Most metals already have claimed dominance in their respective areas of popular usage. Aluminium's light weight has made it the top material for airplane bodies; steel's strength has deemed it necessary for construction; and copper's superior conductibility has given it the edge in electronics. However, continuous innovation by metal producers has widened the range of potential uses for many metal products. Further, a divergence in metal pricing in recent years has made metal substitution an important consideration for manufacturers. We examined the opportunities and trade-offs for replacement among steel, aluminium, and copper in the most likely applications to determine the winners and losers, and whether substitution even moves the needle for global consumption of each metal.
It's Not Just About the Bottom Line
The cost of the metal used is typically less than 10% of the finished product's total cost, so original-equipment manufacturers and other users of metal tend to be less sensitive to metal pricing in the short term, particularly with respect to high-end appliances, automobiles, and electronics. However, long-term price levels and price volatility make metal costs an important determinant of profitability, particularly as a wider array of materials has increased the threat that competitors might adopt cheaper methods of production. The more mission-critical the application, the greater the challenge posed by substitution to the manufacturer. Since price is generally the main driver to substitute and long-term price trends are difficult to forecast, less vital applications will see the most substitution. Other factors such as regulations, energy efficiency, risk of theft, and customer influence have been cited as drivers of metal substitution. But ultimately, we believe price levels and price volatility have the largest impact.
For the last couple of years, supply has been tighter in copper than in steel and aluminium, causing a quicker recovery in copper prices, which hit record levels while steel and aluminium still fall short of their precrisis peaks. The copper/aluminium price ratio, which was only a little higher than 2 leading up to and including the early quarters of the recession, has since risen sharply to a new high of nearly 4. While steel has exhibited the least volatility, both steel and aluminium are currently priced in line with annual averages prior to the boom and bust of 2008 and 2009. Copper, however, has had a turbulent few years. It has remained at or near all-time highs since the fall of 2010. Looking at pricing alone, copper appears to be the most vulnerable to substitution effects, but steel faces a regulatory framework that may give the more expensive aluminium an edge.
Steel vs. Aluminium: Transportation Bodies
Aluminium is on average 20%-40% lighter than steel, depending on the product, and can be made equally strong and crash-worthy--but at about 3 times the cost per ton. With the exception of high-end automobiles where price sensitivity is less important, steel is the standard for car bodies and train cabins. Aluminium can claim dominance only in aerospace, where its lightweight properties more than outweigh its additional cost. However, high gasoline prices and heightened environmental concerns are driving tougher fuel-efficiency standards that heavily influence metal preference, a trend we think is unlikely to reverse.
In the U.S., car companies face stricter Corporate Average Fuel Economy standards by the Department of Transportation and the Environmental Protection Agency, with European countries similarly insisting on greater fuel efficiency to make this a global effort. The American standards adopted in 2009 require cars and trucks to average 35.5 miles per gallon of gas by 2016. This implies a fuel-usage reduction of 7%-20%, which will require the removal of between 250-700 pounds per car. In July 2011, the next set of standards were unveiled, mandating vehicle fleets to average 54.5 miles per gallon by 2025. This represents a considerable challenge for automakers.
In a typical sedan, about 25% of the car's weight is made of the body skeleton, another 25% is the engine and transmission, and 20% is the chassis and suspension. All of these components are primarily made from steel. That is roughly 55%-60% of total car weight coming from the cheaper metal, with aluminium making up only about 8%. The body skeleton is where aluminium makers have set their sights. Current estimates indicate that doing nothing other than switching from a steel car body to one made of mostly aluminium can shave 10%-15% off the weight of a car, which would create about a 10% gain in fuel efficiency while maintaining safety standards and lowering carbon emissions.
While increased aluminium adoption will increase the sticker price of a car anywhere from $500-$1,500, consumers could save up to $4,000 per vehicle in fuel costs, so automakers should have little trouble passing along the higher metal costs to consumers and therefore are unlikely to invest heavily in ways to reduce the weight of a car through methods other than aluminium usage. It is also unlikely that metal pricing could diverge enough to impede the use of aluminium from a cost perspective. Further, automakers are becoming more open to retooling their factories for aluminium than they were in the 1970s, when emissions standards were first introduced and aluminium makers started touting the benefits of their product in automotive vehicles. Also, aluminium is similar enough to steel that car manufacturers will not have to completely retool their equipment.
