Overview
Laura, what's keeping people in your sector awake at night?
There's been a lot of volatility in my space. And you're sort of caught between greed and fear. There's a lot of fear about recession in Europe, possibly recession in the US, and that’s offset by the potential upside that would come if China successfully manages to relax its Covid regulations and restrictions, and what that might mean for demand for the commodities my companies produce.
Aluminium producers in Europe are under threat I understand?
So, for any kind of manufacturer in Europe, power and gas prices pose quite a significant problem. Take fertilisers as an example, you've seen about 75 per cent of European production shut down temporarily for now and we don’t know how much is going to come back.
Similarly, in aluminium producers, unless you’ve hedged power costs, you're running at quite significant losses at current power prices. Some European producers will have hedged power contracts, but these will be of limited duration. Over the next six months or so you're going to see more and more of those contracts roll off, which will put existing production under even more pressure.
The problem is you've got very high power prices, but also very low prices at the moment for the final product and the prospect of a recession worsening that picture going forward. I think companies will take difficult decisions quite quickly once they start paying the full power price.
You mean turn off production?
You can't just turn a smelter on and off quickly, it takes time. So producers will often continue producing at a loss (if they’re still covering fixed costs, as an example) to avoid the additional costs and delays of turning production off and on. But if you're looking at an environment where there's no upside to aluminium prices in the short term, you have to hope for a surge in demand that kind of bails you out in order to justify keeping production online. But given the macro backdrop globally, it's difficult to see that in the short term, which means that, I think, these producers will make decisions about closing [some facilities] this year rather than later.
Closing sounds really dramatic. So that's no aluminium being produced in Europe?
Or just much, much less.
Does that not worry governments?
Obviously as you see in the Inflation Reduction Act in the US, security of supply of commodities is a big deal everywhere at the moment, but I guess it's a hierarchy of needs.
What needs?
In Europe, your primary concern right now is securing enough energy. So gas where you can, coal where you can, oil where you can outside of Russia. If you have markets with diverse sources of supply globally, then that's probably not somewhere you're going to prioritise. If you want to keep these plants open, they're going to need subsidies.
And public budgets are hard pressed…
Governments are trying to cut power prices for consumers and businesses, there's not that much money to throw around. Is aluminium necessarily where you are going to choose to provide support? In some cases, potentially, if it's a very significant employer in a region. But it's going to be on a case-by-case basis.
Are there green shoots there for investors?
I’m sniffing around. I think we’re getting close to the bottom of the cycle but it is very hard to find attractive valuations or where I think equities are pricing in the right scenario. Ideally what you are looking for is something like what you’re seeing in aluminium where the commodity price is on the floor, the shares have derated substantially, and you can have conviction that at some point the demand environment will improve. So that's probably somewhere I'd be looking at over the next six months.
So we seem to be very close to the bottom on aluminium, just there's still fear about the scale of the recession coming?
Exactly.
