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Southeast Asia may hold the key to Chinese aluminum smelters' production woes

  • Featuring
  • Analyst Lucy Tang    Rohan Somwanshi
  • Commodity
  • Electric Power Energy Transition Metals Shipping

China's primary aluminum smelters are looking to transfer some capacity abroad – mainly into Indonesia – as they struggle with a national capacity ceiling and power supply shortages in the southwestern part of the country.

Such a move would also be timely, as Indonesia from this June will be banning exports of bauxite, a preliminary raw material that is used to process aluminum.

Aluminum plays a critical role in global economy and is now increasingly becoming important to the energy transition story. This is indicated by aluminum's application in sectors such as electric vehicles, electricity network, solar photovoltaic, among others. To some extent, it also contributes to sectors such as hydrogen and wind power.

China is the world's largest aluminum producer and consumer. China accounted for around 59% of global primary aluminum production in 2022, according to the International Aluminum Institute.

But aluminum production is also an energy- and carbon-intensive process.

Aluminum contributed to about 3% of the global greenhouse gas emissions in 2021, according to the International Energy Agency.

As China aims to achieve lofty energy transition targets, the pressure on the domestic aluminum industry has only been rising. It needs to strike a balance between meeting the critical needs of the economy and controlling energy consumption and emissions.

China's largest players are already feeling the squeeze as they look to expand their clean energy mix.

For example, Aluminum Corp of China – the world's largest aluminum producer with annual production of about 3.9 million mt – is looking to achieve peak carbon by 2025. By 2035, it expects to reduce its carbon emissions by 40% from 2021 levels.

China's capacity ceiling

Drawing a line that the aluminum industry cant cross is China's 45 million mt/year production cap. But robust demand in recent years has led to increased production in the country, leaving limited room for Chinese capacity to grow in the years ahead.

By the end-2022, China's established capacity reached 44.3 million mt/year and running capacity stood at 40.64 million mt/year, according to the data released by the state-run research agency Antaike.

Chinese smelters are required to secure primary aluminum capacity quotas if they are seeking new projects or expand capacity in line with China's supply-side reform policy. This policy has seen China shuttering several inefficient and polluting plants since 2017.

The quotas are sparse as of now amid the capacity ceiling in place and upsurge in production driven by healthy profit margins.

Hydropower supply shortage

In recent years, several smelters in China transferred capacity to southwest China, specifically into Yunnan and Sichuan provinces, known for their rich hydropower resources.

Aluminum capacity in Yunnan, Guangxi and Sichuan expanded by 5.9 million mt/year from 2017 to August 2022, with Yunnan alone accounting for 62% of this increase, S&P Global Ratings said.

Besides keeping them in line with China's supply-side reforms, the capacity transfer aligns smelters with national energy saving targets.

This move also gives smelters access to cheaper electricity required to power smelting process. Electricity usually accounts for more than 33% of primary aluminum production costs.

But frequent power shortages in provinces like Yunnan and Sichuan have ravaged smelters' production plans, forcing them to rethink their capacity transfer strategy.

An unprecedented heat wave in the Sichuan province in 2022 forced more than 95% of the aluminum smelters to temporary shut down their operations.

After facing a dreadful 2021 when power supply shortages severely impacted aluminum production, smelters in Yunnan were again forced to make output cuts in later part of 2022 on similar problems.

And more cuts have happened in the past few weeks, keeping the Yunnan aluminum industry on tenterhooks. Yunnan smelters started further production cuts over Feb. 18-19 due to power supply issues, bringing total output cuts by the end of February to 40%-42% below their established capacity, sources said.

Smelters have been struggling to maintain utilization rates during the low-water season, generally lasting from December through April, which typically coincides with no or limited rains and higher power consumption.

This has led to concerns around whether power supply in southwest China would be able to meet increasing capacity.

"Absent significant alternative power sources or a means to store significant volumes of power, prolonged power outages could seriously hit aluminum producers. Moreover, production recovery to full capacity takes time and is costly," according to S&P Global Ratings.

Yunnan's electricity supply will face a lot of uncertainty in 2023, and current power supply shortages could worsen if new wind and photovoltaic power projects are not able to come online as scheduled, Kunming Exchange Power Center said in its latest report. Clean energy makes up 90.6% of Yunnan's total power generation.

Besides this, smelters using thermal power are also facing high production costs caused by elevated coal prices as coal plants face pressure to meet low-carbon targets.

Shandong Nanshan Aluminum recently said it plans to transfer 336,000 mt/year production capacity quota, as that capacity was not able to meet new energy consumption requirements. Also, thermal power generated from its captive coal-fired plant was less competitive and not in line with low-carbon development targets.

Why Southeast Asia?

Southeast Asian countries provide Chinese smelters a bounty of solutions to the problems they are facing at home.

Looking toward the region, mainly Indonesia, gives the smelters an option to expand their capacity, meet a behemoth demand at home and not walk past energy-saving rules in the process.

Indonesia is home to rich reserves of mineral resources. Resource nationalism has been growing in Indonesia since 2014, indicated by its government's desire to develop industry value chain within the country itself instead of selling raw materials globally.

Indonesia's bauxite production accounted for roughly 5% of global production in 2020, but just 1% of alumina, according to the US Geological Survey.

As part of plans to build an integrated industry chain, Indonesia President Joko Widodo announced in December 2022 a bauxite export ban from June. The country already has similar policies in place for critical energy minerals such as nickel.

Indonesia banned the export of mineral ores, including bauxite, from 2014 for several years. An analysis of China's customs data showed that its bauxite imports from Indonesia only resumed in July 2017.

From being the top bauxite supplier to China, Indonesia slipped to the third largest exporter.

After the ban, Chinese companies gradually went on a mineral hunting spree, while at the same time, being asked to build alumina refineries on the requirement of local governments.

The bauxite ban could be a possible plan by Indonesia to pull in Chinese smelters to transfer their primary aluminum capacity to Indonesia, sources said.

Another striking benefit of shifting capacity to Indonesia is that the country has a shorter haul distance to China, compared to places like Australia, and this means lower freight costs and shorter delivery time. Indonesia is also home to rich resources of coal, a key ingredient to run aluminum smelting operations.

Apart from Indonesia, Malaysia is also slowly turning into a promising destination for Chinese smelters, with some Chinese companies already making plans to establish facilities there.

Malaysia's aluminum production has risen more than 200% from 2013 through 2021, according to World Bureau of Metal Statistics.

Company name Long-term production plan Country
Indonesian Huaqing Aluminum 1 million mt/year Indonesia
Nanshan Aluminum 1 million mt/year Indonesia
Bosai Group 1 million mt/year Malaysia
Source: Company releases

China's stricter stance on industrial upgrades and environmental regulations is expected to continue in the years ahead, including clean energy push, capacity limitation and placing tiered electricity prices based on aluminum plants' efficiency.

Moving to Indonesia and Malaysia could provide Chinese smelters a large enough playground to meet both their production and decarbonization targets.