FOCUS: Pricing bauxite and alumina

The changing dynamics of bauxite and alumina markets have demanded an evolution in the means of pricing them.

The alumina market – and the way it is priced – has transitioned over the past 10 years. Fixed-price, long-term contracts, agreed as a percentage of the aluminium price on the London Metal Exchange, have instead transformed into contracts tied to third-party reference prices or indices, including that published by Metal Bulletin.

Discounts or premiums are agreed, alongside volumes, for the year ahead, depending on the strength of the alumina market itself, and a month’s business is settled against the preceding month’s index average. An index is a tonnage-weighted calculation of spot market data, giving greatest weighting to concluded spot transactions. Such a way of formatting long-term contracts gives both buyers and sellers rolling exposure to the alumina-specific market fundamentals of the day, and the prevailing spot prices as they adjust accordingly.

This transition – the shift from long-term, fixed-price contracts, linked to the fundamentals of the aluminium market – was pioneered by alumina producers with assets in Australia, whose books are now composed primarily of index-linked contracts.

But Metal Bulletin’s alumina index has nonetheless had to continue to evolve. It has had to adapt to become a suitable tool for what has become, over the past two to three years, an increasingly volatile market, in which spot prices are liable to swing higher or lower from week to week, or move dramatically from one day to the next.

Between 2012 and 2014, alumina traded in a range of $306-358 per tonne, fob Australia, according to Metal Bulletin data. But it was all change in 2015 as the market reacted to oversupply and weaker demand, and alumina prices lost psychological support after falling through $300 per tonne in the middle of that year. Prices have seen far greater fluctuations since.

Metal Bulletin’s benchmark alumina index recorded lows of $198 in December 2015, and rallied to highs of $481 in October 2017, with multiple ups and downs in between. These moves have warranted a change to more frequent alumina pricing. Since December 2017, Metal Bulletin has calculated its alumina index daily, compared with weekly before. This allows it to respond more quickly to fluctuating prices, like those seen since 2015.

Feed diversification
Changing trade flows have also dictated market evolution, and therefore changes to third-party price indices. While Metal Bulletin’s benchmark daily index is calculated with a basis point of fob Bunbury, Australia, activity in the Pacific region more generally is deemed a strong indication of the fob Australia market.

This has become all the more important over the past year, as other refineries in the region have become more active, with their material increasingly seen in the spot market. Fresh alumina supplies from Vietnam, increasing spot availability from India, and consistent stocks from Indonesia as its refineries ramp up, have meant greater diversity in the Pacific market.

This diversification also appeals to aluminium smelter drives to differentiate their feed stock and reduce their dependence on Australian alumina specifically, which proved to be in tight supply for much of 2017. As spot trades from other origins have increased in frequency, they have increasingly been perceived as a reliable indication of the Pacific market.

It follows that data relating to Indian, Vietnamese and Indonesian alumina can be used to inform the benchmark fob Australia index. Data collected by Metal Bulletin over the course of 2017 showed it is possible to accurately normalize other Pacific-origin data to the fob Australia base specification, using in-house developed models based on regression analysis.

Metal Bulletin price development manager Jon Mulcahy explained: “By including regional cargoes that are not directly in line with our base specification and implementing normalization procedures, Metal Bulletin has been successful in increasing the liquidity feeding the alumina index.” He said this inclusion of additional Pacific-based cargoes in the index calculation has enabled Metal Bulletin to continue to provide a reliable and representative pricing level for the alumina spot market in the Pacific region.

Spot volumes in the alumina market are not huge. Of a 20 million tonne export market from Australia in 2016, spot volumes are relatively small at 5-10%. This structure inevitably results in a limited, though not insignificant, number of cargoes which can feed into the index.

But daily pricing need not mean daily price moves; it simply means the capacity to respond quickly to market moves, which have come to be expected in the alumina market, when they happen. Daily pricing also better lends itself to the financial markets. The CME launched alumina futures 18 months ago to enable market participants to hedge price risk and volatility in the alumina market.

