When it came time for Tom Albanese to explain the biggest gamble of his life, when it came time for him to justify shelling out $38.1-billion (U.S.) for a company that wasn't worth half that much a year ago, the rookie boss of Rio Tinto PLC trotted out a familiar platitude.
"It's going to be all about the China story," he assured a group of reporters this week, just hours after tasting victory in a takeover battle for Montreal aluminum maker Alcan Inc.
Hmm. Where have investors heard that before? Amid the frenzied merger environment of the global mining industry, chief executive officers have routinely held up China as a key justification for their deal making and the hefty premiums they are willing to pay to get those deals done.
China, as we all know, has a voracious appetite for raw materials and natural resources, and the world's top miners are only too happy to ride the coattails of the country's economic boom.
This is great if you produce copper, or nickel, or iron ore, all of which China desperately craves. But what if, like Mr. Albanese, you happen to be the world's largest aluminum company? How do you pin your hopes on a country that is not only the world's biggest producer of aluminum, with more than a quarter of global production, but one that makes more than it can actually use?
The answer to this question - a big part of it, anyway - resides in the riverside Saguenay Lac St-Jean region of Quebec. It is there that Alcan has staked out its claim as the most efficient large-scale aluminum maker in the world, thanks not merely to its investment in cutting-edge smelting technology, but to the munificence of the provincial government, which has subsidized the company by providing access to waterways that can be used to generate cheap power.
With these winds at its back, Alcan can do something that few other manufacturers can: It can make a product more cheaply - much more, in fact - than the Chinese can.
In theory, this is fine. But observers are divided over what amounts to the crux of Mr. Albanese's gamble: Will the Chinese, saddled as they are with expensive, coal-burning power, ultimately decide it makes more sense to buy aluminum from companies like the newly Rio Tinto Alcan, and divert their costly electricity to other industries?
Orest Wowkadow, an analyst with Canaccord Adams, certainly believes so, although he thinks it might take a few years.
"At some point, China is going to become a massive importer of aluminum," he predicted. "In a growing economy like China's, using that much power to produce aluminum doesn't create enough jobs."
China produced 28 per cent of the world's aluminum last year, and accounted for 24 per cent of consumption, making it a net exporter of the metal. That has created some skepticism about Rio Tinto Alcan's hopes of becoming a sizable player in China, and even prompted some fears that the Chinese could flood the market and undercut aluminum prices.
"You can be as bullish as you like about China but these guys are self-sufficient in aluminum," said Jon Bergtheil, chief of global metals strategy at JPMorgan in London.
"Western countries should ask themselves: How much aluminum can we export to China? The answer is zero. China doesn't need anyone's aluminum."
Smelters have sprouted around the country to meet demand, including one operated by Alcan. Today there are about 90 of them, with a capacity to produce 10 to 12 million tonnes of the metal annually, up roughly tenfold from a decade ago. In the first five months of this year alone, production grew 38 per cent from the same period in 2006.
This sharp increase suggests that Rio Tinto Alcan could get some support from an unlikely ally - the Chinese government.
Smelters have been pumping out aluminum so fast that the Chinese government, worried about the soaring energy tab, has been trying to tamp it down. Energy use accounts for a third of the cost of making aluminum, which is produced by passing an electrical current through an electrolytic bath to produce molten aluminum from a refined feedstock called alumina.
Last September, China trimmed the rebate on the value-added tax that if offers to aluminum exporters and this spring officials said they were considering erasing the rebate altogether. "China must curb blind investment in the aluminum industry," industry official Lang Dazhan said in May.
Aluminum bulls are betting that Chinese self-restraint, combined with rising demand, will improve the metal's prospects. Rio Tinto, meanwhile, has predicted that China cannot sustain its production growth simply because its costs are too high.
"There are certain metals that could lose their lustre as the early construction phase of economic development starts to decelerate - nickel or copper - but there will be other metals that continue to benefit and aluminum is one of them," said Daniel Bebner, head of commodities research at UBS in London.
He said demand for aluminum in construction, auto making and consumer applications should soar as more and more Chinese join the middle class.
Of course, China could keep producing its own aluminum to meet demand, but it has two big handicaps as a producer.
