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Alcoa’s Production Cuts Worked…Well, Almost

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Alcoa’s production cuts

In our discussion of the potential impact of Alcoa’s production cuts, we’d noted that the cuts would not have much impact on aluminum prices. Aluminum prices are determined based on the daily trading in the LME (London Metal Exchange), which is dominated by the financial participants. As a result, LME aluminum prices reflect the prevailing market sentiments.

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Physical premiums

Alcoa (AA) sees physical aluminum premiums as a better reflection of the aluminum industry’s dynamics than the LME’s aluminum prices. It’s important to note that the all-in aluminum price consists of the aluminum price plus regional aluminum premiums. The aluminum premium is a surcharge that consumers must pay on top of the prevailing prices in order to cover the delivery of the metal from the warehouses.

Aluminum premiums are more regional in nature than aluminum prices, so aluminum premiums in the United States are different than in Europe or Japan. Regional aluminum premiums are based on the demand and supply dynamics in the region.

Physical premiums rise

The above graph shows the movement in spot US Midwest aluminum premiums so far this year, as reported by Metal Bulletin. As of November 18, premiums were quoted at $0.09 per pound. US Midwest aluminum premiums have risen by $0.02 per pound, or more than 28%, since Alcoa made the production cut announcement on November 2. In our previous series, we noted that US Midwest aluminum premiums could rise as a result of Alcoa’s curtailments.

Aluminum producers such as Norsk Hydro (NHYDY) and Rio Tinto (RIO) could benefit from the rise in US Midwest aluminum premiums. Together, Rio Tinto and BHP Billiton (BHP) form ~6.2% of the SPDR S&P Global Natural Resources ETF (GNR).

Could aluminum premiums continue to rise further? We’ll explore this in the next part of this series.

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