The LME aluminium price has risen 25% since the beginning of October, with the metal currently trading at about US$2,150/t.
While the price rise to date could be attributed largely to a bullish industrial metals complex, a number of other factors are at play, with China holding the key.
Perhaps most pressingly, uncertainty surrounds production in Inner Mongolia, which accounts for 15% of China's total aluminium capacity.
Inner Mongolia pledged last week to reduce its energy consumption from 2021 and said it would not approve any new aluminium capacity projects.
The move came in response to calls from Beijing for the autonomous region to rein in its investment in aluminium capacity, which is highly polluting owing to the fact that - like much of China's aluminium capacity - it runs off coal-fired power.
Beijing has been beating the drum for a while on the need for Inner Mongolia to reduce its carbon footprint, but the turning point came late 2020 when China conducted an audit as part of its roadmap to becoming a clean economy by 2060.
"The government wanted to look at certain key consuming industries and aluminium came under the radar, particularly in places like Inner Mongolia" said Uday Patel, senior research manager for global aluminium markets at natural resources consultancy Wood Mackenzie.
"The situation we're in right now is that whilst there hasn't been a wholesale cutback of production, because it was highly polluting, what has happened is that some of the more culpable culprits - smelters - have started to reduce production a little bit by reducing some of the output from the electrolytic cells that produce the metal.
"At the moment, it's very much a wait and see game to see how much production has technically been lost just in Inner Mongolia as a result of the government clamping down," said Patel.
This potential for a drop in production in key regions could be compounded in future as China runs out of options for low polluting aluminium capacity.
Beijing's most recent tactic on that front has been to move smelting capacity from coal-reliant regions to areas rich in hydroelectric power, such as Yunnan province.
"The problem China faces medium term is that there aren't that many Yunnan provinces around in China that are blessed with hydrological resources," said Patel.
The Yunnan relocation has also not been without its challenges. In order to persuade smelters to move, they were promised lower power prices, but their relocation has forced power prices upwards and triggered grid reliability issues.
This has made smelters reluctant to relocate the remainder of their operations, according to Henry Steel, a portfolio asset manager at UK-based hedge fund Odey Asset Management.
"They're thinking: if I can't trust the counterparty on one [asset], I'm not going to move the rest of my production," Steel said.
While China is aiming for a mass roll out of renewable power capacity in the years to come, Patel notes that is "not going to happen instantly".
"It's going to take 10-15 years before you could definitively say that China's grid system is 80% green".
As well as the emissions factor, which could keep a lid on supply, Steel points to the economics of China's aluminium production, much of which is marginal.
"The aluminium industry is still a very low margin business…the lowest cost guys are making money at this level, but they are not making huge amounts of money.
"The point is if you were to shut down stuff that's completely marginal - temporarily at the very least but probably more permanently, and we're hearing policymakers thinking about this and considering importing instead…you're able to reallocate that power to much higher margin businesses with higher returns on capital," said Steel.
Strong economic demand in the wake of the pandemic has already seen China begin to source aluminium from elsewhere, with about 1Mt imported in 2020. Continued appetite for the metal by the world's second largest economy is expected to keep aluminium prices elevated on the SHFE, further incentivizing imports based on lower LME prices.
However, as Patel points out, this could eventually mean the LME price starts to rise owing to supply tightness in the rest of the world.
"It's a medium-to-long term argument that aluminium may well be set for an extended period of elevated prices," said Patel
Steel believes China is most likely to turn to Russia to plug a potential gap, part of the reason why Odey has built up a significant position in Russia's Rusal - the world's third largest aluminium producer after Chinese producers Chalco and Hongqiao - over the past few months.
"Given current power constrains in China, policy makers are beginning to think of Siberian-sourced aluminium imports as imported zero carbon power, at very low margin, enabling the reallocation of power supply to other high margin businesses," said Steel.
"Aluminium has always been seen to be the socialist metal, a factory business with zero barriers to entry, and China has been the one shifting the supply curve out, and down. Whether we see that happen or not, the equities in the space that are on the right side of this shift [for China to limit smelting capacity] seem like great value," he added.
Patel said he could see the rationale, noting that Rusal has long been developing a strategy where it believed the Chinese aluminium industry would hit a limit, with its location in Siberia giving it a material advantage over other potential suppliers.
Rusal's selling point as a low carbon producer also positions it well as governments zero in on high emitters.
"More importantly and prescient to the Rusal case than carbon taxes in Russia, are the carbon import taxes that we expect to be rolled out globally over time, such as the EU Green Deal. This provides a free option on the gross and relative margin of Rusal compared to peers, given the relative implied margin expansion that would occur," Odey said in its investment thesis on the company.
En+, the Anglo-Russian energy and metals group which holds a controlling stake in Rusal, said it expected to see primary aluminium demand grow over 6% in 2021 "and exceed pre-pandemic levels".
"There was some uncertainty as to how quickly production in China could rise to meet stimulus-led demand, but we are now seeing more evidence that the need for decarbonization will limit the expansion of capacity and keep markets in deficit, and prices are moving higher to reflect this," an En+ spokesperson told Mining Journal.
Substitute for copper?
Given aluminium shares some properties with copper, the high price of the red metal has sparked speculation about the potential for substitution, which would further bolster demand for aluminium.
"If this ratio [between copper and aluminium] continues to favour aluminium, of course we will see intensification of substitution," said En+.
Substitution is most likely in applications such as overhead transmissions lines and car heat exchangers.
"Currently aluminium is successfully replacing copper in automotive wiring and harness, especially in the middle and heavy duty trucks and buses. Integral aluminium penetration in EVs is the next step. We also see more and more aluminium in marine cables, which connect windfarms with the ground," said En+.
However, Patel is unconvinced. Firstly, the price ratio is unlikely to remain at current levels, he said, given the supply and demand issues already affecting the aluminium market.
There is also the question of implementation, which may be tricky in areas of business where manufacturers have been extoling the benefits of copper for years.
"One of the drawbacks is that you've got to train all your sales force and your engineers, who may need retooling as well.
"The other soft hindrance to substitution is you've spent the last 20 years telling all your copper customers that you use copper because copper is far superior to aluminium; now you're turning this around and educating your sales force to go out there and sell aluminium. People forget that aspect of substitution: It's not just a pure economic consideration; you've got to sell the metal you've been attacking," said Patel.