First, it has to import most of its bauxite, the raw ore than is converted to alumina and then aluminum. It bought 1.6 million tonnes in January of this year, five times the amount as the previous January. China's need for this raw material is also a boon for Rio Tinto Alcan, which would become the world's No. 1 bauxite player if their merger is completed, positioning it as a key supplier.
A far bigger impediment for China is the high cost of its coal-generated power. Coal is plentiful in China but very expensive. Chinese smelters pay about $65 to $70 a megawatt-hour for power, twice the industry average. As a result, Mr. Bebner said, it costs them $2,000 to $2,200 a tonne to make aluminum, while the cost for producers such as Alcan is more like $1,350 to $1,400.
Miners measure efficiency in the industry by dividing smelting operations into four quartiles, the last of which contains the most expensive producers. China dominates that category, accounting for almost 80 per cent. In comparison, more than half of Alcan's smelting production is in the most efficient quartile, thanks in large part to its hydroelectric contracts with Quebec. This is a major boost, when one considers that power accounts for one-third of the cost of making aluminum.
"Alcan's advantage is that half of its production comes from its own power generation," said National Bank Financial analyst Ian Howat. "The critical element here is cheap power."
The uncertainty of China's future production plans for aluminum has acted like a millstone on the metal's price, according to industry observers. Aluminum has been a clear laggard among its peers, and has been the worse-performing metal over the past five years. Those who are bullish on the sector, like Rio Tinto, believe that this price will begin to climb as China scales back its attempts to match rising demand with greater production. (Japan once smelted its own aluminum, but a lack of cheap power prompted it to abandon production in favour of cheaper imports.)
Mr. Albanese is confident that China will ease off on production, and that Rio Tinto Alcan - bulked up and efficient - will be ready to pounce when that happens. Ever the ambitious CEO, he's already plotting his next moves.
"It's going to be all about China," he said this week. He paused for a moment, before adding: "Then, watch India."
The Canadian subsidiary of the Pittsburgh Reduction Company, later Alcoa, is chartered as Northern Aluminum Company Limited. A wire and cable mill (shown above) opened in Shawinigan the same year. Between 1928 and 1950, Alcoa divests most of its interests outside the U.S., and Aluminum Limited, later to be known as Alcan, is formed.
Construction begins at the rolling and extrusion plant in Banbury Works, England. Aluminum Laboratories Ltd. is also formed in the U.K. later that decade to act as the research, technical and engineering arm of Aluminum Limited
The total aluminum production at all Quebec smelters, including this one in the city of Arvida (now Jonquière), reaches a war-time peak of 1,400 tonnes a day.
Alcan makes investments in new smelting operations in Australia, the United Kingdom, Brazil and India, as well as bauxite and alumina operations in Africa, Brazil and Australia. Alcan's first smelter in Australia is shown above, at Kurri Kurri in New South Wales.
From bauxtie to alumina
Digestion: The bauxite is ground in mills and mixed with hot caustic soda at high temperatures and pressure to dissolve alumina in the ore.
Clarification*: The caustic soda and alumina solution passes into rows of thickener tanks where solid impurities sink to the bottom as a fine, red mud.The remaining solution of alumina trihydrate is filtered to make it even clearer.
From alumina to aluminum: smelting
Alumina is dissolved in an electrolytic bath of molten cryolite within a large carbon or graphite-lined steel container. An electric current is passed through the electrolyte and molten aluminum is deposited at the bottom of the container and siphoned off. It's taken to a holding furnace where it can be blended to an alloy specification, cleaned and cast.
Precipitation: The alumina trihydrate solution is then cooled, concentrated and stirred in open-top tanks until it forms into crystals.
Calcination: The crystals are then washed, filtered and heated in gas-fired kilns at temperatures greater than 1100°C to remove water molecules. The final product is a fine, dry, white powder, which is alumina.
Aluminum can be rolled into plate, sheets, or foils the thickness of human hair. It can be cast into an infinite variety of shapes, forged or welded, made into a powder or paste or used in the treatment of water, papermaking and pharmaceuticals.
MAGGIE WONG/THE GLOBE AND MAIL: SOURCE: MEDIA GUIDE
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