#Sanctions on Russian aluminium: what will Europe do?

In a move that roiled stock markets, the U.S. Treasury slapped sanctions last Friday on seven Russian oligarchs and 12 firms they own or control, charging them with spreading “malign activities” around the world. Under the act, the persons and legal entities listed are effectively barred from the U.S. banking system, prohibits them from using the U.S. dollar for any transactions and forbids U.S. citizens from doing business with them. While this is by no means the first time Washington lashes out against Moscow, the breadth of the sanctions was unprecedented. So much so that Western consumers are likely to be hit the hardest.

“For the first time, the sanctions actually bite”, quipped seasoned Russia analyst Leonid Bershidsky, discussing the unexpected inclusion of Oleg Deripaska and his business empire, which features Rusal - the world’s largest aluminium producer (ex-China). The company accounted last year for around 14% of world aluminium production, with an output of 3.71 million tonnes.

Even if the sanctions on buying Rusal goods only come into force on June 5^th, the effects were immediate. Rusal’s stock tanked on the Hong Kong Exchange, sending aluminium prices close to multi-year highs. Glencore, the company’s biggest customer, said it would re-evaluate its relationship with the Russian producer, and the London Metal Exchange decided to ban the metal from its trading platform. Simultaneously, the premium U.S. consumers pay to get deliver of the metal shot up by 20% to near-record levels, making aluminium-heavy goods such as cars, airplanes, packaging or soda cans more expensive for consumers – and more profitable for American producers.

Due to the scope of the sanctions, similar effects were felt in Europe as well. Even if the odds are low at this point, European banks and consumers are worried they could fall foul of so-called “secondary sanctions”, levied by the U.S. on third parties for facilitating transactions with sanctioned entities. While such extraterritorial secondary sanctions are unlikely at this point, as this extra layer of sanctions has been applied only once - to banks doing business with Iranian entities – users of Russian metal have started looking for alternatives.

Supply chains disrupted

And therein lies the rub. As Robin Bhar, head of metals research at Societe Generale in London said, “There’s a lot of panic and uncertainty. I don’t see how you can easily replace that missing Russian origin material in the short term.”  A similar view was echoed by Colin Hamilton, head of metals at BMO Capital Markets Ltd: “We can’t make it without Rusal. We need Rusal material.”

Indeed, as many industrial consumers and SMEs will soon find out, the global supply gap left by Rusal-branded aluminium will be hard to replace. Why? Because years of low aluminium prices caused by Chinese overproduction have led to massive capacity closures in Europe and the United States.

With the market already in a deficit following the passing of Section 232 tariffs by the United States, which applied an across-the-board duty of 10% on all aluminium imports, sanctioning Russian metal has only added to the pain. Even if a number of U.S. allies – including the European Union and Canada – obtained temporary exemptions from the tariff, the world simply does not have enough spare production to make up for the sudden evaporation of 14% of the world’s ex-China production. Even if China is overproducing and could, theoretically, step in to stabilize prices, Beijing’s policy of applying export tariffs to primary aluminium renders the prospect unappealing.

Much like the U.S., Europe is currently importing almost half of its consumption, or more than 6 million tonnes of aluminium ingot a year - and almost 840,000 tonnes come from Russia. If you add the roughly 2 million tonnes that will be subject to extra duties in the U.S., it’s obvious that the competition for non-Russian or Section 232-exempt metal will grow exponentially.

With so much at stake, the EU would be wise to consider carefully its options and explore avenues that would limit the impact of secondary sanctions on European businesses. Indeed, the two-pronged restrictions on aluminium imports are setting the stage for a perfect storm that the market is ill-equipped to face down. Aluminium prices are expected to break record after record, increasing input costs for a swathe of companies reliant on the metal for their business.

Coupled with weak economic conditions in most European countries, the knock on effects from the U.S.’ trade and sanctions policies will be felt acutely by European consumers. European business confidence gauges have plummeted to six-months lows, as did most subcomponents of the main economic indicator. Industry confidence, services confidence, retail trade confidence and financial services confidence were all firmly in the red.

If there’s one silver lining in this rather bleak picture, it’s to be found in the U.S. According to Morgan Stanley, every 2-cent per pound increase in the U.S. premium represents a $50 million (pre-EBITDA) boon for U.S. aluminium companies like Alcoa. Smelling rich rewards, some producers have already announced plans to restart idled aluminium smelters.

Despite being dressed up as fighting against Russian “malignant activities around the globe”, the latest batch of sanctions seems to be little more than a fresh handout from the Trump administration to its embattled industrial heartland. One can only hope that EU decision makers will show the same grit and take meaningful steps to protect European businesses – even if it means upsetting a few White House hawks on the other side of the ocean.

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