Potential Safeguards for Steel
There are only a few hurdles to making the switch from steel to aluminium in auto bodies. First is the inherent resistance to change, specifically due to the needed investment in equipment to adjust to the different welding properties and thickness of aluminium. There is also a competitive defence--steelmakers are hard at work to come up with a more lightweight steel product to enable automakers to lighten their vehicles without adjusting their production processes for aluminium. Steel giants ArcelorMittal (MT) and U.S. Steel (X) currently are investing in the development of new high-strength steel products specifically for car bodies in order to remain competitive and combat aluminium substitution.
There also could be some unforeseen process challenges. When fuel economy standards were first introduced in the 1970s, some attempts to use aluminium were unsuccessful and steelmakers were quick to develop specialty steel alloys that achieved the same strength with less metal. Aluminium can be more flexible than steel, which can cause difficulty when shaping the metal into a car body. While we do not expect to see aluminium adoption for all car bodies, the benefits of aluminium are clear and the drawbacks are few.
Conclusion: We think aluminium usage in vehicle bodies could double in the current decade, which would add an additional 12 million tons of annual aluminium consumption, an increase of more than 25%.
Copper vs. Aluminium: Cables and Wiring
Copper has been the metal of choice for wiring and cables in electronic appliances, automobiles, and industrial components because of its high performance in conducting electricity. When copper prices first started to rise in 2006, the quality angle still held supreme. But at an astounding $9,000 per ton, copper prices have caused users to take another look at substitutes. While some copper is replaceable with plastic and optical fibre, the majority of the potential is in aluminium, an inferior but still capable conductor.
Aluminium already has gained some traction as a replacement for copper in heat sinks for electronics, wiring for automobiles and building facades, wire harnesses, coils used in commercial refrigerators, and high-voltage cables. On a per pound basis, aluminium is actually more conductive than copper because it is about one third the weight. The challenge is that the diametre of the metal needs to increase in order to make aluminium work. This has made aluminium more popular as a substitute for applications where size is less of an issue; for example, we are more likely to see increasing aluminium usage in car cabling than the wiring of handheld electronics.
Aluminium giant Alcoa (AA) believes aluminium has the potential to replace 20% of the copper used annually, which would constitute more than 3 million tons per year. The company already is trying to position itself in this market, developing new alloys and coatings that could improve aluminium's ability to conduct electricity. While retooling is an impediment, the current difference between the price of copper and aluminium is probably enough to justify the costs of switching some manufacturing processes and paying for the extra aluminium it takes to conduct the same amount of electricity as copper.
Auto manufacturers already are accustomed to using aluminium rather than copper in their most basic models. The average vehicle in the U.S. or Europe uses 20-25 pounds of copper, but the models sent by the same manufacturer to developing economies have only one fourth as much. If copper prices continue to rise at a faster rate than aluminium, we think it is likely that as much as 40% of copper used in cars could be replaced by aluminium in the next several years.
Potential Safeguards for Copper
One of the biggest drawbacks for aluminium is that it will oxidise. Oxidation prevents corrosion, but it decreases the metal's ability to conduct electricity. Therefore, conducting surfaces need to be formed in such a way that the metal is not exposed to air so an oxidation layer will not form. Also, aluminium is less dependable than copper in terms of handling temperature and pressure changes over the lifecycle of a car. Aluminium wire and cable can be difficult to feed, cut, crimp, strip, and splice relative to its copper counterparts. Numerous processing methods are currently being developed, but a demanding approval process could hamper the adoption of aluminium-wired electrical vehicles.
As the cost of energy rises, the need for renewable sources will grow and copper's position is somewhat protected as a green electricity conductor. Aluminium is only about 60% as conductible as copper so while it is a cheaper metal, it requires more fuel. Electric and hybrid vehicles still use 2 to 3 times more copper than standard cars. The shift toward more energy-efficient and environmentally friendly vehicles, equipment, and power generation is likely to offset some of the loss copper will sustain on its more basic applications.
Copper's superior conductivity also protects its position in applications where size is critical, such as consumer electronics. Demand for smaller and smaller computers and mobile phones requires smaller semiconductors, which are not feasible to make from aluminium as they would use more metal to transfer the same amount of power.
