Table of Contents. Executive Summary 1. Background 3. Aluminum Production 4. Aluminum Demand 12. Aluminum Prices 16. GCC Aluminum Sector 19

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3 Table of Contents Executive Summary 1 Background 3 Aluminum Production 4 Aluminum Demand 12 Aluminum Prices 16 GCC Aluminum Sector 19 United Arab Emirates 20 Bahrain 24 Qatar 25 Saudi Arabia 26 Oman 27 Kuwait 28

4 Executive Summary Aluminum, also called aluminium, is the third most abundant element in the Earth s crust and constitutes 7.3% by mass. The Aluminum industry makes a significant contribution to the global economy as well as to more than thirty individual economies. It is estimated that the Aluminum industry employs over a million people world-wide. Aluminum smelting is a capital-intensive, technology-driven industry concentrated in a few relatively dominant companies. In recent years, China has emerged as a main driver of market fundamentals. Russia is also growing in importance in terms of industry developments and the GCC region is set to emerge as a major production centre due to availability of cheap source of power which constitutes more than 25% of the cost. Aluminum consumption has enjoyed good average growth over the last few decades, partly due to general economic growth and partly due to its substitution of other materials. Total aluminum consumption, primary and recycled-based, has been growing at a somewhat higher rate than the development in overall industrial production, while primary aluminum consumption shows a growth rate corresponding to or slightly higher than industrial production. Both production and consumption in China continued to increase at a rapid pace, up about 18 percent in 2006 compared with In 2006, China accounted for about 25 percent of global primary aluminum consumption, contributing about 4 percentage points, or about 55 percent, to the total increase in world consumption. China s share of global primary aluminum production in 2006 was about 27 percent. Further, it seems likely that China will depend on increasing imports of scrap and off-grade metal to meet domestic needs and as a basis for export of semi-fabricated and finished products. It is possible that domestic aluminum production, together with scrap imports, will not be sufficient to meet the growth in Chinese demand over time, resulting in the need to import primary metal. During the last three years, there has been an upward shift in the cost curve for primary aluminum production, triggered mainly by a significant increase in energy prices in historically-important producing areas for aluminum. The increase in energy prices is also influencing the cost of, and consequently the price for, alumina, as well as other important cost elements. Even though the estimated long-term aluminum price expectation has been increased, announcements of temporary and permanent closure of aluminum production plants have been made in Europe and the United States, the regions most severely affected by the cost increases. In general terms, aluminum production plants in these regions may be subject to closure if they are unable to renew or replace their power contracts at sustainable terms. Aluminum production which was once confined to western countries, is now shifting to the developing world. Within the developing world, it is shifting to those countries that either have the raw materials or have the energy resources to produce aluminum namely the GCC region with its abundant energy resources. The GCC region has two established smelters in the UAE and Bahrain. Aluminum Bahrain (ALBA) was commissioned in 1971 to diversify the national economy from its heavy dependence on oil. ALBA has since grown from a modest 120,000 tonnes per annum smelter to 872,000 tonnes per year, making it one of the largest smelters in the world, with plans to expand the capacity further to 1.3mn tones per year. 1

5 Besides U.A.E. and Bahrain, other GCC countries - Oman, Qatar and Saudi Arabia too, are planning to set up aluminum smelters, entirely on the basis of the availability of inexpensive gas. Saudi Arabia also has deposits of bauxite. U.A.E., because of its leading and successful DUBAL, is poised to be one of the leaders because of its experience and expertise. Metals and mineral sector in the Middle East region is attracting private as well as foreign investment and the region is in a favorable position in terms of lower fuel cost, geographic positioning for exports and government support to develop the sector. There are several major smelters coming up in the region and finding enough bauxite to feed them will be a challenge. Alumina supplies account for 45% of smelters operational costs while power is responsible for about 25%. Most GCC producers will have to import raw materials for production but the energy reserves in the region will ensure the GCC remains competitive in the world of aluminum industry over the next decade. Investing in the aluminum sector will diversify GCC economies and they will finally have a large export industry that does not rely on oil production. New capacity, needed to replace closed capacity and to meet increasing future demand, is expected to be largely developed in energy-rich areas where at least some of the energy resources have limited alternative value in the foreseeable future. Such countries and regions include the Middle East, Russia, Iceland and some countries in Africa, Asia and South America. 2

