is clear that something tectonic is happening to China’s aluminum supply chain.
What’s not clear at all are the mechanics of this shock to the country’s production sector.
And the mechanics are complex.
The drive to eliminate “illegal” capacity, for example, is directly interacting with the seasonal winter cutbacks.
There’s been much debate among China watchers as to whether capacity closed as “illegal” can be counted toward the winter cut quota. The answer seems to be a tentative yes.
Then there is the active trading of capacity permits between provinces with “dead” capacity and provinces with new unauthorized capacity.
Henan, one of the provinces affected by the winter cuts, for example, has just put another 70,000 tons on the transfer market.
This “obsolete” capacity comes from three closed smelters, their tiny size suggesting they were shuttered a long time ago, when Beijing was forcing out such small operators.
The transfer should allow an equivalent amount of “illegal” capacity to be restarted, assuming it has indeed been closed.
Amid this whirlwind of change, the anchor point should be the official production numbers, but there’s enough fog swirling around these to inject considerable uncertainty into the whole complex equation.
One other “hard” piece of the jigsaw comes in the form of visible stocks registered with the Shanghai market.
At 542,752 tons these are at record highs, seeming to corroborate anecdotal reports that off-exchange stocks are also high.
It makes sense that smelters in the targeted regions have been maxing out production ahead of the winter cuts, another question mark left hanging over the official monthly production snapshot.
Pricing what’s happening in China remains chaotic work in progress and one that will remain acutely sensitive to the stop-start flow of information out of the country.
With so much money recently entering the aluminum market on the long side, a bumpy, volatile ride seems assured.
Winter may be coming early for China’s smelters but, for aluminum bulls, Christmas is still a long way off.