Sanctions on Russia have hit global aluminium industry

“O ur industry is going to suffer from disruption, distortion and damage. April 2018 has not been a good month for aluminium globally.”

That was the view of Ron Knapp, secretary general of the International Aluminium Institute, in his opening address to CRU’s World Aluminium Conference in London. And none of the analysts, traders, producers and consumers listening would disagree, given the carnage unleashed by the April 6 imposition of US sanctions on Russian oligarch Oleg Deripaska and his Rusal aluminium empire.

The aluminium price has experienced unprecedented turbulence. The raw material supply chain has teetered on the edge of collapse. And the tremors have raced down the value chain through major car makers as far as original equipment suppliers.

Shocked by how its precision strike on Mr Deripaska has ruptured the global aluminium market in the space of just two weeks, the US Administration has rapidly rowed back.

By extending the sanctions deadline to October 23, the Treasury Department has given Rusal and the aluminium market some breathing space.

Both will need it. Because this has been an alarming wake-up call for an industry that has prided itself on its efficiency, innovation and strong usage growth in the transport sector.

The US sanctions have shattered illusions of price and supply chain stability.

The sanctions deployed against Mr Deripaska were draconian, the type of punitive action previously reserved for Latin American drug lords. By including potential secondary sanctions on non-US entities, the result was effectively to shut him and his companies out of the dollar.

When one of those companies is the largest aluminium producer outside of China, that was always going to be traumatic.

The London Metal Exchange price rallied over 20 per cent in the week after the sanctions were announced. Time-spreads went haywire and volumes surged to fresh daily records.

The sanctions’ disruptive power flowed down credit lines in a commodity market that is heavily dependent on bank financing, both for fresh material flows and inventory management, particularly Rusal-brand inventory management. So far, however, the damage in the paper market has been contained.

“We haven’t seen a real break in the supply chain of contracts,” Erik Gundersen, head of aluminium at trade house Mercuria, told the CRU conference. Although Rusal, as the name suggests, is a Russian company with most of its smelting capacity sitting in the Siberian heartland, its raw materials operations are global.

It mines bauxite in Jamaica, Guinea and Guyana and operates refineries to convert bauxite into alumina in Jamaica, Ireland and Ukraine. Each one of these subsidiaries has its own subset of sanction problems.

But Rusal’s activities run deeper still. Although on paper it is almost self-sufficient in alumina, it, like many other producers, is a big and active trader, swapping tonnages across regions.

In 2017 it sold more than two million tonnes of alumina to third parties and bought just under that amount.

This largely hidden layer of the supply chain has caused US sanctions to ricochet in totally unexpected directions.

Consider the case of the Aughinish refinery in Ireland.

If Rio Tinto halts deliveries of bauxite to Aughinish, it closes, removing two million tonnes of alumina from the European market, which in turn causes smelter closures in Scotland, France and Iceland. Even if physical flows could be maintained, the pricing dislocation would probably close the smelters anyway.

Western world alumina supply had already taken a hit with the partial closure of Hydro’s giant Alunorte plant in Brazil. The Rusal sanctions have sent the price to record highs above $700 per tonne.

Aluminium smelting is a conversion business and “margins have just collapsed overnight”, according to Mr Gundersen.

And that applies to smelters in the United States as much as anywhere else.

The Rusal ripple effect has directly undermined the Trump administration’s stated goal of seeing idled capacity restart in the US.

As Eoin Dinsmore, head of CRU’s aluminium department, put it, “you can’t yank the biggest supplier out of the supply chain and think it’s going to be OK”.

That super-lean, just-in-time supply chain has proven to be as brittle as glass.

For protectionists it’s proof that “a global supply chain is vulnerable to geopolitical risk”, to quote Jesse Gary, general counsel for Century Aluminum, the US producer that has led the lobbying for import tariffs.

For globalists, it’s a warning that messing with deeply-enmeshed global supply chains risks multiple unintended consequences.

In aluminium’s case, all of them bad.