The coming crisis for alumina

Low aluminium prices caused by a worldwide glut are flowing through the industry in Australia, with consequences for WA’s South West.

Officially there is no crisis brewing in Western Australia’s bauxite mining and alumina refining industry, which plays a dominant role in the South West, employs thousands of people and makes a major economic contribution to the state.

Unofficially there is ‘smoke’ billowing off the alumina side of a complex process, which is ultimately part of the worldwide aluminium production chain.

Hints that the winds of change are blowing through the three stages of aluminium production, which in WA starts with bauxite extracted in the Darling Range, can be detected across the industry and can all be traced to a single cause – low prices caused by a glut of aluminium (identical to the problems facing the iron ore industry).

Trial shipments of Darling Range bauxite by Alcoa World Alumina & Chemicals (AWAC) earlier this year were explained as a way of developing a new income stream to supplement alumina exports from the organisation’s three alumina refineries – Kwinana, Pinjarra, and Wagerup.

The question not being asked is why AWAC (which is incorrectly referred to as Alcoa in WA) has suddenly started making shipments of unprocessed ore after more than 40 years of converting all bauxite mined into value-added alumina.

The answer, which is emerging from the smoke surrounding AWAC, is that alumina refining has become a low-profit and low-growth business that needs to be propped up by a higher-growth, higher-profit business – bauxite exports.

A good place to start in trying to see through the bauxite/alumina smokescreen to determine what’s happening is at the corporate level of AWAC, which is being dramatically altered.

Formed as a joint venture between one of the oldest industrial companies in the US, Alcoa (with a 60 per cent interest), and Melbourne-based Alumina Ltd (40 per cent, and once an arm of Western Mining Corporation), the AWAC structure is under pressure.

While AWAC remains intact today in name, Alcoa itself is in the process of becoming a totally different company following a split between its metal processing and fabricating arm (to be known as Arconic), and the mining and aluminium production business, which will retain the Alcoa name.

Arconic is expected to emerge as the stronger half of the split. Alcoa is seen as the weaker half, as was confirmed last month when it copped a downgrade by the ratings agency Standard and Poor’s to a BB level, which is seen as ‘sub-investment grade’.

A few years ago, Alcoa was one of America’s leading companies. To be relegated to a category below the credit rating of WA’s once-troubled iron ore miner, Fortescue Metals Group, is stunning.

Unfortunately for Alumina, the junior partner in AWAC, it has been dragged down by Alcoa’s fall and has also been assigned the same sub-investment grade of BB from S&P, a cut that has increased the cost of the company’s debt by increasing the interest rate paid on its bonds from 5.5 per cent to 7.25 per cent.

The comparison between Alumina and Fortescue is worth a closer look, because Alumina’s downgrade in September came a month after Fortescue’s debt was upgraded.

Financial analysts are divided on how to value Alumina. Investment bank Credit Suisse argues that the stock is a ‘buy’, setting a 12-month share price target of $1.30, which somewhat oddly is 16 cents below the current share price of $1.46. (Why buy if you’re expecting a price fall?)

Macquarie, another investment bank, has a ‘sell’ recommendation on Alumina and a price target of $1, noting that it might suffer from “contagion from a weaker joint venture partner” – Alcoa.

But the more important aspect of Macquarie’s analysis is that it doesn’t like the outlook for the merchant alumina business, which is alumina sold into the wider market as opposed to being part of an integrated chain linking mines, refineries and smelters.

And that leads back to the threat of more aluminium smelter closures, which have reduced demand for WA-produced alumina, and more exports of unprocessed bauxite ore, which has become the most profitable part of bauxite-alumina-aluminium chain.

To say an analysis of the bauxite-alumina-aluminium is complex is an understatement, but every indication emanating from a notoriously secretive industry points to a crisis brewing that has the potential to wash across the South West of WA.