6 Background History Aluminum, also called aluminium, is the third most abundant element in the Earth s crust and constitutes 7.3% by mass. It has the symbol Al and atomic number 13. Its name was derived from the Latin word alumen. Its most important properties are corrosion resistance and light weight. Naturally aluminum only exists in very stable combinations with other materials (particularly as silicates and oxides), and mostly found as the ore bauxite. It was not until 1808 that aluminum s existence was first established. It took many years of meticulous research to unlock the metal from its ore and many more to produce a viable, commercial production process. Aluminum has only been produced commercially for 146 years and is still a very young metal. Mankind has been using copper, lead and tin for thousands of years and yet today more aluminum is produced than all other non-ferrous metals combined. Applications Aluminum is essential to modern living. Without it, commercial air travel would have been difficult. It makes a key contribution to fuel-efficient engines in cars and trucks as well as to high speed rail and sea travel. It facilitates the construction of corrosion-resistant and low maintenance cost buildings. Aluminum in packaging preserves food quality and avoids waste. Its low weight reduces fuel consumption and emissions during transportation. Globally, most high voltage overhead transmission and distribution lines over long distances are made of aluminum. Exchange trade Aluminum is traded on the London Metal Exchange (LME), the New York Mercantile Exchange (NYMEX), the Tokyo Commodity Exchange, the Osaka Mercantile Exchange (OME) and the Shanghai Futures Exchange (SFE). The LME aluminum forward is quoted in US dollars per ton. On NYMEX, aluminum is quoted in US cents per pound. Economic contribution The Aluminum Industry makes a significant contribution to the global economy as well as to more than 30 individual national economies. It is estimated that the Aluminum industry employs over a million people world-wide. Aluminum smelting is a capital-intensive, technology-driven industry concentrated in a few relatively dominant companies. In recent years, China has emerged as a main driver of market fundamentals. Russia is also growing in importance in terms of industry developments. There are two raw material sources for new aluminum products: primary aluminum made from electrolysis of alumina, as well as from re-melting and recycling of aluminum scrap. Scrap is generated throughout the value chain while producing finished aluminum products and is collected in the marketplace after the use of the products is over. The recycling process requires approximately 5 percent of the energy needed in the electrolytic primary production process. About one-third of new aluminum products are made from collected scrap according to the International Aluminum Institute (IAI). 3

7 Aluminum Production Aluminum ore, most commonly bauxite, is plentiful and occurs mainly in tropical and subtropical areas: Africa, West Indies, South America and Australia. There are also some deposits in Europe. Bauxite is refined into aluminum oxide (alumina) and then electrolytically reduced into metallic aluminum. Two to three tonnes of bauxite are required to produce one ton of alumina and two tonnes of alumina are required to produce one ton of aluminum metal. Three major global integrated companies have emerged from the substantial consolidation of upstream aluminum activities in the past 10 years: Alcoa, Alcan and Hydro controlling more than 35% of the market. We expect the consolidation activity within the aluminum industry to continue. In addition to the three integrated companies, there are several large companies that focus mainly on upstream operations -- bauxite, alumina and/or primary metal -- such as BHP Billiton, based in Australia and the United Kingdom; Rio Tinto Aluminum, based in Australia, and CVRD, based in Brazil. The Russian aluminum industry is being consolidated into one major company as a result of the announced merger of two Russian companies, Rusal and Sual, and the Swiss natural resource group Glencore, which will contribute part of its aluminum business. The new company, United Company Rusal, will control Russia s entire annual aluminum output approaching 4mn mt, but will have only minor downstream operations. Table 1: Bauxite Reserves Bauxite Reserves (in Giga tonnes) Guinea 8.6 Australia 7.7 Brazil 2.5 Jamaica 2.5 China 2.3 India 1.4 Source: United States Geological Survey Global production remains supported by Chinese growth Since the 1990s, China has emerged as a major consumer as well as producer of primary metal. The industry structure in China is still rather fragmented with many small- and medium-sized companies, although the number of players has been reduced by more than 40 percent during the last four years. Chalco has evolved as the most significant operator in China; with a 2006 production of about 1.8mn mt. Alcoa has an 8 percent ownership interest in Chalco. Many smaller companies have merged with or been taken over by Chalco. According to the IAI, total output for the first three months of the year rose by 11.9% yearon-year to 8.866m tonnes with the steady growth in all producing regions with the exception of Africa. However, the bulk of support came from a 38.8% rise in Chinese production over the same period to 2.859m tonnes. Production outside China rose only 2.4% year-on-year over the first quarter to 6.007m tonnes. Chinese alumina company Bosai Minerals Group is reportedly considering the construction of a 400,000 tpy aluminum smelter in Guyana, to be constructed over the next five years. 4

8 Regional production trends Smelting needs access to cheap electricity. In the past 20 years this has taken place mainly in energy-rich areas such as Canada, Australia, Southern Africa and the Middle East. In spite of the uncertainty of domestic energy supply, the greatest expansion has occurred in China. Table 2: Aluminum Production by Region ( 000 tonnes) Region %(05-06) Africa 1,428 1,711 1,753 1, % North America 5,495 5,110 5,382 5, % Latin America 2,275 2,356 2,391 2, % Asia (excl. China) 2,475 2,735 3,139 3, % West Europe 4,068 4,295 4,352 4, % East/Central Europe 3,996 4,139 4,194 4, % Oceania 2,198 2,246 2,252 2, % China 5,547 6, , % Total 27,482 29,281 31,269 33, % Source: International Aluminum Institute China China has witnessed a major increase in Aluminum production capacity over the past five years. Figures have almost gone up three times since 2001, and all future forecasts show a strong growth in the Chinese aluminum industry. Table 3: China s Aluminum Production Production Year Production Capacity (mn tonnes) Jan - Apr (2006) 2.8 Jan - Apr (2007) 3.8 Source: index mundi, International Aluminum Institute (IAI) Aluminum Corporation of China Ltd., CHALCO, is the main producer of aluminum in China. It is a state-owned company and the only producer of alumina, which is needed to produce aluminum. CHALCO has been actively seeking to acquire the smaller independent smelters in China, and since December 2005, it has been successful in acquiring 7 smelters in China, with a capability of producing 1mn tonnes of aluminum. China s second largest aluminum producer is the Qingtongxia Aluminum Group. The company has recently signed a joint venture with Canadian aluminum giant, ALCAN, and this venture will see its yearly contribution to the Chinese aluminum capacity at 400,000 tonnes a year. The group is planning many upgrades so as to achieve its desired capacity of 700,000 tonnes per annum by

