Aluminum Needs More Output Cuts

Faced with declining aluminum prices and rising costs, the largest producers in Europe and North America are starting to reduce output and hoping their Chinese rivals will make bigger cuts to send prices higher again.

Three-month, benchmark aluminum prices have fallen about 28% since May, closing Wednesday at $2,165 a metric ton on the London Metal Exchange. The decline is forcing companies to make tough decisions about whether they can afford to operate plants.

So far, a few operations in Canada, the U.S. and Europe, owned variously by Alcoa Inc.; Rio Tinto Alcan, a subsidiary of Rio Tinto PLC; and the private-equity firm Klesch & Co., have cut output, for reasons including labor issues and the cost and availability of power.

More reductions could follow. Norway's Norsk Hydro ASA is considering cuts at its Kurri Kurri smelter in Australia, an operation plagued by high energy prices and hit by the appreciation of the Australian dollar against the U.S. dollar.

The company's Albras smelter in Brazil faces a similar picture, a person familiar with the matter says, while other facilities, in Europe in particular, are struggling at current prices.

But sizable cuts to capacity in China, the world's largest producer of aluminum, would provide bigger support to prices, say analysts.

Aluminum consumption has fallen by far more than output. Analysts estimate that even after the current cutbacks, production still will exceed demand by as much as one million tons. Official aluminum stocks are at all-time highs. The question now is whether producers will cut output enough, especially in China, where the government must balance its desire to maintain employment at smelters against the need to keep aluminum prices steady.

The situation is reminiscent of the aftermath of the 2008 economic downturn, when slumping demand in transportation and construction, key markets for aluminum, caused prices to more than halve. Companies cut their planned output of aluminum by a total estimated at more than 4.5 million metric tons, the majority of it in China.

Now, Russia's United Co. Rusal PLC estimates, about 30% of Chinese aluminum smelters are losing money with prices at $2,200 per ton. At $2,000, this figure could be as much as 45%.

"Chinese aluminum producers should be the driver for smelter closures," said Vladislav Soloviev, Rusal's first deputy chief executive officer. "The Chinese should make cuts and help drive prices back up."

"The question is, how quickly the Chinese government and the regional government[s] will react," he said.

Some Chinese capacity cuts have already come. Plants accounting for almost one million tons of capacity have been closed, at least temporarily, said Max Layton, an analyst with Goldman Sachs, and scope remains for another million tons of cuts if demand remains weak.

He estimates that 4% of global aluminum-production capacity could be lost in 2012, reducing output by 2%.

Still, he remains optimistic that prices will rise this year as users in Europe stop reducing their stockpiles and consumption growth in China reaccelerates. Stronger oil prices will underpin the market as well, he said. Energy accounts for about one-third of smelters' expenses.

"But we see the rally being capped by overcapacity, mainly in China, and we've therefore downgraded our 12-month forecast to $2,400/ton from $2,650/ton," he said.