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Sunday, 23 November 2014

China syndrome

China's role in Rio Tinto chief’s downfall

Rio Tinto’s $38 billion purchase of aluminium producer Alcan has cost the company billions of dollars in write-downs, leading chief executive Tom Albanese to fall on his sword. But it’s not all Albanese’s fault. Rio’s biggest customer, China, shares some of the blame.

The rationale for buying Alcan was that China’s urban growth would prompt it to consume more aluminium and produce less. Albanese was right about demand. Fixed asset investment has grown 26 percent a year on average since 2007. The silver metal figures heavily in China’s plans - such as a project to expand the national grid with aluminium cables.

But on the supply side, Rio’s reckoning was dead wrong. In 2007, Albanese argued that the company’s low production costs - around $1600 a tonne - gave it an edge over Chinese producers, whose average cash costs were then around a quarter higher. China’s uneconomic aluminium producers were likely to be squeezed out, reducing supply and keeping prices afloat.

China’s state capitalists had other ideas. While prices have fallen, the government has propped up suppliers. Energy costs are subsidized, while banks offer cheap loans and roll them over when they can’t be paid back. Earnings have evaporated: the average cash cost of production of $2400 per tone is roughly the same as the price for which aluminium is sold in China, according to AZ China. The consultancy reckons a quarter of Chinese producers are now on life-support funding.

The result has been a disaster for Alcan. Far from tailing off, China’s production of aluminium has increased by 10 percent a year since November 2007. China now makes up 43 percent of world production, compared with 33 percent in 2007, according to the International Aluminium Institute. To add insult to injury, Chinese producer Chinalco is also now Rio’s biggest shareholder.

Albanese can take comfort that his other big career bet, iron ore, fared better. There, China’s high costs and fragmented supply have kept market prices elevated, and delivered Rio healthy profits. By contrast in aluminium, China’s decision to put jobs before profit has just made a bad situation worse. Future dealmakers underestimate that penchant for market meddling at their own risk.

Readers' comments (1)

  • Saying that the Chinese are to "blame", even partly, suggests a transfer of responsibility to them, from the Board of Rio. The Chinese did what they did the last several years because that's what they have done before, and because that's what happens in a Socialist system. It isn't as if they Chinese had any part in the planning or accepted any responsibility in the decision-making that the Rio Board undertook.

    In fact, many of the new low-cost smelters in China were being planned even as Mr. Albanese was mounting his attack on Alcan. Perhaps if he had checked with the Chinese supply-side before he put his money on the table, he might still have a job.

    You also have to wonder, how exactly was the old Alcan going to meet China's needs? Through Gladstone and Tomago smelters in Australia? From Quebec? Alcan was not in such a great position to meet China's needs in the first place.

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Context News

Rio Tinto’s chief executive, Tom Albanese, resigned on Jan. 17 as the company revealed a $14 billion accounting writedown related to the value of its coal and aluminium businesses. Most of the aluminium writedown related to the purchase in 2007 of Canadian aluminium producer Alcan, a deal which had already been subject to significant downward revaluations.

China is the world’s biggest producer of primary aluminium, with 43 percent of global supply, based on data from the International Aluminium Institute. The cash cost of aluminium in China was 14,965 yuan per tonne on Jan. 17, compared with an average cash cost of production of 14,900 yuan per tonne, according to consultant AZ China.

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