9 China has a wealth of smaller independent smelters, such as the Shandong Huaxin Aluminum Company and Shanxi Guanlv Holding Co. Ltd, which have an annual capacity of over 330,000 tonnes of aluminum per year. Smelting in China is fuelled mainly by domestic coal-fired electricity. Energy shortages in 2004 led the central government to replace an export rebate with an export tax, to increase electricity prices and to restrict investment in aluminum smelting. Further restrictions were imposed in 2005 to discourage new projects. This appears to be slowing down the investments in new smelting capacity. Even though world price of aluminum is expected to fall due to China s continuing production increase causing an aluminum surplus, China is not expected to significantly feel the impact as its increased production is likely to outweigh the price drop. The aluminum industry in China is blossoming, and production is expected to rise significantly as they continue to expand their facilities and production capacities. Chinese aluminum production leaps to 12.2m tpy annualized The release of Chinese aluminum production data for February has further helped to explain the rise in spot alumina prices in early The annualized rate of Chinese aluminum production jumped to 12.2m tpy in February, from 11.2m tpy in January. The commissioning of idled capacity due to increased alumina availability has supported this acceleration in production growth. We estimate that there was around 1.8m tpy idled smelting capacity in China and the reactivation of a large proportion of this has supported the higher rate of Chinese aluminum growth since mid What this suggests is that there is likely to be a further slowdown in the rate of Chinese aluminum production growth further out. Nonetheless, we forecast Chinese aluminum production to 12.6m tonnes this year. The global alumina demand will be higher than expected this year and what impact this has on alumina prices will depend on the strength of supply. As with demand, the major factor shaping global alumina supply is China. Chinese alumina production continues to rise at a strong rate. For the first two months of this year alumina production rose by 60%, year-onyear, to over 2.8m tonnes (18.9m tpy annualized). The commissioning of capacity across a number of refineries is driving this increase in production. In particular, rising alumina production in Shandong and Henan provinces continue to be the largest contributor to the strength in Chinese output growth. In Henan province, alumina production will be supported by higher output at Wanji, East Hope and Sanmenxia Kaiman refineries. In Shandong, two of the largest refineries in the region are the 4.2m tpy Chipping Xinfa and the 2m tpy Weiqiao, both of which are ramping up production. Moreover, the latest refinery to commence production in the province is the 400,000 tpy Lubei Chemical operation. However, the refinery, as yet, does not have a license to import bauxite and this may stretch the start-up schedule. We estimate that around 80% of the refining capacity in Shandong is dependent on imported bauxite and thus it is not surprising that we see an accompanying surge in bauxite imports. Chinese bauxite imports ballooned to 2.6m tonnes in the first two months of this year, compared to 685,000 tonnes in the same months of If this rate is maintained then imports will surpass the 16m tonne level for the whole of this year. Indonesia remains the key bauxite supplier with India and Australia playing a larger role. 6

10 Russia Russia is the world s second largest producer of Aluminum. For the past five years, the Russian aluminum production has been steadily increasing, even though at a slow rate. Table 4: Russian Production Production Year Production Capacity (mn tonnes) (as of September 2006) Source: Index Mundi RUSAL, accounted for 2.714mn tonnes of Russian aluminum production in RUSAL was found in 2000, and is currently the world s third largest producer of aluminum. RUSAL operates four smelters. On 15th December 2006, the launch of another smelter, Khakhas Aluminum Smelter, had taken place. This new smelter has the initial production capacity of 71,000 tonnes, but when fully operational, it will produce approximately 300,000 tonnes of aluminum per annum. The Siberian-Urals Aluminum Company (SUAL) is another company that shares the production load of Russian aluminum. It was found in 1996 after a merger between Irkutsk and Ural Aluminum smelters, and it currently produces approximately 1mn tonnes of aluminum annually. It is the second largest aluminum producer in Russia, and it is firmly placed in the world s top ten production capacity list. In late December 2006, RUSAL announced that the company s creditors have approved the transaction to merge RUSAL, SUAL and the alumina assets of Glencore International AG, to form United Company Rusal. The shareholders of RUSAL will own 66%, SUAL will own 22% and Glencore will own 12%. United Company Rusal became the new leader in the global aluminum and alumina production industry. The total production capability is 4mn tonnes of aluminum and 11mn tonnes of alumina. The combined company commands 12.5% of the global primary aluminum market and 16% of the worldwide alumina volumes. It is also reported that the company will go public by early 2008, with IPO sales to reach up to 25% of the companies stock. Even though world price for aluminum is expected to decrease, the formation of the new Russian Aluminum company, the major increase in production, and the impending sale of Russian Aluminum IPO s, the Russian aluminum industry is seen as a healthy and thriving industry, with even more future projects and upgrades already being planned. Canada The third largest producer of aluminum, Canadian aluminum production has been increasing steadily over the past 5 years, barring the Overall, total production capacity has increased, 7

