METALS INSIDER-European aluminium smelters an endangered species

LONDON, Dec 23 (Reuters) - The European aluminium smelter sector is buckling under the strain of high power and environmental costs and may be in danger of disappearing altogether in the not-too-distant future. That is the view of Patrick de Schrynmakers, secretary-general of the European Aluminium Association (EAA). He told Reuters earlier this month that around two-thirds of the region's smelters are in danger of closing. There is plenty of evidence to corroborate his gloomy prognosis. Rio Tinto has just closed permanently its 150,000-tonne per year Anglesey smelter in the UK after the expiry of the plant's long-term power contract. Alcoa is threatening to close both its smelters in Italy if the government cannot provide competitive power prices. Its previous attempt to do so has landed both company and government in hot water with the European authorities, who allege a power subsidy scheme amounted to illegal state aid. That finding is currently being appealed but the fate of almost 200,000 tonnes of smelter capacity is hanging in the air. In Germany Norsk Hydro's 230,000-tonne per year Neuss smelter is facing imminent closure, according to German metals federation WVM, which has written to the government pressing the case for alleviation of C02 charges for the plant. A SUNSET INDUSTRY? It's worth stressing that not all European smelters are in the same boat. A broad demarcation line can be drawn between Northern Europe and Central Europe. Hydro's Norwegian smelters, for example, have a comparative advantage in the form of captive power supply, which accounted for around 48 percent of requirements in 2008, according to the company's annual report. The balance is covered by long-term contracts extending at least as far as 2020. The company's Neuss smelter, by contrast, has no long-term power deal and is subject to the vagaries, and what the EAA claims are the inefficiencies, of the central European power market. Iceland is also a low-cost power producer and is emerging as something of a production hub for primary aluminium. With the commissioning last year of Alcoa's 320,000-tonne per year Fjardaal smelter, national aluminium capacity is over three-quarters of a million tonnes. More smelter projects are in the works. But in central Europe, comprising the UK, France, Spain, Germany, the Netherlands and Italy, smelters are finding it almost impossible to replace expiring long-term power contracts. The additional overlay of C02 compliance costs amounts to a further financial burden on an already struggling sector. Some operators may have been able to lock in a "profit margin" spread by hedging both metal price and power costs, but they would have had to do so by the third quarter of last year, since when the spread has become unprofitable, according to analysis by CRU. In this context, survival, as Alcoa is finding out in Italy, will depend on government willingness to support local smelters, a task made all the more difficult by the close scrutiny likely to come from Brussels regulators. DOES IT MATTER? The closure of large parts of the European Union's aluminium smelter sector will of course have repercussions for the region, but does it matter to the global aluminium industry? The EAA's views on the outlook for regional production have been reverberating around the market for the last couple of weeks and may well have been a supportive factor in the light metal's recent price strength. But the reality is that much of Europe's smelters could slide into oblivion without any significant impact on the global market's supply-demand dynamics. At risk is around 2.3 million tonnes of annualised smelter capacity, split roughly between almost 700,000 tonnes in Germany, 390,000 tonnes in Spain, 350,000 tonnes in the Netherlands, 300,000 tonnes in France, 225,000 tonnes in the UK (post-Anglesey), 190,000 tonnes in Italy and 180,000 tonnes in Greece. It's worth stressing that actual production levels are probably considerably lower since many core European smelters have been operating below capacity since the collapse of aluminium prices at the end of 2008. Equivalent new capacity is right now being brought on line in the Persian Gulf. The new 350,000-tonne per year Oman smelter is now up and running after being commissioned last year. The 585,000-tonne per year Qatar smelter, in which Hydro is a partner, has just commenced the firing-up process. So too has the EMAL smelter, which is even bigger with 700,000-tonnes of capacity at the first stage. Then, of course, there is China. China is the world's largest producer of aluminium and both output and capacity are still increasing. Chinese smelters lifted annualised production rates by 1.3 million tonnes in the last two reported months (Oct and Nov) alone. Output was running at an annualised 16.1 million tonnes in November, a fresh all-time high. There is believed to be at least another 2 million tonnes of capacity which is either idled or is new and has yet to start up. In short, there is no shortage of global smelter capacity and nor will there be, even if the core European smelter sector were to vanish overnight. Alcoa's announcement earlier this week that it is partnering with Saudi mining company Maaden on a new mega smelter project in Saudi Arabia is proof of the general optimism that surrounds aluminium's long-term prospects. Such future considerations mean little for European smelters, however. They are locked in a short-term battle for survival. Not many are going to be left standing, barring an unprecedented and seemingly unlikely level of government intervention.