September 16, 2022

Due to a worsening power crisis, aluminum producers in China’s Yunnan province, a key production hub, might cut production by 20 to 30%, or 1 to 1.5 million mt, Shanghai Metals Market stated yesterday, citing a recent producer survey. This revelation comes just days after the local government ordered local producers to curtail production by 10%, or 500,000 mt. Earlier this week, an anonymous source cited by Fastmarkets, proclaimed that deeper production cuts than the initial 10% could occur, as the government plans to ration power until May 2023. At 5 million mt, Yunnan province represents about 12.8% of China’s total aluminum production last year, based on USGS and Fastmarkets data. 

Will more production cuts cause LME aluminum prices to rally? Prices are down nearly 19% in 2022, as last trade on the 3M Select contract was $2,268.50/mt (7:00 AM CST). Also, this is barely off the 2022 low price of $2,233/mt, which was set on September 7.  Aluminum end-users might consider using the recent dip in prices by applying simple hedges involving swaps and call options. One other possible strategy is a costless collar. In this case, a “zero-cost collar” creates a maximum and minimum aluminum price for an end user, as they would simultaneously buy a call option (creating a cap, or maximum) and sell a put option (creating a floor, or minimum). The call and put premiums offset, making the construction costless. It is popular because of the upside price protection, but you sacrifice access to much lower prices if prices should fall. Such positions are standard for consumer hedging, but they can result in opportunity costs or cash costs if metal prices decrease. Please contact AEGIS for specific strategies that fit your operations. (9/16/2022)

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