Chalco Stuck in the Dilemma of Transformation Again

Aluminum Corporation of China Limited (hereinafter referred to as Chalco)announced in its 2012 annual report that it suffered huge losses after small profits gained in 2012 and 2011.The net loss of shareholders of the parent company reached 8.23 billion yuan, surpassing the biggest loss of 7 billion yuan when 2009 financial crisis broke out.

Related person in charge of Chalco explained in the interview conducted by the National Financial Weekly that 2010 and 2011 saw Chalco recover from the crisis, with profit of 960 million yuan in 2010 and 690 million yuan in 2011, respectively. However, as the European debt crisis deepened and the growth rate of national economy dropped, the growth rate of demand for aluminium products suddenly dropped from over 10% to about 7%, causing overcapacity in the aluminum industry of China and great drop of products price. The whole industry suffered losses and Chalco was no exception.

In 2012, as two profit pillars of Chalco, alumina and electrolytic aluminum both saw a substantial price fall. Compared with 2011, their prices dropped by 168 yuan and 1150 yuan,respectively, both down by over 6%. Just these two drops made the company’s alumina profit decrease by 3.24 billion yuan compared with 2011 and electrolytic aluminum profit decrease by 3.39 billion yuan, totaling 6.63 billion yuan and accounting for over 80% of the total loss of 2012.

However, industrial experts do not accept the explanation of Chalco. “It is a big mistake for Chalco to excessively attribute losses to macroeconomy and overly emphasize external causes, if it intends to break through the dilemma.The fundamental reason for Chalco’s loss is its structure problem and system constraint. The illusion of stable aluminum price caused by the economic stimulus measures in these two years concealed the problem temporarily,” said Wen Xianjun, vice-chairman of China Nonferrous Metals Industry Association, in the interview.

Bauxite is the core material for manufacturing alumina, which is a profit pillar of Chalco. The alumina profit of Chalco in 2010 and 2011 both exceeded 3 billion yuan, accounting for almost half of its main business’ profits.

According to its 2012 annual report, the average alumina price of the company is 2,568 yuan per ton, decreasing by 6.1% and 1.6% respectively compared with the year 2011 and 2010.If calculated on the basis of the production cost of 2,490 yuan in 2011, its profit of alumina business in 2012 should be at least over 900 million yuan. However, although the price of bauxite since November of 2011 has been increasing rapidly, the alumina business suffered a loss of about 600 million yuan.

Since 2012, bauxite produced by Chalco has stood at 17.26 million tons, only meeting 53%of its own demand. In addition, its bauxite mine mainly comes from such provinces as Henan and Shanxi. However, after many years of exploitation, the quality of the bauxite from these places becomes increasingly poorer, while its cost increases gradually. The price of bauxite in Henan has reached 310 yuan per ton in October of 2011, almost twice as much as the price of that imported from Indonesia.

In order to reduce the cost, it has become the optimal choice for Chalco, or even the whole industry, to depend on imported low-price bauxite. By 2011, the degree of dependence on imported bauxite reached 60%, among which 80% came from Indonesia. The price of imported bauxite has gradually become the indicator of that of domestic alumina.

“The utilization of bauxite resources almost gets into the same dilemma as that of iron ore.As one of the largest alumina enterprises in China, Chalco does not have pricing power in the international market, which buries a potential danger for its future development,” said Sang Yongliang, research fellow with Guotai-Junan Securities Co., Ltd.

In November of 2011, the Indonesia government suddenly announced that it would impose an additional 40% tariff on export of bauxite and other 13 minerals, and comprehensively ban export from 2014 on. In December of 2011, the price of bauxite in Indonesia correspondingly increased by 53.6%, or around 267 yuan per ton. In January of 2012, the price of domestic bauxite also fluctuated. The price of bauxite in Henan increased from 300 yuan per ton to 360-380 yuan per ton; the price of bauxite in Guangxi increased from 240 yuan per ton to 280-330 yuan per ton. The increase of both prices exceeded 20%.

If calculated in accordance to the rule that every ton of alumina produced needs 2.7 tons of bauxite, the price increase of bauxite causes the cost of alumina for Chalco in 2012 to increase by about 150 yuan per ton compared with the year 2011.

