Silicon shortage forces change in 2022 supply contract structure | LME Week 2021

Aluminium producers are now considering different contract structures for value-added products with alloying elements such as silicon to mitigate upside production cost risks

By Alice Mason and Justin Yang

Aluminium producers are now considering different contract structures for value-added products with alloying elements such as silicon to mitigate upside production cost risks.

They, along with traders and consumers, have noted in recent weeks that contracts for long-term supply of products such as 7% silicon primary foundry alloy (PFA) will include various mechanisms to protect producers and traders selling the product from surging silicon costs.

An energy shortage in China propelled Fastmarkets’ price assessment for silicon export 98.5% Si min, fob China to $9,000-10,000 per tonne October 1. This is 150% higher than the start of September. View the silicon prices in this article.

Rising production costs have been a major driver pushing up premiums for the product.

Fastmarkets assessed the aluminium primary foundry alloy, silicon 7 ingot premium, ddp Germany at $550-620 per tonne on September 10, up by $40-70 per tonne compared with $510-550 per tonne on August 13. The latest assessment is a new high.

Fastmarkets also assessed the monthly aluminium primary foundry alloy, silicon 7 ingot premium, ddp Eastern Europe at $550-620 per tonne September 10, up by the same amount from $510-550 per tonne on August 13. This assessment is also a new high.

Magnesium, which is also a key alloying element in other products, is also experiencing a similar uptrend.

Prices for magnesium 99.9% Mg min, fob China main ports were assessed at $10,000-11,000 per tonne on October 1, up by $5,280-6,000 per tonne from $4,720-5,000 per tonne September 3.

Market participants expect premiums for primary foundry alloys with silicon content to continue to surge higher in the Friday October 8 assessment.

Under its current methodology, Fastmarkets’ PFA premium in Europe includes a P1020 premium, a fixed upcharge to cover conversion charges, payment terms and duty and delivery costs. This is also how market participants traditionally sign contracts for PFA supply.

Index-linked solution?
But with raw material prices such as those for silicon being extremely volatile, producers are worried about premiums not helping to cover production costs in the coming months - especially if the shortage persists and deteriorates.

As such, producers have started to offer what is known as an index-linked contract - meaning that the silicon content that was traditionally embedded in the fixed conversion upcharge has now been isolated and tied to a reference silicon price instead. This allows the seller to pass on the costs to consumers if they decide to take it.

“Concerning the silicon adjustment, it’s good that people are considering this. Otherwise it doesn’t make sense to produce PFA,” one aluminium producer who is also offering silicon index-linked contracts for 2022 supply said.

Without that component, producers say they are hesitant to sign contracts going into next year because they could take a loss on rising raw material prices.

“Silicon has gone through the roof,” a trader in Europe said. “Producers have stopped offering [on a fixed-premium basis] and are asking for an index linked to the silicon price.”

Others say that the alternative to signing the index-linked contracts is being offered a fixed contract with much higher costs priced into the premium.

“You work in a formula that assists in that price increase or ask for more [on a fixed-price basis],” a second trader in Europe said.

Consumers remain skeptical about the newly proposed contract structures, with its complexity a main concern and that it could lead to a slippery slope of adding a similar mechanism to other costs such as freight.

“We are also hearing people floating the separate compartments of the PFA. They want to do floating silicon for example and that is pretty tough. People have worked hard to incorporate the premiums into one and not have lots of volatile factors. But if we start floating individual elements then things get tricky.

“It can go either way too, we have seen the spike but we don’t know enough about the situation,” an aluminium alloy consumer source said.

The situation has others thinking about signing shorter supply contracts instead to mitigate the long-term risk of signing an untested pricing contract.

“It is making negotiating contracts hard because, depending on your opinion, the situation can be bullish or bearish and no one really knows which way it is going to go,” a third trader in Europe said.

“So do you want to sign a long-term contract now for the whole year [based on] all that uncertainty? I wouldn’t. Maybe a quarter - but it’s a risk.”

Long-term uncertainties
Market participants are also uncertain about the further consequences of a shortage of raw materials such as silicon going into 2022 and what it means for the supply and demand for aluminium value-added products.

If materials such as silicon and magnesium become tougher and more expensive to acquire, market participants say there is also a risk of producers switching their product mix more toward P1020 instead of value-added products.

That would be bullish for value-added products, but potentially bearish for commodity-grade P1020 in 2022.

“If smelters lack magnesium, they cannot produce alloys so they will have to go for [P1020],” a third trader in Europe said.
Premiums for P1020 in Europe have started to ease this week on weaker fundamentals compared with previous months.

“You can’t build a car without chips, you cannot build a car without magnesium and you can’t deliver aluminium wheels without silicon,” a fourth trader in Europe said.

“You can paint a scenario with more P1020.”

Fastmarkets assessed the aluminium P1020A premium, in-whs dup Rotterdam at $295-305 per tonne on Thursday, unchanged for a second day.

“The news about silicon makes foundry really strong,” the first trader said.

“A producer with 1.0-1.5 million tonnes of production might see some [production] issues if silicon remains around $10,000 [per tonne]. It has an impact, that’s why the news we are hearing is supportive.”

London metals week remains a key milestone in the commodities calendar. Find out why it’s still a big draw for the world’s commodity trading community, and discover our special LME Week 2021 coverage on key commodities such as nickel, lead, tin and lithium.

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