Base metals prices are mixed as we start 2023. We have identified several potentially bearish items (and a few bullish items) related to slowing demand and lower energy costs.
Global Supply/Demand (Equally Bearish/Bullish, Surprise).
Argus’s weekly domestic HRC assessment was unchanged this week at $1,150/st, breaking the streak of six consecutive weekly rises. Mills are reporting sales at $1,150/st, while others such as Cleveland-Cliffs and Nucor are targeting $1,200/st. No sales have been reported at $1,200/st, however. Buyers are now cautious about new purchases, fearing that prices could drop in 2H2023. AEGIS notes this cautiousness could stem from the nearly 40% rally in the prompt month (March) CME HRC futures that has occurred in the past two months.
We also note that this skepticism on HRC prices could also stem from increasing production. US Steel said last Thursday it has reopened its 1.5 million st/yr furnace in Gary, IN due to improved demand. This furnace had been idled since September 2022 due to poor steel prices and high import volumes. The company in February had already reopened the 1.4 million/yr furnace at Mon Valley Works in Pennsylvania. AEGIS notes that most American steel producers have over-doubled their base price for physical sales to $1,100/st or higher compared to late last fall due to this uptick in demand. This in turn has led to a significant rally in CME HRC futures. Most of the rally in CME HRC has occurred towards the front end of the futures forward curve, leading to a severely backwardated market. We do note that production capacity has been increasing since early January while prices have been rising due to increasing demand. Please contact AEGIS on how steel consumers should hedge in a severely backwardated market.
Finally, regarding aluminum demand, China imported 538,000 mt of Russian aluminum between March 2022 and February 2023, up 94% compared to the previous 12 months, according to Chinese customs data. This surge in import volumes could put a “floor” underneath Russian production, according to Capital Economics. Rusal, which is Russia’s top aluminum producer and one of the world’s largest, produced 3.84 million mt in 2022, up about 2% from 2021. AEGIS has been following Russian aluminum export flows in recent months, and we note that some trading houses have broken ties with Rusal, while others are pursuing opportunities. According to Bloomberg, Trafigura is in talks with Rusal to purchase 150,000 mt/yr on a delivered-China basis, while Glencore will end its relationship with Rusal next year. Please contact AEGIS for further discussion on the potential market impact of these evolving relationships and import flows, as well as LME aluminum hedging strategies.
USD/Federal Reserve Policies (Mostly Bearish, Equally Priced In/Surprise). On March 22, the Federal Reserve raised interest rates by 25 bps, putting the Fed Funds target rate between 4.75% and 5.0%. In their statement, they removed the phrase “ongoing increases in the target range will be appropriate” and replaced it with "some additional policy firming may be appropriate." The median forecast for the target rate at the end of 2023 was 5.1%, and 4.3% at the end of 2024. Thus, interest rates could stay near 5% for most of 2023. They also noted that inflation remains elevated.
As for the US Dollar, the USD index fell after the latest FOMC announcement. The Federal Reserve’s policy appears dovish; however, it is yet to be known how metals markets will react over the long term. If this policy is perceived as dovish, this would be bearish to the USD. Due to the inverse relationship of the DXY and dollar-denominated commodities, an interest rate policy that is bearish on the DXY and therefore could be supportive of CME & LME metals prices. As always, we will continue to watch the Federal Reserve’s actions and any hints of future rate hikes.
Energy Costs (Bearish, Mostly Surprise). The aluminum production issues in Europe show no signs of slowing. European primary aluminum smelter capacity will shrink this year; however, the market impact will likely be minimal. German aluminum producer Speira Gmbh will close its 145,000 mt/yr Rheinwork primary smelter and revamp operations for aluminum rolling and recycling. The company cited stubbornly high electricity prices for the change. AEGIS notes that this could be an outlier event, as it is the first time that a European smelter has announced it is switching operations after a previous curtailment. If this trend continues, primary aluminum supplies could drop, leading to higher prices.
The LME primary aluminum market has largely shrugged off the number of curtailments that occurred in Europe, with prices finishing down about 15% last year and essentially flat in 2023. AEGIS wonders how much aluminum prices need to rally, or electricity prices need to fall, to entice production. According to our research, most aluminum smelters are subject to month-ahead electricity prices, as opposed to longer-term contracts. Using our European smelter margin calculator which is based on month-ahead electricity prices, we estimate that in most cases margins are at least $800/mt away from enticing previously curtailed production to restart. We note that margins have improved dramatically over the past several months, largely because electricity prices throughout Western Europe have fallen by over 80% or more since last August. However, in some cases, electricity prices are still nearly double historical norms. It appears that electricity prices need to fall further, or aluminum prices need to rally, to incentivize producers to increase production.
CME natural gas prices could be starting to stabilize. Prompt month April ’23 now sits near $2.45/MMBtu, up over 30 cents from the lows of late February. The April through September ’23 contracts now hover between $2.50/MMBtu and $3.25/MMBtu. We note that even with the recent rally, prices are still down nearly $3.50/MMBtu from the highs of early- to mid-November. Thus, this could be a good time for consumers such as aluminum extruders to hedge future natural gas needs. We also note that natural gas prices have been extremely volatile in recent weeks. Please contact AEGIS for specific strategies that fit your operations.
Economic Slowdown (Bearish, Mostly Surprise). Most recent economic data shows that economies throughout the world are slowing. For example, most economic data taken from China’s Lunar New Year indicates better activity than in 2020 & 2021 but is still down compared to the pre-COVID era. Slowing economies, especially that of China’s, will likely weigh on metals prices and demand. However, we will keep reading the “tea leaves” for any hints of economic recoveries and predicted ramp-ups in metals demand.
Tariffs/Regulations (Bearish, Priced In). On Friday morning, February 24, the White House announced it will increase tariffs on imports of Russian aluminum to 200%, up from the current level of 35%. AEGIS believes this could provide a bullish price risk to the aluminum Midwest Premium (MWP) market; however, this price risk exposure can be mitigated via CME MWP swaps. This bullish price risk exists mainly because this tariff could effectively shut off our imports of Russian aluminum. Moreover, those that buy Russian aluminum would need to fill the void by buying from other global suppliers. As US buyers compete for the same cargoes as other major importers, the MWP would likely need to rise to entice cargoes that would otherwise go to Europe or elsewhere. Please contact us for further thoughts on the Russian tariff/sanction situation and implications for the MWP.
According to Bloomberg, this “tariff on Russian aluminum will take effect on March 10, and aluminum products which are manufactured using any amount of aluminum cast or smelted in Russia will be affected from April 10.” This announcement comes on the one-year anniversary of the start of the Russia-Ukraine conflict. Based on USGS data, approximately 3% of U annual aluminum imports currently come from Russia. However, as we stated above, this new tariff could drop import volumes to zero. (Sources: Bloomberg, Reuters, White House, USGS)
Raw Materials (Bullish, Mostly Priced In). Bloomberg Intelligence expects a global copper market surplus of 91,000 mt this year, compared with a deficit of 106,000 mt in 2022. The supply surplus could more than quadruple to 369,000 mt in 2024, even if developed market regions avoid a recession. If those regions enter a recession, the supply surplus could reach almost 400,000 mt this year. AEGIS notes in both of Bloomberg’s “best” and “worst” case scenarios, supply will continue to grow and ultimately outpace demand. Under normal market conditions, a copper surplus would likely put downward pressure on futures prices. Please contact us for strategies that involve LME or CME swaps or options.