Related person in charge of Chalco said that although Chalco decreases the cost of alumina by 30 yuan per ton by transforming operation and exploring its internal potential, the production cost of alumina was still higher than 2011 by 120 yuan, which alone reduced profit by 1.46 billion yuan.

In addition, another profit pillar of Chalco--electrolytic aluminium business also saw poor performance in 2012, with profit of only 327 million yuan. That was a decrease of 3.39 billion yuan compared with 2011 and 3.2 billion yuan compared with 2010.

“It might be reasonable for Chalco to attribute the losses of alumina to the slowdown of economic growth, overcapacity and dropping price of aluminum products. However, the above mentioned reasons could not justify the sharp decrease in the profit of electrolytic aluminum.The average price of electrolytic aluminum in 2012 was about 15,700 yuan per ton. Although it decreased by about 1,100 yuan compared with 2011, it was almost the same as that of the year 2010,” said Wen Xianjun in the interview.

Since Chalco could make huge profits in 2010 when the price of aluminum was low, then why didn’t it make it in 2012? The fundamental reason for this does not lie in price decline, but in the fact that since 2010, the electricity price has increased a lot and its power supply structure is not rational. The relatively high electrolytic aluminum price concealed the crisis temporarily. Electricity fees are the main cost for producing electrolytic aluminum. Producing a ton of electrolytic aluminum will consume 14,000-15,000 KWH. For the power rate to increase 0.01 yuan/KWH, the cost of electrolytic aluminum would increase by 140 yuan per ton.

Sang Yongliang said in the interview that at present, the electricity in producing electrolytic aluminum mainly comes from power grid and self-supply power plant (with coal mining,electricity generating and aluminum producing integrated in one enterprise). The cost of the latter is only 0.2-0.3 yuan/KWH while the cost of the former is as high as 0.4-0.6 yuan/KWH However, Chinalco started the integration of coal, electricity and aluminum quite late, without its own base of coal supply and supporting power plants. Half of its current power supply still comes from power grid, which causes its electricity cost to stay high.

Since June 1st, 2010, because the state abolished the favorable policies electricity use for electrolytic aluminum production, electricity cost of Chalco has become even higher. The power rate of power grid in 2011 and 2012 increased by an average of 0.1-0.2 yuan compared with 2010. This caused the cost of electrolytic aluminum in 2012 to increase by 1,400 yuan per ton compared with 2010.

Related person in charge of Chalco said in the interview that Chalco has transformed its operation and explored its internal potential, making the average unit energy consumption for electrolytic aluminum decrease by about 500 KWH compared with 2010 and the cost decrease by 240 yuan per ton which, however, compared with the high electricity cost, was still insignificant. The high electricity cost alone caused the profit of electrolytic aluminum to reduce by 4.6 billion yuan compared with 2010.

To make it worse, the cost of alumina increases. If calculated in accordance to the rule that every ton of electrolytic aluminum needs 2 tons of alumina, the profits of electrolytic aluminum in 2012 decreased by 2.3 billion yuan compared with 2010.

Because it was difficult for Chinalco to control the costs of resources and electricity, its profit reduced by 8.3 billion yuan compared with the year 2010 with the prices of aluminum products at the similar level, which was almost the same as the figure of losses in 2012.

“The key of this company’s success lies in its strategic transformation, accelerated attainment of mining resources and establishment of energy base with integration of coal, electricity and aluminum so as to effectively control costs of resources and electricity,” said Zhang Wuzhuang, chief expert of Antaike Information Development Co., Ltd, in an interview conducted by the National Finance Weekly.

Person in charge of Chalco said that it has quickened the development of mine with rights and interests since 2011 by adopting the mode of equity cooperation, after it encountered two consecutive setbacks in the Queensland and Aurukun bauxite projects in Australia in 2008 and bauxite project in Brazil in 2009.

In April of 2011, the company founded a joint venture with the Service Company of Laos to jointly develop mineral resources in the south of Laos. In August of 2012, it concluded a cooperation agreement on Kalimantan Barat bauxite project with the Indonesia Company,with an expected annual capacity of 1.8 million tons. In 2012, its newly increased volume of bauxite with rights and interests at home also exceeded 48 million tons.

