Why Are Alumina Prices a Key Driver for Aluminum Companies?

Alumina prices impact different aluminum companies. First, let’s look at aluminum’s value chain. It begins with mining bauxite, one of the most abundant metals in the earth’s crust. Because of bauxite’s many impurities, it must be refined to produce alumina. Alumina is then processed to produce raw aluminum. Companies like Rio Tinto (RIO), Norsk Hydro (NHYDY), and Alcoa (AA) have alumina refining as well as aluminum smelting operations. However, Century Aluminum (CENX) produces aluminum by sourcing alumina from outside parties.

Investors looking to diversify the risk of investing in a single security can also consider the SPDR S&P Global Natural Resources ETF (GNR). Almost a quarter of GNR’s holdings are invested in metal companies.

Alumina is a key input in aluminum’s production process. It can take almost two pounds of alumina to produce one pound of aluminum as can be seen in the graph above. Naturally, changes in alumina prices would impact aluminum’s production cost.

Alumina doesn’t have a very liquid market, and that makes pricing it difficult. Aluminum, on the other hand, is the most widely traded metal on the London Metal Exchange (or LME). As a result, most alumina producers used to price their products at a percentage of aluminum prices. However, over the last few quarters, several aluminum companies have been gradually moving away to the alumina price index (or API).

Alumina prices through API are less dependent on aluminum prices and help in independent price discovery of alumina. Nonetheless, alumina prices can’t be totally independent of aluminum prices. This is similar to the steel industry, where iron ore and steel prices have a close correlation with each other.

In the next part, we’ll explore the recent trend in alumina prices and how they impact Alcoa and Century Aluminum.