China bails out struggling base-metals producers

China has been bailing out its struggling domestic smelters by stockpiling metals since December.

The State Reserve Bureau (SRB) has made sizable purchases of aluminium and zinc, which has had a positive influence on domestic metals prices, Standard Chartered said in a client note on Jan. 23.

The SRB bought 59,000 tonnes of zinc through a tender on Jan. 14 and plans to complete an acquisition of 290,000 tonnes of aluminium by the end of January, Standard Chartered reports.

SRB’s aluminium stockpile is now estimated to be about 2% of the country’s 2008 primary aluminium production and less than 2% of its zinc production.

In late November, the State Council advised China’s provincial governments to increase stockpiles of key commodities and resources, Standard Chartered reports.

The first provincial government to respond to Beijing’s request was Yunnan province, the country’s second-largest base metals producing province. Yunnan sits in the far southwestern part of China and borders Myanmar, Laos, and Vietnam.

In mid-December, Yunnan announced an ambitious plan to stockpile 1 million tonnes of base metals – about 50% of the province’s annual output. The move came after some of the major commodities companies there reported shortages of working capital.

Yunnan’s plan features stockpile targets of 150,000 tonnes of copper (4% of the national total), 300,000 tonnes of aluminium (2.3%), 150,000 tonnes of lead (4.5%), 300,000 tonnes of zinc (8%) and 100,000 tonnes of tin (80%).

According to Standard Chartered, the Yunnan government will ask metals producers and trading houses to stockpile their inventories in state-owned warehouses until Dec. 31, 2009. State-owned banks will then lend about US$2.9-3.7 billion as working capital to companies, using the stockpiles as collateral.

Under the arrangement, the Yunnan provincial government will pay the interest on the bank loans and warehousing charges and will also be allowed to select the timing of the sale of these stockpiles.

In terms of the amount of metals being stockpiled, Standard Chartered expressed reservations about the plan to stockpile 100,000 tonnes of tin, calling it “very ambitious.”

By its calculations that amount is about 30% of the world’s total and twelve times the LME’s current inventory of the metal.

On Dec. 27, Yunnan Tin Group, China’s largest tin producer, said the government had approved a plan for the company to stockpile 30,000 tonnes of tin, or 52% of 2008 annual production, for the 13 months ending on Dec. 31.

“This is equivalent to 30% of the stockpiling target set by the government,” Standard Chartered wrote, “but it does not mean that Yunnan Tin will immediately stockpile that much metal, as only 6,000 tonnes of the metal will be stored in the first stage.”

Yunnan Tin, which produces half of China’s tin supply, stopped tin smelting late last year and, according to Standard Chartered, does not pan to resume production until February.)

Ultimately the amount and timing of stockpiling in the province will depend on production, sales and prices, the bank’s research team noted.

While China’s plans to stockpile metals may be good news for prices in the short-term (SRB’s stockpile of aluminium, for instance, was a key factor in pushing up the metal’s price by 7% between December and January), they threaten to weight on any price recovery, Standard Chartered reasons.

If Yunnan does manage to stockpile 100,000 tonnes of tin, for example, the stockpile overhang alone “is likely to cap any future rebound in tin prices, not mentioning the ideal capacity.”

Ultimately, and in the absence of further state purchases, Standard Chartered said it forecasts China’s metals prices will “see further downside” in the first half of this year and even for tin, state reserves will “limit the pace of recovery when it comes.”