The West European market for secondary aluminium : supply and demand models

Abstract: This thesis consists of two self-contained papers on the West European market for aluminium metal made from scrap, so called secondary aluminium. The purpose of the first paper is to identify and estimate the relative importance of factors determining supply and demand of secondary aluminium casting alloys in the short-run. The analysis is carried out within a neo- classical market framework using pooled time series and cross section data for Germany, France, Italy and the UK over the time period 1983-97. The results show that both the supply and the derived demand for secondary aluminium is own-price inelastic, which is reasonable considering the short run framework. On the demand side, the level of auto production is found to have a substantial impact on the level of secondary aluminium alloy demanded. We conclude that the model seem to describe the market reasonably well. The inelastic supply in combination with the cyclical demand from auto manufacturers provides a tentative answer to the observed volatility in secondary aluminium prices. Further, the inelastic supply identified, indicates that policies aimed at increasing recycling by using price-based incentives will be relatively inefficient. The first purpose of the second paper is to examine pricing in the market for secondary aluminium, especially the interdependencies with the market for primary aluminium. We develop a simple model assuming that the price for secondary aluminium is determined by the price of primary aluminium and industrial activity. The entire secondary industry is thus viewed as a price taker. Using pooled time series and cross section data for Germany, France, Italy and the UK over the time period 1983-97, the OLS results show an inelastic, though still sizeable reaction of the secondary price to changes in primary price, leading us to conclude that the secondary aluminium industry as a whole indeed seem to be a price taker. The inelastic response also leads us to further conclude that the secondary industry cannot completely fill the slack caused by fluctuating primary prices. The cause of this is that substitution between secondary and primary only takes place in the market for castings. A second purpose is to refine the supply elasticity estimates from paper 1, and further to calculate and estimate the impact from the stock of aluminium scrap on the supply of secondary aluminium. To do that, a theoretical model of secondary aluminium supply is developed, that integrates microeconomic theories of production and cost with a simple model of scrap generation and accumulation. The parameters of the supply model are estimated in ‘two steps', using data for the same countries and time period as above. In the first step, we explicitly include input costs for scrap. The TSLS results show an inelastic, though still quite significant own-price response of secondary supply. However, we demonstrate that since the input price of scrap is not independent of the output price of secondary aluminum alloys, the resulting own price elasticity will be overestimated. Thus, in a second step, an alternative supply function accounting for this is estimated, where we assume that secondary and scrap prices have a fixed relationship to each other. The results of this exercise indicate, as expected, a significantly reduced own-price elasticity. A 1 percent increase in price leads to a fifth of a percent increase in secondary output, which is in accordance with previous research. We show that due to the inelasticity of supply, subsidies to secondary refiners equaling almost 20 percent price increase will increase the market share of recycled aluminium with only 1 percent. Thus, we confirm the result from the first paper that price driven policies will fail to achieve increased recycling. We further calculate a continuously growing stock of scrap during the period in question. The increased availability of aluminium scrap increases the probability of secondary producers to find the wanted quality, thus lowering the cost of recycling. The impact on supply is however found to be small, less than on tenth of a percent. Given that increased recycling probably must come from the stock, the low responsiveness of supply from increase scrap availability indicates that attempts to stimulate ‘mining' of the scrap stock will be costly.