Recommendation Although aluminum prices are at relative historic low today, we recommend that Alusaf go ahead with plans to construct the Hillside smelter plant. Based on the following analyses, we project the price of aluminum to rise to approximately $1,590 per ton in 5 years. This price exceeds the minimum required level of $1,416 per ton to yield Alusaf a positive net present value (NPV) on its initial plant investment of $1. 6 billion. Analysis of Hillside plant profitability
At a minimum market price of $1,416 per ton of aluminum, the Hillside plant can produce annual profits of ~$216 M, beginning in 1997. Discounting these annual profits to their 1994 value, using an 11% cost of capital, the project will be worth undertaking (see details in slide 1), assuming the price of aluminum holds at or above this level. Projections of primary world aluminum supply and demand To estimate the supply and demand levels of primary aluminum 5 years from now, we analyzed current supply capacity and world consumption. Supply
Beginning with future supply, we assumed that producers would continue production as long as the market price exceeds their variable costs. State suppliers, however, are an important caveat; we assume that they are also currently producing aluminum at prices below variable costs, and will continue to do so, in order to meet strategic or economic needs. The model that we constructed based on these assumptions explains the current aluminum production levels (19. 8 mtpy) with higher than 99% accuracy (predicted at 19. 62 mtpy). Demand
To forecast world primary aluminum demand over the next 5 years, we first constructed a demand schedule for 1993 using real prices and quantities supplied based on historical data between 1988 and 1992 (Exhibit 3 and 4 in case). Keeping these prices constant, we predicted an overall increase in quantity demanded over the next 5 years based on an estimate of the growth of world consumption. We isolated demand for primary production by subtracting the growing secondary production demand over the same period from total world demand. This gave us a very steep demand curve.
This final primary demand estimate was a forward projection based on the CAGR observed over the last 10 years. Due to unusually high price volatility during this period and its potential negative impact on demand, we selected the value of the 10 year growth. Based on these assumptions, we found out that unless new entrants come into the market, aluminum prices will see new historic highs as industry will be using its full capacity to meet growing demand. New Entrants & Long Term Price At current prices, there are no incentives for new entrants.
In order for an ‘average smelter’ to enter the market, price should be above $1590 to meet its operating ($1210) and capital costs ($380)even under the most conservative scenario (An average smelter with 466 mt capacity can be built by spending $1. 6 billion today and it can start production next year). Using our predictions for world supply capacity and consumer demand, we can estimate the world market price for aluminum in 1998 to be ~$1,590 per ton because only when price is at or above this level will there be incentives for new entrants.