11 and with new upgrades being planned, it looks as if the production will increase for a while. Table 5: Canada s Aluminum Production Production Year Production Capacity (mn tonnes) Source: Aluminum Association of Canada Canadian production has been steadily increasing over the years, and it is the efforts of two worldwide aluminum giants that are having this effect on the Canadian aluminum market. Together they represent the vast majority of the Canadian aluminum production capacity, and they are currently ranked 2nd and 3rd in worldwide aluminum production. Aluminum Canada (ALCAN) is the largest Canadian aluminum producer. It owns 7 smelters in Canada, and has a stake in 2 others. Its total worldwide production capacity reached 3.483mn tonnes in 2006, of which 1.748mn tonnes were produced in Canada. ALCAN has recently announced that it will invest US$1.8bn to expand its Kitimat Aluminum plant. This expansion will see the 250,000 tonnes capacity smelter upgraded to a 400,000 tonnes capacity smelter. The other major player in Canadian aluminum is ALCOA. The US based company has a large stake in the Canadian aluminum industry, and it produces approximately 1mn tonnes of aluminum in Canada annually. Most of its Canadian operations are based in Quebec and Ontario, and it has plans to upgrade and modernize several of the existing plants to help increase its Canadian production. As the third largest aluminum producer in the world, and as a host to two of the top three aluminum companies in the world, Canada is a real contender in the world s aluminum market. With planned expansions by both companies taking place soon, the overall production of Canadian aluminum is expected to continue its steady increase. Moreover, ALCAN has been able to forge many joint-ventures and acquisitions in the world, and it seeks to continue improving its worldwide production figures. With prices set to fall next year, and production to only marginally increase, Canada could be slightly affected. United States US, thanks to low-cost hydro- and coal-fired power, was the world s largest producer of primary aluminum till In 2000 an energy shortage in California played havoc with electricity prices in the Pacific Northwest, putting a large block of primary smelter capacity out of business. Normalcy returned to the regional electricity market in 2002, but much of the 8

12 smelter capacity in the region can be considered permanently closed. US aluminum imports rose by over 1m tonnes between 2000 and 2005 and the US is the world s largest importer of primary metal. Currently, US is the 4th largest aluminum producer in the world. The production capacity has been stable over the past five years, with marginal rises or drops in the overall production. Table 6: United States Aluminum Production Production Year Production Capacity (mn tonnes) Source: Index Mundi, Aluminum Statistics The main aluminum leader in the US is the Aluminum Company of America (ALCOA). ALCOA, found in 1886, was the world s leader in aluminum production, owning smelting sites all around the world. However, after the merger between RUSAL, SUAL, and Glencore, ALCOA is now the worlds second largest producer of aluminum and related products. Another leader in the aluminum production field is the Century Aluminum Company which owns 3 large smelting facilities in the US, and co-owns two others. It also has a large investment interest in Iceland, where it is upgrading a smelter to increase production capacity. In 2006, Century produced approximately 510,000 tonnes of primary aluminum in the US, while its total worldwide production was approximately 685,000 tonnes of aluminum. It is forecasted that in 2007, its production in the US will be around 515,000 tonnes of aluminum, while its worldwide aluminum load is expected to be 785,000 tonnes. Production in the US is expected to increase next year because of an increase in the demand for aluminum, which is mainly driven by the aircraft industry. These production and consumption increases are expected to outweigh the predicted fall in the aluminum price and with more upgrades and cost reduction techniques on the cards at ALCOA. Global Aluminum Production Shift According to Alcan, the Middle East s contribution to global aluminum production has increased from 1% in 1980 to 6% in 2006 and is expected to increase to 10% by The major shift in production was witnessed in China as it contributed to 27% of global aluminum production in 2006 from only 2% recorded in

13 Chart 1: Aluminum production by region Other 19% China 2% Former USSR 17% Other 21% China 27% Australia 2% Europe 22% Canada 7% Middle East 1% Europe 12% USA 7% Former USSR 12% USA 30% Middle East Canada 6% 9% Australia 6% 2020 E Other 23% China 23% Europe 8% USA 5% Middle East 10% Canada 7% Australia 4% Former USSR 20% Source: Alcan; Global Research However, its share of aluminum production is expected to slightly decrease to 23% of world s total production, as new capacities are being planned in the energy rich areas in the former USSR and the GCC region. China has been responsible for almost 50% growth in the world primary aluminum consumption and production in the past decade. On the other hand, US and Europe s contribution to the world production has declined from 30% and 22% in 1980, respectively, to 7% and 12% in Market Balance At present, we believe the market will remain finely balanced into Q2. As supply, especially from China, begins to outpace demand growth in the second half of the year, we should see the market move back into surplus. As a result, a retreat in prices from current levels is anticipated. 10

