What seemed to be China's infinite production growth has stalled and shows signs of potentially going into reverse as energy restrictions make their presence known. The supply struggles in China have been compounded by a lack of hydropower availability in the major producing province, Yunnan. With demand still strong, China's domestic supply-chain tension is evident in the form of a sustained flow of primary metal imports—at levels not previously seen since a brief period during the GFC, when prices were also at a similar level.

(Power) Crunch Time

China–by far the world’s largest aluminium producer – has continued to crack down on pollution and has been enforcing reforms aimed at decarbonising the country’s economy. The Chinese government capped electricity consumption for energy-intensive industries such as aluminium and steel production earlier in 2021.

Coupled with power shortages in many parts of China, this means several aluminium smelters in the provinces of Guangxi, Xinjiang and Inner Mongolia have been required to cap output for the year. The country's power-hungry smelters have been hit by both a temporary power crunch and structural energy restrictions linked to Beijing's decarbonisation goals.

Many Chinese provinces have historically incentivised aluminium production by offering reduced power tariffs to metal producers. However, the Chinese government has banned the practice of preferential electricity tariffs for the aluminium industry under a decarbonisation policy announced in August. This is just one policy making up China’s reforms to transition to a green, low-carbon economy.

According to China’s state-backed research house, Antaike, some 2.33Mtpa of smelter capacity cuts had been made by the end of September as a result of provinces having to remain within energy consumption targets. Production in many cases could also get more expensive with the changes to power tariffs, helping drive up domestic prices in China.

The power constraints are not just impacting operating capacity but new capacity as well. While China had been expected to increase production this year, with new capacity of up to 1.8Mt, the vast majority of this is now expected to be postponed by up to a year given the current power shortages and administrative shutdown initiatives.

When the River Runs Dry

Looking to improve its environmental performance, China has been looking to hydropower to supply a larger proportion of its aluminium production capacity. This has seen capacity shift—under the country’s quota transfer system—from coal-powered centres to regions with higher hydropower capacity. The shift has primarily been to Yunnan province, where the world’s largest producer, Hongqiao group, has already shifted 1Mtpa of capacity from its home province of Shandong with active plans for an additional 1Mt to be transferred. Shenhuo Coal & Power Group has also already transferred a major portion of its current production quota to the province.

This is, however, currently compounding the impact of the power crunch on China’s wider aluminium production capacity. The separate issue facing production capacity in Yunnan is a lack of sufficient water to keep its hydropower system running. Drought in the region has seen reservoir levels struggle to replenish and, to date, the wet season hasn’t been wet enough.

Despite its aluminium capacity being developed to utilise ‘clean energy’, and therefore to comply with the environmental initiatives, as Yunnan province battles low water levels in its hydro system capacity cutbacks have had to be brought into place. Many of the cutbacks will last through to the end of the year at a minimum, with major producers such as Shenhuo Group and Yunnan Aluminium (an indirect subsidiary of state giant Chalco) downgrading production guidance. Yunnan has curtailed in excess of 1Mt of its primary aluminium production capacity. While Yunnan Aluminium had planned to bring online 380ktpa of capacity, this has reportedly been postponed until the power restrictions end.

Upstream Ructions

Looking upstream, it hasn’t all been smooth sailing either. China has increasingly struggled with its domestic bauxite. Declining quality, predominantly in the form of increasing silica content, has made processing to alumina increasingly expensive. Looking to alternative sources, and through a period of relative political stability in the country, China has invested heavily in securing bauxite supplies from Guinea, home of the largest global reserves.

Despite China’s increasingly apparent issues maintaining aluminium production levels over 2021, in early September 2021 news within the industry was dominated by events in Guinea, where a military coup ousted the sitting president of eleven years. As Guinea is an emerging dominant force in the bauxite market alongside Australia, the events raised significant concern for bauxite supply around the world and potential ripple effects down the value chain.

China’s explosive aluminium and alumina production growth in the last decade has been increasingly reliant on bauxite supplies from Guinea to maintain production levels. Any major disruption will flow through to create issues within the Chinese industry as there is no equivalent alternate raw material source.

Whether the coup—and its leader’s stated objectives to return more of the mineral wealth to the people—has a major impact on bauxite markets still remains to be seen. Moves were quickly made to lift curfews in mining regions and ports were kept open, allowing trade to continue and limiting disruptions so far. China also has a history of operating in jurisdictions largely deemed too risky by western producers, though it expressed concern at the coup given the established relationship with the previous administration.

Keep Feeding the Beast

Power for China’s aluminium capacity—and alumina refining—remains dominated by coal, so the industry is likely to be affected by Beijing’s initiatives to promote decarbonisation. As it is currently struggling to manage the on the ground impact of its de-carbonisation strategy, it is possible the government may ease or abandon the initiatives if faced with the prospect of economic troubles from out-of-control commodity prices, stalled economic development or job losses.

Further, China currently has its self-imposed capacity cap of 45Mt approaching. Despite struggling to power its currently active capacity of ~40Mtpa, should the country shift its environmental approach—i.e. freeing up more coal to meet energy needs—could this too be abandoned to help meet its domestic aluminium demand?

If it’s a structural change and China’s in it for the long haul, will we see existing ex-China capacity restart as seen with Alcoa’s Alumar smelter (the company still has ~20% of its capacity currently idle), and the restart of Rusal’s Taishet project? This will be dependent on prices in regions, which may see their own challenges. Or, potentially, as a longer-term proposition, will China ‘outsource’ its emissions through its companies developing capacity in other countries?