In February of 2013, through equity acquisition and capital increase, Chalco obtained 70.82%stock equity of Ningxia Power Generation Group and 2.38 billion tons of coal resources,with the coal capacity under construction and in production reaching 16 million tons per year.

Apart from these, Chalco has secured 8 million tons of coal capacity with rights and interests in Shangxi, Gansu, Guizhou and Qinghai by utilizing the opportunity of national coal resources integration.

“Chalco is doing its utmost to establish and improve its resources base and energy base of coal, electricity and aluminum. However, because the projects were at their initial stage, the cost of its strategic transformation also comprised an important reason for its losses in 2012,” said relevant person in charge.

According to its 2012 annual report, thanks to its structural adjustment and strategic transformation and upstream expansion of business, the scale of its liability with interests expanded,with financial expense reaching 4.66 billion yuan. Compared with 2010 and 2011, newly increased financial costs account for 15.6% and 25.9% of the total loss.

“The current loss is by no means lethal to Chalco, and the key lies in whether it can achieve strategic transformation in future,” said Pan Pinlin, research fellow with Jintai Futures R&D Department, in an interview made by the National Finance Weekly. He said that there will be a long way to go before Chalco establishes resources bases, particularly in terms of getting overseas minerals with rights and interests, and it is hard to solve the problem of bauxite price increase and high cost of alumina in a short period. However, its breakthrough in establishing integrated energy base will get instant results. The cost of electricity for integrating coal, electricity and aluminum is 0.2-0.3 yuan/KWH. At present, the average cost of electricity is about 0.43 yuan/KWH. If Chalco increases the proportion of self-supply power by 10%, the cost of electricity will be reduced by 0.087 yuan/KWH, increasing the profit by 4.95 billion yuan.

In theory, in view of its annual coal capacity of almost 30 million tons, Chalco can basically achieve the integration of coal, power and aluminum and abandon grid power supply so as to extricate itself from the mire of losses.

Pan Pinlin said that currently some private enterprises such as Weiqiao and Dongfangxiwang in Shandong have been a success story for Chalco in joint operation of coal, electricity and aluminum. Nevertheless, theory reasoning is a far cry from realities. It is hard for Chalco to copy the success of private enterprises.

“The antidote for other companies is perhaps just the poison for Chalco. What its rapid development of integration of coal, electricity and aluminum brings is not profits, but perhaps bigger losses,” Wen Xianjun told the journalist of National Finance Weekly. He said that the so-called integration that people talked about always neglected the most important element -power grid.

The integration of coal, electricity and aluminum carried out by Weiqiao and Dongfangxiwang in Shandong are both supported by industrial clusters and have a power grid system independent of national power grid. The operation of generator sets operating off grid incurs great potential of dangers. Faults, maintenance and loop current will all increase the instability and cost of power supply. Safe and economical operation of this integration can be achieved only when there are a network among generator sets and industrial clusters such as textile and manufacturing surrounding the electrolytic aluminum enterprises to cushion the impact of loop current and regulate the peak-valley load.The electricity cost of 0.2-0.3 yuan/KWH in integration is realized with the assistance of power grid.

The biggest obstacle for Chalco to copy the success story of these two enterprises is the constraint imposed by its own system and the grid system.

Chalco can obtain coal resources on its own. It can also have its own power-supply plant to achieve a breakthrough of energy and electricity development by purchasing large-scale power generation group. However, as a state-owned enterprise, Chalco can hardly break through the shackles of monopoly by national power grid,and therefore it is impossible to establish a power grid to sell electricity by itself. Its integration of coal, electricity and aluminum can only be achieved with the support of national power grid.

Under the current system, the national power grid has the power to deploy the generator sets with access to network. Because of its dependence on the national power grid, a 3,350-megawatt generator set of Chalco with integration of coal, electricity and aluminum in Lanzhou had to shut off one generator and cut the other’s generation capacity by half on receiving a directive. The result was that the self-supply electricity and electricity provided by the national grid accounts for 50% each, making it difficult to reduce electricity cost.

“It is a trap for Chalco to simply expand integration of coal, electricity and aluminum. It must break the dual restriction of current corporate system and power grid system before it gains success in strategic transformation,” said Wen Xianjun.