14 Table 7: Global Market Balance ( 000 ton) E 2008E 2009E Global production 26,076 28,001 29,922 32,021 33,952 36,349 38,344 42,143 Global consumption 25,625 27,882 30,262 32,020 34,390 36,114 38,063 42,266 Global balance Source: IAI; Metal bulletin Research; Global Research Expansion The 560,000 tpy Qingtongxia aluminum smelter has received formal approval from India s central government to progress with a joint venture alumina project. The US$651mn (Rmb 5 bn) venture with India s Ashapura Minechem Co is expected to have an initial capacity of around 1m tpy, with plans for future expansion. Qingtongxia plans to use the alumina to help raise its aluminum smelting capacity to 700,000 tpy. The Western Australia government has granted environmental approval for an expansion at the Wagerup alumina refinery. The construction of a third production unit at the refinery would raise capacity from its current 2.4m tpy to 4.7m tpy. Feasibility studies for the expansion are currently underway with a decision likely to be made in early Venezuela has agreed to supply gas to Jamaica s 1.4m tpy Clarendon refinery, following Trinidad & Tobago s decision to pull out of an agreement to supply liquefied natural gas to the plant. Clarendon had recently completed the construction of a 150,000 tpy expansion but had been forced to halt a 2nd stage, 1.35m tpy expansion due to a lack of gas supply. Global Alumina Corporation has agreed to sell two-thirds interest in its greenfield alumina project in Guinea to BHP Billiton, Dubal and Mubadala for US$260mn. The US$260mn will be paid in four installments. The first payment of US$151.1mn will occur within 10 days of the confirmation by the parties that all conditions precedent to the completion are satisfied. The remaining installments will be due when specified milestones are met. The final agreement will see the ownership structure as Global Alumina (33.33%), BHP Billiton (33.33%), Dubal (25%) and Mubadala (8.33%). The project involves a 3m tpy refinery to be constructed in two phases at a cost of US$3bn. 11

15 Aluminum Demand Aluminum consumption has enjoyed good average growth over the last few decades, partly due to general economic growth and partly due to its substitution of other materials. Total aluminum consumption, primary and recycled-based, has been growing at a somewhat higher rate than the development in overall industrial production, while primary aluminum consumption shows a growth rate corresponding to or slightly higher than industrial production. Global demand According to the World Base Metal Study, global demand over the first two months of this year was up 8.7% year-on-year at 5.876m tonnes. Reflecting the different conditions in Europe and the US, demand in the regions registered growth rates of 3.4% and 11.3% respectively. Asia continues to see the bulk of demand growth, up 23.7% to 2.974m tonnes, with China, India and Japan seeing growth rates of 41.7%, 19.7% and 2.9% respectively. In 2006, the global primary aluminum consumption growth rate was around 7 percent, greatly influenced by a very strong rise in Chinese consumption. Primary aluminum consumption in the western world increased by an estimated 4.5 percent in 2006, compared to 2.5 percent in Western world production increased by about 2 percent during 2006, compared with Globally, the increase was about 6 percent, also led by China. Both production and consumption in China continued to increase at a rapid pace, up about 18 percent in 2006 compared with Demand in China In 2006 China accounted for about 25 percent of global primary aluminum consumption, contributing about 4 percentage points, or about 55 percent, to the total increase in world consumption. China s share of global primary aluminum production in 2006 was about 27 percent. Net exports of primary aluminum amounted to approximately 700,000 mt in Adjusting for net imports of scrap metal, and including net exports of rolled and extruded products, as well as other fabricated products, China was for the first time a net exporter of aluminum, estimated at about 500,000 mt for the year. Chinese production of semi-fabricated aluminum is increasing rapidly, up an estimated 37 percent from 2005 to This has led to a significant rise in net exports of semi-fabricated products, reaching about 500,000 mt in It is uncertain whether China will remain a net exporter of primary aluminum in the long term, but is expected to concentrate on labor-intensive production of semi-finished and fabricated products for export. This would be in line with announced Chinese policy, as demonstrated by the increased export tax for primary aluminum from 5 percent to 15 percent. Further, it seems likely that China will depend on increasing imports of scrap and off-grade metal to meet domestic needs and as a basis for export of semi-fabricated and finished products. It is possible that domestic aluminum production, together with scrap imports, will not be sufficient to meet the growth in Chinese demand over time, resulting in the need to import primary metal. 12