Daily pricing provides near-real-time market insight into the direction of physical markets. The increased frequency of pricing associated with physical markets provides a critical component in allowing market participants to accurately determine their position. Hedging opportunities are therefore made increasingly viable as market participants can interpret daily market indications and implement strategic commercial decisions based on their physical market exposure.

If alumina is to follow a similar path to market maturity as iron ore, hedging mechanisms which are specific to the alumina market, such as that provided by the CME, will inevitably pick up the pace.

Bauxite plays catch-up
Unlike the alumina market, the bauxite industry is yet to reach a consensus on pricing mechanisms, beyond long-term, fixed-price contracts. Further upstream in the aluminium supply chain, spot market volumes are thin and still reflect a minority of the sales book that is not captured by integrated activities or long-term contracts. As such, bauxite looks several years behind the alumina market in terms of its maturity, but market players nonetheless expect it to develop along the same lines.

For now, the relative immaturity of the bauxite market poses a challenge to price reporting through limited spot activity on which to feed a price index. The diversity in product specification – which is not present in alumina – amplifies the challenges for third-party price discovery. Different brands and origins contain a different chemical specification. Material is priced on its own merits, rather than as a uniform product which results in a wide range of prices.

Last April, Metal Bulletin launched two regional price assessments for the bauxite market, as representative references for bauxite sold on the spot market out of Brazil and Guinea. Base specifications for the two price assessments are tied to the most commonly traded spot volumes out of these locations, while the regional focus helps to mitigate for the broad variety of specifications and prices. Furthermore, price assessment methodology adopts a more subjective approach than an index – an objective, tonnage-weighed calculation – engaging the expertise and judgment of the price reporter, and is better suited to more illiquid spot markets, such as bauxite.

China is expected to be key in driving the shift in the bauxite market which facilitates a more sophisticated third-party price index. As the quality of its own bauxite reserves declines, its (third-party) imports are expected to increase. As the market matures in this way, price assessments can inevitably evolve to become indices, like those which have become the norm in alumina and iron ore.

At last year’s Metal Bulletin bauxite and alumina conference in Miami, Alcoa forecast an increase in demand for seaborne bauxite to 130 million tonnes by 2026, growing at an average rate of 8% per year, primarily driven by Chinese demand.

Figures like these have got merchants interested: last year saw Concord Resources agree an offtake for 5 million tonnes per year of bauxite produced by Noranda at St Ann in Jamaica, of which 2.7 million tonnes is open to be marketed to third parties. Shifts like these are a necessary precursor for price indices to develop.

From 2010, the iron ore market witnessed a similar transition to index-linked pricing as the traditional market structure, dominated by long-term contracts, broke down. “In the iron ore market, price volatility was the necessary precursor to the breakdown in market structure; the resultant spot liquidity meant the opportunity to deliver a new pricing mechanism,” Mulcahy explains. “This was necessary to provide the spot liquidity to feed a more sophisticated pricing mechanism.”

He added: “Some producers saw [the breakdown] as a good thing: the resultant transparency meant they could price their product against an independently-published index, but account for their own unique chemical composition using value-in-use factors.”

In carving its own path to market maturity, the bauxite industry can also draw on the experiences of the alumina market. Between December 2015 and October 2017, the alumina market traded between 12.9% and 22.5% of the LME aluminium price. Such volatility has been proof that the alumina market has its own fundamentals, needing its own pricing mechanism away from the aluminium market.

Bauxite too can be regarded as a standalone market, with prices not necessarily bound to follow alumina, or aluminium, higher or lower, but greater spot liquidity, which will facilitate the evolution of more sophisticated, bauxite-specific pricing mechanism; experiences of volatility, in alumina and further afield, should spur their adoption in the physical market.

This article was first published in the March issue of the Metal Market Magazine, which carries in-depth feature articles, analyses and reviews of metal and steel markets.