The Global Resource Hunt
The shocking shortages in industrial commodities—spurred in large part by China’s economic emergence—have sent metals producers scurrying to develop new supplies.
Canada’s Alcan Inc., the world’s second-largest aluminum producer, is in the thick of the hunt, with projects that span the globe from South Africa to Iceland, from Western Canada to Northern Australia.
Leading the charge is CEO Richard B. Evans, 59, who assumed the top job in March, replacing Travis Engen, who retired after overseeing the company’s blockbuster acquisition of French rival Pechiney SA in 2003 and the January 2005 spinoff of its rolling operations as Atlanta-based Novelis Inc.
Evans has international experience to match the company’s global perspective. As a manager for a Kaiser Aluminum facility in Ghana, West Africa, between 1978 and 1982, he steered the operation through three coups and two monetary crises. Two decades later, he returned overseas, this time to Zurich, Switzerland, to oversee Alcan’s integration of Alusuisse Group Ltd. in 2000 and 2001. That deal increased the Canadian company’s revenues by two-thirds to $12.6 billion, although Alcan’s revenues have risen since to $20.3 billion, reflecting the Pechiney acquisition and Novelis spinoff.
“He doesn’t wear his American heritage on his sleeve—he is much more a global manager,” says Arthur Sawchuk, a fellow director at Greenville, South Carolina, paper company Bowater Inc. “He can go anywhere and be accepted. He’s not imperial or hierarchical.”
Evans found the fast track early. A native of Oregon, he was a state champion hurdler in high school, which helped him win a scholarship to Oregon State University. In 1968, he was ranked among the top 15 in the state for the 400-meter hurdles.
“I was not fast enough to run anything shorter and not patient enough to run anything longer,” he quips.
I DON’T SEE A MAJOR REDUCTION IN ELECTRICITY PRICES, AND OF COURSE, ELECTRICITY IS THE SINGLE-BIGGEST COST COMPONENT FOR PRODUCING ALUMINUM.
A scholarship helped him land a job as an industrial engineer at Kaiser Aluminum & Chemical Corp., in Spokane, Washington. He would spend the next 27 years at Kaiser, holding positions in plant operations, sales and marketing, and strategic planning. Kaiser became a victim of the 1980s corporate raids, when Texas financier Charles Hurwitz acquired a controlling stake in the company with the help of the fashionable junk bond financing of the time. Evans, who in 1988 was vice president of sales and marketing for fabricated products based in Oakland, California, would stay for another eight years—he didn’t want to lose retirement benefits and had daughters in high school. But he worried about the debt Hurwitz piled on the company.
“My view was that the leverage would prevent Kaiser from growing,” he says. He retired in 1996 as a corporate vice president, a prescient move since Kaiser filed for Chapter 11 bankruptcy protection in 2002 and only emerged this year.
Evans joined Alcan in 1997 as a senior advisor for corporate development and held a series of executive positions until assuming the top spot in March. With a worldwide shortage of aluminum, among many commodities, one of his biggest challenges is ensuring the company makes wise choices in its expansion of primary aluminum capacity.
Mark Liinamaa, an analyst at Morgan Stanley & Co. Inc. in New York, says Alcan has an attractive position on the upstream side of the business.
The spin-off of Novelis, he adds, has enabled the company to focus on the higher-value end of the market, such as aerospace.
While aluminum is doing well, its price hasn’t taken off as much as other nonferrous metals such as copper and nickel. The tightness is more a result of processing bottlenecks than scarce raw materials.
Still, higher prices are starting to benefit producer profits, which had been constrained by rising energy prices, a huge factor in aluminum production, Liinamaa says.
Nevertheless, Alcan is enjoying a good year. Net income for the first six months more than doubled to $908 million or $2.42 per share. The company increased its quarterly dividend by a third to 20 cents per share—the first dividend hike in a decade.
“The challenge for Alcan is capitalizing on strong cash flows today,” Evans says. “Our future depends on how well we deploy that capital.”
Q: THE ALUMINUM INDUSTRY IS ENJOYING ROBUST DEMAND. ARE WE IN A CYCLICAL UPTURN, OR IS THE INDUSTRY DEALING WITH A LONGER-TERM SHIFT DICTATED BY THE SHORT SUPPLY OF RAW MATERIALS NEEDED TO MAKE ALUMINUM—PARTICULARLY ENERGY?
A: It’s a combination of cyclical and structural factors. Cyclical factors include alumina prices, which were very high but have come down fairly sharply. The weakness of the U.S. dollar is mostly cyclical.
