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Europe could cut 2.5 mil mt/year of aluminum capacity: analyst

By Tina Allagh, with Nick Jonson in Washington and Greg Smart in London

January 17, 2012 - On the heels of Alcoa' s recent aluminum production cutback announcement, analysts and other producers were quick to point to further possible curtailments, with one research analyst predicting that about 2.5 million mt/year of aluminum capacity in Europe could be curtailed near term in response to the weaker market conditions and higher power prices. (See related chart: GW Premium Paid IW Rdam: Nov 15, 2011 - Jan 13, 2012).

Alcoa recently said it will close or curtail about 531,000 mt, or 12%, of its global aluminum smelting capacity and predicted a further 1.1 million mt would be curtailed in China.

Commerzbank the week ended January 13 cited a recent Rusal prediction that up to 3 million mt of aluminum capacity would have to be closed on the back of low prices.

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Norway-based Norsk Hydro said the week ended January 13 it is considering curtailing production at its Kurri Kurri aluminum plant in Australia in "response to the weak macroeconomic environment with low metal prices and uncertain market outlook."

Kurri Kurri, fully owned by Hydro, has three production lines with a total production capacity of 180,000 mt/year and has been operating since 1969.

Rio Tinto Alcan has already announced plans to divest or shutter significant amounts of uncompetitive capacity in Europe, North America, Australia and New Zealand.

At the same time, Middle East capacity is likely to grow over the long term, and Canadian smelters will expand, said the research analyst, who asked to remain unnamed.

GW Premium Paid IW Rdam: Nov 15, 2011 - Jan 13, 2012
Click image to view full size GW Premium Paid IW Rdam chart

"I would say anything in Europe -- other than Scandinavia because of low-cost power -- is fair game" for curtailments, he said. The analyst said the current grid price for power in Europe is $70/MWh, but the smelters need a $30-40 power price to be profitable at the current aluminum price.

He said many of Europe's power contracts expire at the end of this year and next, "and when those end, they will shut the door one by one."

"Whether it happens today or in the next few years, it'll happen," he said, noting that Alcoa Chairman and CEO Klaus Kleinfeld said at the company's investor day in November that he did not think any smelters would operate in Europe beyond the next few years, other than Scandinavia and Iceland.

Alcoa's Kleinfeld said the week ended January 13 during a quarterly conference call that 5.7 million mt, or 32% of Chinese production, was unprofitable at or above a Shanghai Futures Exchange price of $2,400/mt ($1.09/lb). He said that at costs below that price, 12.1 million mt, or 68% of Chinese output, was profitable.

Most of the unprofitable production is in Henan (1.7 million mt) and Guizhou and Yunnan (800,000 mt each). Alcoa is predicting that about 1.1 million mt/year of Chinese aluminum production will be curtailed in the near term.

The analyst said he thought that over the next five years, "the bulk of [Chinese] smelters will shut down permanently as less and less power is available."

To keep the supply base up, Middle East capacity is expected to rise as there is "a lot of capital to build there."

The analyst said that "another good place to build is Iceland, but there are only so many people there to run them." It's the same issue with Greenland, where the analyst said workers would have to be imported.

The analyst noted that state-of-the-art smelters use about 12 MWh/mt, while other smelters consume 17 MWh/mt.

At the time of its announcement of its capacity curtailment, Alcoa said that aluminum prices have fallen more than 27% from their peak in 2011.

However, aluminum prices the week ended January 13 gained momentum on the various cutback announcements, rising 7.5% since the beginning of the year and 2.7% on January 11 alone.

"This is doubtless thanks to recent announcements of extensive production cuts after the price fell well below the marginal costs of production, as well as to optimistic predictions about the development of demand," said Commerzbank the week ended January 13.

Bank analysts noted that in the wake of the last sharp price slump in 2008-2009 nearly all major aluminum producers had slashed their capacities, thereby shoring up the price.

Despite economic uncertainties, Alcoa anticipates 7% growth in global demand this year. This will be driven by China, where demand is expected to rise 12%.

The world market will see a 600,000 mt deficit, Alcoa predicted. "We believe the aluminium price to be well-supported and anticipate further moderate gains," said Commerzbank.

US ratings agency Fitch Ratings said the week ended January 13 it regarded Alcoa's aluminum capacity reduction plan in the US and Europe as "a necessary but insufficient step toward a recovery in aluminum market fundamentals" this year.

Following a steep price decline from last May's peak, most of the world's largest aluminum producers are evaluating ways to cut unprofitable capacity and push the metals price above the marginal cost of production at less-competitive smelters, Fitch analysts said in a report.

"Even with these announced cuts, however, additional curtailments are likely until aluminum prices rise above $1.13/lb ($2,491/mt), a level that could drive profitability in a stable cost environment," the analysts wrote. "We remain focused on the pace of smelting capacity curtailment in China, particularly since high operating costs make many Chinese smelters uncompetitive at current world prices."

Meanwhile, Goldman Sachs said the week ended January 13 that the cutbacks are expected to support modest price gains for the metal.

It said global capacity had been reduced by as much as 2,168,000 mt, or 4%, and that so far this year aluminum had been the strongest base metal price performer.

Goldman Sachs estimates that this will lead to around 2% of actual production loss in 2012 and will amount to a reduction of 1,018,000 mt at current production rates at those plants impacted by cuts or closures.

Goldman Sachs said rising global demand as a result of the end of destocking in Europe, Chinese policy easing and solid construction activity would help support price gains in the first half of 2012.

RBS said in a research note the week ended January 13 that it also was forecasting global aluminum demand to grow by 7% this year but recognized "prevailing headwinds that could potentially disrupt this forecast."

RBS added that a major positive was that aluminum had defensive characteristics in terms of a broad demand spread from a variety of end-use sectors.

RBS also said production cutbacks would be central in supporting aluminum prices over the long term.

It is forecasting that 2012 will see the sixth consecutive world supply surplus and that between 2007 and 2012 the implied cumulative surplus "will have been a hefty 8.60 million mt/year," the bank said.

RBS has lowered its average price forecast for 2012 and expects global output to increase to 59 million mt/year in 2015 from a forecast output of 48.5 million mt/year in 2012.

Investment bank Dahlman Rose lowered its 2012 LME aluminum price forecast to $1/lb from $1.10 and offered an initial 2013 estimate of $1.10/lb due to excess global capacity.

Research firm Davenport said in late December 2011 that it expected global aluminum demand to increase 5.8% and production to increase 3% in 2012.

It cut its LME cash forecast for 2012 to $2,300/mt ($1.04/lb) from a previous $2,500/mt ($1.13/lb), "as negative sentiment that became pervasive in Q4 will likely extend into H1 2012." Davenport is expecting a surplus of 800,000 mt in 2012.

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