Fat Dragon had that feeling when reading a report recently about the aluminum industry in China, or more to the point, the alumina industry.
Fat Dragon has always regarded the alumina industry as one of the great examples of the weaknesses of China's political economy, to wit, the ability of large state enterprises to defend monopoly positions by strangling potential competitors. Such is, or apparently was, the case with Chalco, or the Aluminum Corp of China.
One of the perils of writing a column about China is that you can thunder on about a topic with great certainty, only to find in the short period of time it takes to get into print that events have passed one by and rendered your observations all but worthless.
Alumina is used to make aluminum (the raw material when it is dug out of the ground is bauxite), which in turn is used to make everything from wiring to packaging. Aluminum is also used in cars and nuclear power stations, both key growth industries in China.
A few years back, Chalco faced a challenge from Liu Yongxing, one of the two Liu brothers from Sichuan, pioneering entrepreneurs who had become among China's richest men in the 1990s through their pig feed business. Liu wanted to diversity into alumina but Chalco headed him off by agreeing to take a large stake in his proposed project in Henan province, thus neutralizing what would have been a challenge from the private sector to its monopoly.
Chalco was worried about setting a precedent. If one entrepreneur could enter their business, then why couldn't hundreds more? But it appears that in a virtual twinkle of an eye, this is what has happened.
China's alumina production is soaring as a result of rising prices. The country is expected to produce 13.1 million tonnes of alumina in 2006, up from about 8mt in 2005. By 2007, it could reach 19.1mt and more than 27mt by the end of the decade, according to a report by Macquarie Equities. With such a massive and sustained rally in prices, even Chalco has not been able to hold back the tide. New players have been rushing into the market in the last three years, and as a result, non-Chalco Chinese production could exceed Chalco's production by 2008.
For all of the Wild West elements in this story and doubtless the lack of environmental oversight that has gone into the construction of such plants, Fat Dragon is somewhat encouraged by this story.
Rent-seeking state-owned monopolies, or at least oligopolies, are an impediment to the rise of China's private economy.
For the surge in private business in recent years, the commanding heights of the Chinese economy – telecoms, energy, steel, petrochemicals and coal – are all dominated by big state players. If any private business starts to gain any kind of scale, it will struggle to survive unless it allows itself to be adopted by a large state partner.
So what has happened in the alumina industry?
It is not yet clear, even to experts like Macquarie. In a kind-of-only-in-China line in its industry report, the brokerage fesses up that it had to redo its analysis after visiting the mainland and "discovering several previously unknown alumina projects under construction".
This is where Fat Dragon starts to have reservations. The upside of this story is greater competition for Chalco. The downside is that new entrants may have only been able to ramp up the extra capacity at such speed if they were working hand-in-glove with local governments. (Chalco is owned by the central government.)
Competition is great, but if it is competition funded by cheap loans backed by local governments, the only people who benefit unambiguously are consumers in Western countries who get all those cheap Chinese imports. For China, the picture is a little mixed. Sure they get a short burst of economic activity but at great environmental expense and the growth may be ultimately unsustainable.
Chalco might yet prevail in the end. After all, they have the technology and most of China's bauxite all to themselves. Fat Dragon might return to this topic in a couple of months to check.