While the price of aluminum, copper and gold all have gone up dramatically, a part of that is the U.S. dollar has weakened, relative to the value of all commodities.
I believe that energy prices are more structural than they are cyclical. I don’t see a major reduction in electricity prices, and of course, electricity is the single-biggest cost component for producing aluminum. On average, it’s about one-third the cost of aluminum production.
The growth in China is another structural change. My view from visiting China on a number of occasions over the last 15 years is that there has been a true acceleration of growth. While there will be fluctuation, I don’t see that turning back anytime soon. It has reached a critical mass.
Q: ALUMINUM SUPPLIES HAVE BEEN TIGHT RECENTLY. WHAT DOES THE SUPPLY-DEMAND BALANCE LOOK LIKE FOR THIS YEAR?
A: We had forecast that we would have about a 300,000-ton deficit this year, and we still think that’s about right. That’s based on a forecast 6.8% increase in demand and 5.7% increase in supply for primary aluminum.
Q: WHY HAS ALUMINUM BEEN IN SUCH SHORT SUPPLY? ISN’T THERE PLENTY OF BAUXITE IN THE GROUND?
A: There is plenty of bauxite in the world. It is fundamentally the time and the cost of major refinery projects that were creating a bottleneck. But prices are coming down because there are some large projects coming on stream, both in the West and in China.
PRICES HAVE GONE FROM ABOUT $150 A TON SEVERAL YEARS AGO, UP TO WELL OVER $600 A TON AND NOW HAVE DROPPED TO ABOUT HALF OF THAT.
Q: HOW EXACTLY HAS CHINA INFLUENCED TODAY’S MARKET?
A: China 15 years ago was a small player in aluminum. Today, it is the biggest producer and biggest consumer in the world—it represents roughly 22% of production and consumption.
Just as China overbuilt its primary aluminum production capacity, I think it recently has been in a mode of overbuilding its alumina refinery capacity. In primary aluminum over the last three or four years, China’s production has started to outstrip consumption—they were overbuilding their capacity. They were subsidized by the government through soft loans and other support.
Alumina prices have gone up dramatically, making the cost more expensive. Prices have gone from about $150 a ton several years ago, up to well over $600 a ton and now have dropped to about half of that.
So that stimulated a lot of expansion in China. And I think some of that expansion is unwise, because it will be fairly high-cost. A substantial part of it will rely on imported bauxite. And it has been done without the perspective of alumina prices likely coming back down, which they are now doing.
Energy costs in China also have gone up considerably, as China is short of energy. Therefore, the economics of building new capacity in China are less attractive today than three or four years ago. In fact, the Chinese government has publicly stated that it is going to crack down on unauthorized refinery projects.
Our view is that the rate of new primary production capacity growth in China is slowing. And at the same time, the rate of exports is slowing. That could even turn around in the next year or two, and China could become an importer again. Of course, that would be very favorable for primary aluminum prices.
Q. AS AN INVESTOR IN CHINA, WHAT HAS IT BEEN LIKE TO OBSERVE THAT BOOM AT GROUND LEVEL? AND WHAT HAVE YOU LEARNED FROM THE EXPERIENCE?
A: In terms of our operations, we are managing partner and have 50% of a large, relatively low-cost smelter, the Alcan Ningxia joint venture, in Ningxia province in China’s Northwest. We have seven or eight other operations, but they are all on the fabrication side—in packaging or engineered products.
Our expansion has confirmed that operating costs in China are relatively high. Labor is cheap, but again, energy and alumina are quite expensive. Some logistics are fairly expensive. It’s validated our thesis that we think China will move away from being an exporter of primary aluminum.
We’ve also learned that there’s a tremendous commitment in China to develop its economy. There’s a great stimulus coming from the 2008 Olympics in Beijing, and then there’s the World’s Fair in Shanghai in 2010. I think there’s a considerable stimulus behind the Chinese economy in terms of infrastructure building being driven by both of those, as well as the evolving standard of living.
I don’t know if you’ve visited China recently, but if you visit Shanghai or Beijing, the infrastructure building is absolutely tremendous. They’re building a Chicago skyline in the course of five years. It’s amazing.
Q: WHICH REFINERY PROJECTS OUTSIDE OF CHINA WILL BE MOST IMPORTANT IN ALLEVIATING CURRENT SHORTFALLS?
