Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

There's a simple story about why U.S. aluminum is hurting.

Chinese competitors have been sucking up government subsidies to undercut their rivals. Were aluminum to trade in a free market rather than one distorted by Beijing's statist economic policies, U.S. smelters would be fine. Mooted tariffs on Chinese products -- one possible result of a U.S. government investigation of the global trade -- aren't about protectionism, but rather leveling the playing field.

That's a comforting idea at a time when North American production of primary aluminum is running at its lowest levels since 1983. But the reality is harsher: China is winning not because of unfair state support, but because its factories are better, and it can produce metal more cheaply.

Melting Metal
Primary aluminum output by North American smelters is running at its lowest levels since 1983
Source: International Aluminium Institute

Aluminum, to quote an old industry cliche, is basically congealed electricity. The raw material for smelters is alumina, the same near-indestructible substance that makes up rubies and sapphires. Turning that into ductile metal requires melting it under vast electric currents in lines of electrode cells. The Jebel Ali smelter in Dubai, one of the world's largest, can generate about 2.35 million kilowatts of electricity, about the same capacity in all of Lebanon.

With electricity forming between a fifth and a half of the cost of raw aluminum, its price and a plant's efficiency in using it are generally the main factors that make a difference between profit and loss. China is way ahead on both counts.

Just 8 percent of the electricity used in North American smelters last year came from power stations owned by the plant itself, compared to 85 percent in China. This captive power is often cheaper than grid energy, since consumers aren't paying a margin to the generator and don't face increased costs if demand from other users goes up. Chinese producers with captive power pay as little as 0.2 yuan ($0.03) per kilowatt-hour, versus 0.5 yuan for grid power, according to Bloomberg Intelligence analyst Yi Zhu.

Raised in Captivity
Almost all of China's smelter electricity consumption comes from plant-owned captive power sources. Almost all of North America's depends on the grid
Source: International Aluminium Institute

It's a similar situation when it comes to power source. Around three-quarters of North America's smelters get their electricity from hydroelectric power, which tends to be fairly stable in price and has if anything been rising in cost in recent years. In China, most smelters are powered by coal -- and while seaborne prices of that commodity have been on a tear over the past year, in inland provinces where many smelters are based, it's still on the floor.

The Tyranny of Distance
Thermal coal prices have been consistently higher in coastal provinces like Shandong relative to western Xinjiang or coal country in Shanxi
Source: National Development & Reform Commission, Bloomberg

Chinese smelters have taken full advantage of this situation, screwing discount prices out of generators in some of the northern and western provinces where they're most dependent on grid power, according to metals consultancy CRU.

If you think those deals look like uncompetitive subsidies, it's worth considering that their U.S. counterparts have managed to get similar agreements, such as at Alcoa's Massena West facility in New York state. Smelters are often the biggest buyers of electricity on local grids, so one person's unfair subsidy looks a lot like another's preferential commercial price.

The more damning problem for U.S. smelters relates to the technology they use. The higher the current you can pump through a smelting electrode, the lower your energy costs are likely to be per kilogram of metal produced.

All U.S. smelters use older-style technology that runs at less than 300 kiloamperes, according to AME Group, compared with 23 percent in China. About two-thirds in the U.S. are even more antiquated, running at less than 200 kiloamperes versus 4 percent in China. At least half of China's industry is using the latest technology of 400 kiloamperes or higher, compared with 4 percent elsewhere in the world.

None of that is to suggest China's aluminum industry is squeaky clean. The Wall Street Journal last month documented the lengths that the country's largest producer of extruded aluminum pieces, China Zhongwang, allegedly went to in its attempts to evade U.S. import controls. Chalco, the nation's second-largest producer, is government-owned, and in China, the line between state and private ownership can be permeable.

Even so, those calling for fresh tariffs to exclude Chinese metal from the U.S. are being disingenuous if they suggest they're acting in the interests of open trade. The same factors that are hurting U.S. smelters are also damaging Chalco, and helping its more efficient private rival China Hongqiao to prosper.

It's not protectionism that's killing U.S. aluminum. It's free markets.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net