16 China shifts to a net importer of primary aluminum Net exports of primary aluminum continue to suffer from last year s tax changes. The country became a net importer for the first time in four years in March 2007 recording net imports of 23,559 tonnes (as exports dropped 87% to 10,362 tonnes). Following net exports in January and February, however, the country remained a net exporter for Q1, 2007 as a whole, although, the 8,500 tonnes of net exported material is down 94% year-on-year from last year s reported level of 134,400 tonnes. The reduction in exports has come about despite strong output growth, which expanded by 37.6% in March. Meanwhile aluminum product exports have seen an 88.9% rise over Q1 to 408,814 tonnes on the back of a 44% year-on-year surge in semis production. This sharp increase in semis exports has led to the Chinese government to consider a further cut in the export tax rebate on aluminum fabricated products in an effort to curb the recent rebound in primary aluminum investments and as well as within the downstream fabricating industry. According to the National Development and Reform Commission, urgent steps are required as following the rise in prices and easing of power shortages (which have plagued the sector in China), investments in new aluminum smelting and alumina refining have risen by around 124% year-on-year over the first two months of One step being considered is to cut export tax rebates on aluminum products from its current level of between 8 and 11 % to either 3-8%, or 0-5%. Demand situation in the US The US Aluminum Association reported net orders in the first three months down by 5.2%, 10.3% and 13.9% respectively. March orders of extruded products were reported down 19.6% year-on-year, while orders for flat rolled products such as sheet and plate were down 20.3%, as demand from the residential construction and auto sectors remains soft. Japanese demand improves marginally In line with Japan s modest growth rate, the country s production of rolled aluminum products saw a 0.9% rise over the fiscal year ending March 31 to 2.37m tonnes, and shipments rose by 1%, the first rises in both production and shipments of fabricated aluminum products in two years. The Japanese Aluminum Association expects another modest improvement this year, backed by a continuation of demand growth from automotive and transport industries to drive the country s consumption of fabricated aluminum products up 1.7% year-on-year to 4.577m tonnes. Robust semis exports In 2006, semis (semi-finished) exports (including foil) from China grew at 74 % to 1.2m tonnes. Imports grew by 6%. Increased semis exports was one of the key drivers of primary aluminum consumption in China in 2006, accounting for about 5 percentage points of the 21% rise last year. And it looks like exports will provide very strong support to demand in Chinese semis exports will continue to grow strongly, and displace demand in the rest of the world. In the western world, primary consumption has grown at below Industrial Production (IP) since 2005, just about the time that Chinese semis exports began to grow at an exceptional pace. In 2006, demand grew by an estimated 3.6% in 2006, on the back of a western world 13

17 IP growth of 4.5%. In 2007 we are forecasting only 2% growth with IP growing by 3.3%. However, over the latter part of the 1990s and into this decade, primary consumption in the western world had on average grown faster than IP. Strong domestic consumption growth in semis however is still the main driver of the expansion in primary consumption, with the growth supported across many sectors. In construction, activity in the housing market remains robust as the government plans 100mn square meters of building in a bid to provide affordable housing for low-income earners. In addition, commercial construction activity is expected to maintain a healthy pace as increased infrastructure spending on the back of the 2008 Beijing Olympics and the 2010 Shanghai World Expo drives demand from this sector. In the power sector RMB500 bn is to be invested in China s power grid project between the period, increasing wire and cable consumption. The State Grid Corporation of China is making investments in transmission systems from power generating areas to high consuming regions and aluminum s price competitiveness vis-à-vis copper, will help boost demand for the light metal. The country is also upgrading transmission systems to less developed areas. The packaging sector will also be a major source of growth in Within the Chinese foil market, aseptic packaging is developing fast, while prospects for aluminum can making appears to be more encouraging after several sluggish years. The transport sector will continue to provide growth prospects for aluminum consumption. Motor vehicle production rose 26 % in 2006 and is set for similar strong growth in A large and rapidly expanding consumer base is driving demand from the automobile market. At the same time, China s export market is also growing. In 2006, auto exports reached 340,000 vehicles, more than double 2005 levels. Aluminum usage is increasing across most applications and product forms, especially as the quality of the cars being produced is rising. Within other transportation markets, the rail sector continues to provide strong support. While it is clear that semis exports are providing excellent support to the growth in semis production in China, and is therefore causing some degree of displacement in primary demand, it is the growth in domestic demand that will continue to be the main driver of growth, with demand from all key sectors likely to remain exceptionally strong in Main Consumption indicators: - US extrusion demand remains weak as consumption from the residential construction market fell further. Demand from the truck and trailer market is set to soften but consumption in the aerospace market is firm. - We expect consumption to remain weak in the next two years as we expect a slowing in the transport market and continued weakness in the housing sector. - European extrusion demand growth is easing although levels remain firm. Activity in the automotive sector has held up despite lackluster demand from the French and UK markets. Consumption from the construction market remains healthy although the Spanish construction market is slowing. Demand from the engineering sector is also strong. - We expect demand growth to soften in the months ahead. 14

18 - Japanese extrusion demand growth is firm although shipments to the transport and building & construction sectors are faltering. Activity in the non-automobile transport sectors continue to hold up whilst the electrical and machinery sectors have provided some support to demand. - We expect the commercial construction sector to remain robust as we anticipate firm business investment. - Chinese primary demand continues to grow at a staggering pace. Domestic end-use demand continues to drive growth in the key power, construction and transport markets. Semis production is also being boosted by a rapid rise in exports. - We forecast healthy demand over the next few months although the pace of growth will slow. - Base demand in China is growing robustly. However, current tax regimes appear to be providing an incentive for Chinese producers to look to export more semis, rather than primary metal. 15