A: First would be the combination of all the independent Chinese projects. There are a dozen or so projects that are coming on stream. Then, in terms of the large Western projects, it would certainly include our own expansion of the Gove refinery in Australia’s Northern Territories by 1.8 million metric tons. It would include the Comalco alumina refinery project in Queensland, which came on stream last year. And it would include CVRD’s Alunorte alumina plant in Brazil.
Yet BHP Billiton has just postponed a project it had on the drawing boards in Australia—for two reasons. I think they see the alumina prices softening. But even more importantly, there’s such a boom going on in Australia now that construction costs have gone up dramatically. And most major projects are coming in substantially over budget because there’s a shortage of construction labor, contractors and support for major projects.
IF RUSSIA STAYS ON A TRACK OF POLITICAL STABILITY, FIVE TO 10 YEARS FROM NOW, YOU COULD SEE NEW CAPACITY COMING OUT OF RUSSIA.
Q: WHAT IS DRIVING ALCAN’S INVESTMENT DECISIONS FOR UPSTREAM OPERATIONS? IS IT PRIMARILY POLITICAL STABILITY AND ENERGY? HOW DOES THIS APPLY TO YOUR PROJECTS IN AFRICA, THE MIDDLE EAST AND ELSEWHERE?
A: The prime determinants in alumina are the bauxite reserve, the location and then the logistics—being on a deepwater port. And the energy source for the refinery is critical. Taking the Gove example, we have bauxite right next door. We have good logistics because we have a deepwater port. For energy, we’re currently using oil, but there are prospects in using natural gas from Papua, New Guinea.
On the smelting side, the No. 1 determinant is electricity. Alumina and aluminum are traded commodities, and their price is set by the market. Our important cost is in the logistics of getting the alumina to the smelter.
We have a list of primary metal projects that are quite attractive, and we think are the best pipeline of projects in the industry. That includes our facility in British Columbia, Kitimat, which we expect to expand at a cost of [U.S.] $1.8 billion.
The expansion in Kitimat has been controversial because of Alcan’s sales of surplus power. The mayor of Kitimat contends Alcan isn’t living up to a previous agreement and that power sales end up undercutting the number of potential jobs at the smelter—that the company could use all the power available, produce more aluminum and employ more workers.
By going ahead with this project, we would reduce the amount of power that we would sell. And there’s a handful of people—including the mayor—that apparently have not gotten this straight. They would like to have us build an even bigger smelter that would use 100% of the power. Now, the reason that we don’t want to do that is that this is hydropower. It varies year to year, depending on the rainfall. So we want to build a smelter big enough to use all the firm power that we are sure we will have. We think it would not be prudent to build one based on the peak power that you only have in some years. That’s the political issue.
Q: WHERE ARE YOUR OTHER SMELTER PROSPECTS, AND WHY ARE THEY PROMISING?
A: At Coega, a site in South Africa, we have a potential large supply of coal-generated electricity, at attractive rates. We have an attractive port site. The government wants this project to go ahead. It originally was a Pechiney project. We think we now have it structured such that it would be an attractive investment [Alcan this fall still was negotiating terms of power supply and other contracts].
We also have a smelter project in Oman approved and moving ahead. We are the developer and manager, and we own a 20% equity stake. We have a partnership with the Omani Oil Company and the Abu Dhabi Water & Electric Board. That project is based on natural gas-fired power at attractive, long-term rates. It’s being built as part of a new port, which will be an absolutely first-class facility, with about $15 billion of other investments spilling in.
There’s one other we have that’s interesting. That’s Iceland, where we currently have a smelter. Iceland is long on electricity from hydropower and geothermal. And of course, being an island, there’s no convenient way to export it. So putting [the power] into aluminum and exporting it is a good economic proposition. We have secured a power block for about 40% of an expansion, and we’re working on securing the additional 60%.
Q: YOU’VE SAID RUSSIA COULD BE A BIG FACTOR IN ALUMINUM, ALTHOUGH IT’S NOT A PART OF YOUR CURRENT INVESTMENT STRATEGY. WHY?
A: Russia has the raw ingredient, in terms of energy, to be a major primary aluminum supplier. The existing capacity is owned by RUSAL and its competitor SUAL, the result of a restructuring when Communism collapsed. New capacity would require additional power development. And up to this point, the political risks of investing in Russia have been such that they’ve overwhelmed the advantages.
We do have two plants that we’re building in Russia on the fabricating and packaging side. These are much smaller plants.
The infrastructure is lacking and the legal certainty has not been there. In fact, RUSAL and SUAL have not been investing in Russia either because of the same issues. I do think this will change over time. If Russia stays on a track of political stability, five to 10 years from now, you could see new capacity coming out of Russia.