Metals rally needs more than China’s anti-pollution rhetoric

At a Sichuan-style restaurant opposite a giant aluminium production facility in Shandong province in eastern China, waiter Liao Dongdong has no customers to greet at 6pm on a recent Wednesday.

“Normally this is the time when workers would finish their shift and come to eat,” Liao, 26, says. “But as you can see there is no one here. It’s been like that since the plant closed about 10 days ago.”

The plant, owned by China Hongqiao, the world’s biggest aluminium producer, has fallen foul of a wide-ranging environmental crackdown in China that has helped shape global metal markets this year.

After years of rapid expansion that stoked tensions with China’s trading partners, Hongqiao was this year ordered to close 2.7m tonnes of annual capacity. Staff at Hong Kong-listed Hongqiao told the Financial Times that three large aluminium production sites in Zouping county where the company is headquartered had been closed, with their workers moved to other facilities.

The shutdowns are part of President Xi Jinping’s plans to cut excess capacity and clean up the environment after years of rapid expansion that has made China one of the most polluted countries in the world.

Environmental inspectors have been sent across the country to fine and shut down polluting plants guided by Xi’s slogan that “green mountains and clear water are equal to mountains of gold and silver”. From eastern Zhejiang to western Sichuan province, that has hit zinc smelters and aluminium producers.

“This round of (supply side) reforms is comparatively strong, and polluting or low productivity will be punished. That’s what explains the strong prices,” Liu Wenping, an analyst at China Merchants Securities, says.

Investors in the global metals market have taken Mr Xi’s ambitions to curb pollution-generating production seriously. Zinc, a metal used to galvanise steel, has climbed 22 per cent this year and is trading at its highest levels in a decade at more than $3,000 a tonne. Aluminium has advanced 25 per cent to a four-year high.

That, in turn, has helped the fortunes of China’s largest state-owned producers as well as global miners. Mining shares have returned 26 per cent in 2017, the second year of double-digit percentage increases following three years of losses, according to the Bloomberg World Mining Index.

The prospect of less Chinese supply has not been the only stimulant for metals this year. Dollar weakness has helped, as has the resilience of many major economies. Global growth will hit 3.5 per cent this year and 3.6 per cent in 2018, according to the latest forecasts from the International Monetary Fund.

However, despite Mr Xi’s forceful rhetoric on cutting pollution, doubts are growing that the government will be able to deliver the scale of cuts that the rally in metals has anticipated.

“People are buying the story, but the facts don’t back it up,” one commodity trader says.

While privately owned companies like Hongqiao have been ordered to shut down some of their production, others such as state-owned rival Aluminium Corp of China, or Chalco, have said they will increase output. Indeed, Chalco could emerge as the second-largest producer in the world by 2019, up from fifth-largest today, according to commodities consultancy CRU.

“The government has been increasingly successful in their ultimate objective of lifting the price and boosting SOE profitability,” says Eoin Dinsmore, an analyst at CRU. “The closures are coming through but what people shouldn’t expect are declines in Chinese output.”

The picture so far this year for Chinese aluminium production supports this view. Output has climbed 17 per cent in the first eight months of the year, according to CRU.

China’s refined zinc production slipped just 1.2 per cent in the first half of the year even though smelters were shut down, according to ICBC Standard Bank, a unit of China’s largest bank.

“We had a dip (in production) in July but one swallow doesn’t make a summer,” says Robin Bhar, an analyst at Société Générale, referring to aluminium. “We need to see that continue to give the market confidence otherwise this whole rally just unravels again.”

For those who believe Beijing will deliver cuts, the winter may be a blessing. Aluminium plants should cut production by more than 30 per cent this autumn and winter, when pollution is at its worst, China’s Ministry of Environmental Protection said on Friday. Liu Bingjiang, an official at the ministry, told a press conference there would be “doubled efforts to combat pollution” this year.

However, the ambition of authorities in Beijing faces other obstacles. While the Chinese media is trumping the environmental campaign as the Communist Party gears up for its 19th Party Congress that starts on Oct 18, much will depend on whether the central government can enforce its will against local governments, where mining and smelting industries provide jobs and stability.

“There’s always been this provincial government opposition because they want jobs and tax revenues,” Société Générale’s Bhar says. “But it does seem the Ministry of Environmental Protection is coming down hard on the producers.”

CRU estimates Beijing’s efforts will bear fruit next year, when it forecasts aluminium production growth will slow to 3 per cent in the first half — far below the recent historical average.

Metals investors will be hoping it proves accurate.

Additional reporting by Wang Xueqiao in Shanghai and Archie Zhang in Beijing

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