19 Aluminum Prices Primary aluminum in its basic ingot form is traded on various metal exchanges, primarily the London Metal Exchange (LME). In the long run, prices generally reflect market fundamentals of the physical market as well as underlying cost developments. However, financial investors high trading volumes in the derivative markets can have a strong influence on price developments in the short and medium term, occasionally in contradiction with developments in the physical market. Price volatility may therefore be high. During the last three years, there has been an upward shift in the cost curve for primary aluminum production, triggered mainly by a significant increase in energy prices in historically-important producing areas for aluminum. The increase in energy prices is also influencing the cost of, and consequently the price for, alumina, as well as other important cost elements. Even though the estimated long-term aluminum price expectation has been increased, announcements of temporary and permanent closure of aluminum production plants have been made in Europe and the United States, the regions most severely affected by the cost increases. In general terms, aluminum production plants in these regions may be subject to closure if they are unable to renew or replace their power contracts at sustainable terms. However, high aluminum prices, combined with low spot alumina prices, have triggered the restart of certain idle capacity. From a fundamental point of view, we expect a 200,000 tonne deficit in Q However, this situation could change if further Chinese production surplus starts making its way into the export market. Chinese production is still growing year on year. Indeed, National Bureau of Statistics (NBS) data indicates that China produced 955,376 tonnes of primary aluminum in May, bringing the total production for the first five months of the year to 4,683,000 tonnes, up 36.1% year-on-year. Stocks of primary aluminum in China have continued to grow and currently stand at around 400,000 tonnes. The figure comprises around 80,000 tonnes of metal stored in the SFE, around 40,000 tonnes in Nanhai areas and around 200,000 in other unreported locations. An additional 80,000 tonnes is thought to be stocked by semis producers, who are increasing production and delivering their products to bonded warehouses. Their goal is to secure the tax benefits they are entitled to in case the government removes these benefits unexpectedly. Although Chinese primary aluminum surpluses are building up, it may be some time before this material reaches the market since the LME-SFE arbitrage does not encourage exports. The medium term outlook, however, will be greatly determined by the ability of the Chinese economy to absorb the estimated 35% increase in aluminum production estimated at 12.6m tonnes in Consumption in 2006 amounted to 8.7m tonnes while data for the first five months of the year suggests that apparent consumption increased by over 50% year-onyear. Lower Chinese exports of primary aluminum are explained by strong local demand, a situation that in their view is unlikely to change anytime soon. In addition, a market deficit in Q2, together with a tight alumina market and steady smelting costs justify our view that the only 16

20 risk in the aluminum market at present is the upside risk. This view is further reinforced by recent unexpected smelter cutbacks in Africa and CIS, as well as by a slower than expected commissioning of smelting capacity elsewhere. These unexpected events deteriorated the non-chinese supply demand balance, increasing the world reliance on Chinese surplus of aluminum, which is estimated at 1.2m tonnes in Primary aluminum demand in China has also benefited by substitution of scrap. This is encouraged by a relatively low price for ingot in China in comparison to an LME based price of imported scrap. Consumers of high-grade aluminum scrap are reducing their demand for scrap and replacing it with primary aluminum, adding to the increase in primary aluminum consumption in the country. This is in part explained by the high price of aluminum scrap in the western world due to the high LME price and lower growth in industrial activity, the latter being the main driver of scrap supply. Consumption of low-grade scrap will not be replaced by primary aluminum because the large price differential makes primary aluminum uncompetitive in certain applications. Demand supports price and premiums in Europe Demand in Europe remains strong across most sectors, including aerospace, construction and automotive. In fact a resilient LME hasn t yet put pressure on European premiums, which remain steady. Premiums for good western metal duty paid in Rotterdam are quoted at US$ /t, while duty unpaid is at around US$50-60/t. In the US, volumes are thin and some believe that consumers are waiting for the aluminum price to drop before making their buying commitments. Forward premiums reflect this theory and premiums for the second half of the year are being quoted at around /lb, for P1020 metal delivered Midwest. Premiums in Japan have been agreed at around US$71-74/t in Q2 2007, lower than the US$76-78/t range in Q1. Hence, the market remains well supplied and stock levels at Japanese ports remain stable at around 250,000 tonnes. Short-term risk is on the upside The LME market continues to gather momentum, as funds force copper and nickel prices upward. Aluminum benefits from this buying interest while tightening Q2 fundamentals also help. Aluminum price may briefly test US$3000/t level in However, market participants will watch Chinese trade closely, and any deviation from expectations of low exports could lead to downward pressure on prices. Aluminum s price rally had been partly based on bullishness in the base metals rather than on fundamentals. There is the potential for further gains (again not necessarily based on the fundamentals). Despite the increase in prices, we are cautious about the prospect for further significant gains, projecting small surpluses in both 2007 and The bottom line is that demand growth outside China is weak with the US exerting a major drag, while there are steady gains in output. Although we do not expect a repetition of the extreme tightness seen in the other base metals, some speculative interest will inevitably focus on aluminum s under-performance. As such we could see prices briefly exceed US$3,000/tonne. However for the year as a whole, we project an average of US$2,700/tonne, followed by US$2,300/tonne in

21 Aluminum stands out in that the improvement in prices in 2007 has come about despite a steady uptrend in LME inventories. The main reason behind the rally is the focus of investment funds on the underperformance of aluminum earlier in this cycle. The extreme tightness at the raw material stage seen in other base metals has not been duplicated in the aluminum market. Although there have been temporary periods of high alumina prices, primary aluminum output has not been curtailed. The market balance was affected by the surge in China s exports of primary metal in Although these have fallen sharply so far in 2007, they have been replaced by a massive surge in exports of aluminum semis. Although the impact on the market of this development is less immediate than the exports of primary, they will inevitably have a knock-on effect on semis production elsewhere in the region. 18

