Fitch: Aluminium producers search for electricity in Middle East

In recent times, new power supply contracts at considerably higher prices in the United States and parts of western Europe have resulted in a number of smelter output reductions and permanent closures. This trend is expected to continue over the next decade with around 3.2 million tonnes of primary aluminium production capacity (equal to around 8% of current world capacity), expected to be taken off-line in the US, Europe and China by 2011.

'The world is currently experiencing a shrinkage in the number of 'power islands' able to support energy intensive industries such as aluminium production,' says Peter Archbold, London-based Director in Fitch's Industrials Team. In the future, new aluminium smelting capacity is expected to be concentrated in areas such as the Middle East, Russia, Iceland and South America. China will also continue to add new capacity over the next decade; however, most of the new small-to-medium smelter capacity added is expected to be located in the top quartile of the global cost curve.

The Middle East is forecast to have the highest growth rate in primary aluminium production over the next five years, with a doubling of its current production of around 2 million tonnes by 2011. Driving this growth are energy costs of an average of USD20 per mega watt hour ('MWh'), which compares favourably with USD28/MWh in the US, and over USD40/MWh in China.

Currently, production in the region is dominated by two established players - Dubai Aluminium ('DUBAL') in the UAE and Aluminium Bahrain ('ALBA') - which account for around 85% of existing production. Future production growth is expected to come from capacity expansions by DUBAL and ALBA, as well as new smelters planned in Qatar (Qatar Petroleum/Norsk Hydro), Oman (Alcan; 'A-' (A minus)) and the UAE (Dubal/Mubadala).

While cheap electricity costs represent a substantial advantage, Fitch notes that the economics of future aluminium smelter projects in the Middle East could be impacted by higher construction costs in the region (estimated at approximately USD5,300/t of installed capacity compared to around USD2,700/t in Russia), and increased transportation costs to ship raw material to the region.

Electricity typically accounts for around 25-30% of the total cash cost of primary aluminium production, and while a smaller proportion of overall input costs than alumina, is the key cost- differentiating factor between aluminium producers. Smelters have always been located in areas where electricity could be sourced cheaply.

However, the breaking down of trade and investment barriers is resulting in primary aluminium production, which has historically been concentrated in western countries, shifting to developing regions. As aluminium prices are set globally, there is limited opportunity for smelters at a comparative cost disadvantage to pass on electricity cost increases to end users. Aluminium smelters are now also less important as base load consumers of electricity in developed economies, which has led to a loss of bargaining power relative to electricity suppliers.