Conclusion: We think up to 10% of copper uses could see a switch to aluminium, but much hinges on the stability and level of metal prices as the decision to substitute is almost entirely price-driven.
Substitution Effect Already Apparent
Despite the fact that copper prices have greatly outpaced steel and aluminium, consumption has not. Steel and aluminium demand grew 24% and 30%, respectively, from 2005 to 2010 whereas copper usage only climbed about 8%. Some of the slower growth in copper consumption is likely due to the difference in end markets. Copper's primary uses are in electrical appliances, industrial equipment, and utilities.
While steel and aluminium have seen a boom in consumption due to construction in emerging markets, namely China, infrastructure uses much less copper on a tonnage basis. Still, we attribute some of the faster growth in aluminium consumption relative to copper--and to a lesser extent steel--to substitution effects.
Mining giant Rio Tinto (RIO) estimates an average of 400,000 tons of copper demand per year was lost to substitution of other materials for the last five years. Estimates by the International Copper Association are even higher, with as much as 570,000 tons lost in 2007 when the market peaked, and aluminium picking up most of that share. Aluminium has also already made significant headway in automotive bodies. Nearly all hybrid cars use aluminium in the hoods and wheels, and high-end cars such as those made by Jaguar and Audi are already significant users of aluminium in the skeleton. In 2006, the average weight of aluminium per car was 316 pounds. That has since climbed to nearly 340 pounds, while aluminium weight in heavy trucks and trailers has increased about 20%-25% in the same time frame.
The Winners and Losers
While the opportunity varies by application, aluminium is the clear winner in the game of substitution, with copper, and to a much lesser extent steel, likely to bear the largest brunt of aluminium's gain. While the market opportunity for aluminium as a replacement for steel is much larger than as a substitute for copper, the steel sector dwarfs the base metals in size (as shown in the charts below) and thus is unlikely to feel as great of a hit. A loss of 12 million tons of steel globally is only a pinch, but 1-2 million tons of copper replaced is 10% of the entire market. Also, copper has other threats besides aluminium. For example, the substitution of plastic for copper is becoming more popular in plumbing and gas piping applications. Steel has no other major competitors in its primary applications.
Aluminium should make the most headway in the automotive industry as a replacement for both cabling and vehicle bodies. In our view, energy prices are the largest hindrance to aluminium when it comes to more environmentally friendly applications. Wind turbines, solar panels, and hybrid cars are all likely to stick with copper for their wiring as efficient energy transfer is paramount in such applications. However we think the metal markets are probably not the only place aluminium is likely to gain some share. For example, aluminium is recently attracting more attention as a substitute for plastic and glass in the packaging sector, particularly in emerging economies.
Within the aluminium sector, we don't think any of the major players--Alcoa, Rio Tinto, UC Rusal, Norsk Hydro (NHY), Aluminum Corp. of China (ACH)--have a particular unique edge to take advantage of these trends at the expense of peers. Aluminum's high value/weight ratio makes it a globally traded product and its standardised price, as traded on the London Metals Exchange, reflects changes in consumption all over the world. But we think our view of the substitution potential fits with the narrative that aluminium producers give on the direction of the market. Alcoa expects the size of the aluminium market to double to more than 80 million tons by 2020. We think the company is banking on some support from substitution to meet this target rather than pure growth in its traditional end markets.
Among steelmakers, those that make flat-rolled steel largely for the automotive and appliance sectors are most likely to feel the pressure from aluminium substitution, but not enough to materially threaten their sales in the next decade. Copper is similar to aluminium in that it is a globally traded product with standardised pricing, and thus we think the substitution burden will be equally shared by copper producers. The direction of copper prices relative to aluminium will play a big role as to the long-term impact on the market for copper. Retooling requires new equipment and new processes that carry risks, and manufacturers are generally resistant to take a chance on a path less travelled. But if the spread in metal prices was enough to initiate some of this change in cable and wiring applications, there likely will be an even quicker reaction back to the tried-and-true metal should historical pricing patterns resurface. So while copper is the most at risk, it also has the greatest likelihood to maintain its market position, as the decision to use aluminium in place of copper hinges more on flexible prices than rigid regulations and climate change initiatives as is the case with steel.