22 GCC Aluminum Sector Aluminum production which was once confined to western countries, is now shifting to the developing world. Within the developing world, it is shifting to those countries that either have the raw materials or have the energy resources to produce aluminum namely the GCC region with its abundant energy resources. As a result, aluminum production is constantly falling in the energy-deficient western world, except Australia, Norway and Canada due to availability of raw material. The GCC region has two established smelters in the UAE and Bahrain. Aluminum Bahrain (ALBA) was commissioned in 1971 to diversify the national economy from its heavy dependence on oil. ALBA has since grown from a modest 120,000 tonnes per annum smelter to 872,000 tonnes per year, making it one of the largest smelters in the world, with plans to expand the capacity further to 1.3mn tones per year. Besides U.A.E. and Bahrain, other GCC countries - Oman, Qatar and Saudi Arabia too, are planning to set up aluminum smelters, entirely on the basis of the availability of inexpensive gas. Saudi Arabia also has deposits of bauxite. U.A.E., because of its leading and successful DUBAL, is poised to be one of the leaders because of its experience and expertise. This plant has also developed proprietary technology, which it is willing to license to others. Besides the 25% energy cost component, there is a 45% raw material component in the production of aluminum, namely alumina, which is made from bauxite. U.A.E. has no deposits of bauxites and entirely depends on the imports of alumina. Thus it makes sense to acquire alumina production to secure raw material supply, even if it be outside U.A.E. Dubal is entering into a joint venture with an Indian company to develop alumina manufacture in India at an estimated cost of US$3bn, and is also negotiating equity investment in alumina manufacturing in Guinea. Investing in alumina production is made even more attractive on account of shortages of alumina and its high prices in recent years. Metals and mineral sector in the Middle East region is attracting private as well as foreign investment and the region is in a favorable position in terms of lower fuel cost, geographic positioning for exports and government support to develop the sector. There are several major smelters coming up in the region and finding enough bauxite to feed them will be a challenge. Alumina supplies account for 45% of smelters operational costs while power is responsible for about 25%. Most GCC producers will have to import raw materials for production but the energy reserves in the region will ensure the GCC remains competitive in the world of aluminum industry over the next decade. Investing in the aluminum sector will diversify GCC economies and they will finally have a large export industry that does not rely on oil production. The share of GCC in total primary aluminum production of the world has steadily increased during the last three decades from 0.9% in 1975 to 4.9% in We expect a quantum jump to take place during the next decade raising GCC share to around 10% by 2010 with the expansion of existing smelters and commissioning of new smelters, thus establishing the GCC region as a major player in global aluminum industry. 19

23 Capacity build up is likely to exceed 3.75 MPTA by 2010 when the new smelters are commissioned in Oman, Saudi Arabia and Qatar, and when the planned expansion program of ALBA with installation of the sixth pot line project is implemented. The capacity will further increase if the long-term plan of DUBAL is realized to achieve 1.5 Mt/yr by Due to the expansion in the construction sector, several extrusion plants have been set up all over GCC states. There are 22 major extrusion plants in the region with a total production capacity of 300,000 TPA, and the overall capacity utilization exceeds 88%. Most of the plants have anodizing, powder coating and painting facilities. About 60% of the extruded products are used in GCC and the balance is exported to international markets. The number of firms for aluminum finished product industries amounts to 496 with investments exceeding US$950mn, and labor force of more than 24,000. The GCC region as a whole is a net exporter of aluminum products as Bahrain and UAE are the net exporters while all other states are net importers. UNITED ARAB EMIRATES The United Arab Emirates is ahead of other GCC countries in income diversification. The development of the aluminum industry is one of the cornerstones of the industrialization polices of the country. This industry is a strong example of the development of large scale industries. The government has established an aluminum smelting plant, called Dubai Aluminum Company (DUBAL), in 1979 with a capital cost of around AED 1bn. The development of the aluminum industry is one of the cornerstones of the industrialization policies of the U.A.E. The country has invested about AED 1bn in one of the highly successful large-scale aluminum smelting plant in Jebel Ali (Dubal). Aluminum smelting is highly energy intensive accounting for about 25% of the costs of producing aluminum. The development of a domestic aluminum smelting plant has also given impetus to downstream aluminum activity namely aluminum extrusion, rolling and final products. Dubai s large scale aluminum smelting plant stands out among the large number of smallscale and light industries that characterize the U.A.E. manufacturing sector. This plant is the largest manufacturing establishment in the country. It is a resource-based industry, employing abundant and cheap gas resources available in the country. Production is at such a large scale and far in excess of domestic demand that virtually all of it is exported. Even though the plant depends on imported raw materials, U.A.E. now ranks among the top ten aluminum producers in the world. Aluminum smelting was established in Dubai in Such has been its success that the plant has constantly been adding capacity almost every year since its inception. Current capacity is tonnes per annum. An estimated 92% of the production is exported. In 2005, production had reached an all time peak of 722 thousand tonnes, against a production of 688 thousand tonnes in 2004, amounting to a 5% increase. The Jebel Ali smelting plant is also engaged in power generation, and produced 1,305 MW in U.A.E. now exports aluminum all over the world. The most important destinations are Japan 20