Over the past year, CRU Consulting has recommended casthouse product marketing strategies to numerous leading aluminium companies and their stakeholders. In fact, the work of CRU Consulting, alongside sister company CRU Analysis, has supported most the casthouse expansions outside China in the last ten years, enabling companies to invest in this complex and opaque market with confidence.
Introduction
Cast aluminium shapes occupy a position in the aluminium value chain between the smelter potroom and the semi-fabricator. Shapes can be divided between remelt ingot on one hand and value added products (VAPs) on the other:
• Remelt ingot is the most common smelter product. It has the most liquid and transparent market and it can be used in all types of semis plant. However, it must be remelted and cast at the semis plant.
• VAPs include rolling slab, billet, primary foundry alloy (PFA) and wirerod. By purchasing VAPs, the semis plant can avoid the cost of remelting and casting and feed the product straight into the semi-fabrication process.
There has been a clear trend away from the production of remelt ingot: in the world excluding China it makes up an estimated 43% of the smelter product mix, compared to 46% in 2011 and 51% in 2009. Or put a different way, smelters outside China have increased production of VAPs by 4.5M tonnes in the last ten years, whereas production of remelt ingot has been virtually unchanged. The surge in premiums during this period provided the incentive: a GCC smelter selling 200,000 tonnes of billet and 100,000 tonnes of PFA to the European market would have made $229m more during 2014-2019, after accounting for the additional revenue and costs, than if the same smelter had just sold 300,000 tonnes of remelt ingot to Europe.
Aluminium companies with a greenfield or brownfield smelting project continue to see the VAP market as an opportunity to enhance returns. Existing producers are proposing to add a VAP casthouse to replace remelt ingot sales. But it is not a one-way street: if too many smelters invest in billet manufacture, for example, the market could tip into value-destroying excess capacity.
The challenge for the aluminium company, in making its business case to shareholders and lenders, is to decide which VAPs to produce, where to sell them, and how to mitigate risk. Then it must demonstrate that this will be better than the low-risk alternative of selling remelt ingot.
CRU’s approach
CRU helps clients to navigate the complex, opaque VAP market. The ultimate driver of demand for casthouse products is the demand for aluminium semis by product form. Thus demand for slab is driven by the demand for rolled products, billet by the demand for extruded products, PFA by the demand for castings and so on. CRU uses its 40 years of understanding end-use markets (transport, packaging, construction etc.) to make the link from underlying economic drivers, through demand for semis, to demand for VAPs and remelt ingot.
On the supply side, VAPs can either be produced at a primary smelter, or they can be cast at a semi-fabricator or remelter using a mixture of remelt ingot and scrap. VAP demand is therefore dependent not only on semis production, but also on the split between primary and secondary shapes.
We identify those markets with an attractive net import requirement and growth potential, in particular assessing the extent to which our clients will need to compete on price to win market share. We forecast the netbacks from producing different VAPs for sale to different regional destinations. CRU’s shape premium forecasts form a key part of this calculation, alongside the costs of duty, VAP casthouse conversion costs, freight to market, finance costs and marketing costs.
Some of our clients are already selling VAPs and the incremental volumes to their overall business may be modest: they are well placed to manage the marketing risk that occurs when selling products that are tailor-made to end-users’ requirements, rather than readily saleable to a buyer of first resort via the London Metals Exchange. But a number of our clients are entering the VAP market for the first time, and need more guidance on barriers to entry and the marketing capability they would have to invest in for the different VAPs.
We use a weighted score methodology to rate the different combinations of product and destination on the criteria below. We align the weightings to match our clients’ experience and risk appetite, to come up with a recommended marketing mix by VAP and product:
• Margin / Netback (1 = highest)
• Size of market (1 = biggest)
• Growth rate of market (1 = fastest)
• Number of buyers (1 = largest number)
• Ease of market entry (1 = easiest)
• Intensity of competition (1 = least intense)
• Trader activity (1 = most activity)
• Liquidity (1 = most liquid)
• Ease of qualification (1= easiest)
• Importance of customer relationship (1 = most important)
Finally, we can demonstrate to shareholders and lenders how the investment in a VAP casthouse would move a smelter down the cost curve. The “net realisation cost” component of CRU’s VBCTM methodology captures all the costs and benefits incurred in the sale of a tonne of metal, i.e. subtraction of the sum of marketing costs, freight to market and interest on finished products but also addition of the premium realised on value added products over remelt ingot, as well as any regional variation in the remelt ingot price above or below the LME benchmark.
Example: a new entrant to VAPs
One of our Clients did not have prior experience of producing or marketing VAPs. For this client, we recommended an optimal product mix of remelt ingot, PFA and billet:
• Billet capacity could also be switched to slab in the future: much of the equipment is common. We explained how slab is a very difficult market to enter and should only be considered if a long term offtake agreement with a customer is reached; but recommended the flexibility to shift production in the future, if a sufficiently attractive off-take agreement can be negotiated.
• We recommended keeping some exposure to remelt ingot, but advised the client to review this if it was able to partner with a more experienced industry marketing group that can feed VAPs into its existing international portfolio, with the possibility of bringing that share down.
We proposed a regional marketing mix that split sales between the three main net importing regions, Asia, North America and Europe. We were able to demonstrate the client’s share of net imports of VAPs in those regions would be a maximum of 4%, and as a share of total billet and PFA demand, its share would be much less. In other words, the client is unlikely to significantly disrupt the markets it targets.
A particularly important set of recommendations was around flexibility. Markets will always be subject to risk, whether that is premiums, volumes or tariffs – the latter becoming particularly visible since the USA imposed 10% import tariffs on many producers in 2018. It was, and still is, unclear whether our client will be able to secure duty-free access to the USA in short to medium term. Operators of value added casthouses have an ongoing process of customer dialogue, forecasting and review to help them determine the product mix and regional splits in the coming year, quarter and month. Building flexibility into the casthouse design was also important, allowing for production to shift between VAPs and if need be, revert to casting remelt ingot in the event it was unable to place its VAPs in the market.
Similarly, we advised the client how to plan for marketing flexibility across different sales destinations.
Conclusion
With so much focus on casthouse product strategy as an opportunity to enhance a smelter or project’s value, it has never been more important that the market analysis underpinning important investment decisions is independent, robust and insightful. The work of CRU Consulting, alongside sister company CRU Analysis, has supported a large number of the casthouse expansions outside China in the last ten years, enabling companies to invest with confidence.
