METALS INSIDER:Aluminium can take Russia dam hit, but can RUSAL?

LONDON, Aug 21 (Reuters) - Monday's calamity at the Sayano-Shushenskaya hydro power plant in Siberia has sent a tremor through the aluminium market. The RusHydro plant is a strategic power supplier to two huge aluminium smelters with combined capacity of over 800,000 tonnes per year. It looks as if repairs could take several years and UC RUSAL, owner and operator of both smelters, has said that some 500,000 tonnes of metal could be under threat. The aluminium market is quite understandably concerned. In a 40-million tonne per year industry, the loss of 500,000 units cannot be ignored. The market, however, should be able to absorb with some degree of comfort such a supply-side hit given the current supply-demand dynamics. It's whether UC RUSAL can absorb the impact of Monday's events that may be the more relevant question. TAKING THE STRAIN Although the news about Sayano-Shushenskaya caused a knee-jerk price reaction on Tuesday, the overall effect on market sentiment has been muted relative to how comparable supply-side shocks, such as South Africa's early-2008 power crisis, have played in the past. There are four reasons for this relative calm. Firstly, UC RUSAL has secured alternative power to ensure both the Sayanogorsk and Khakassia smelters, the two plants most dependent on Sayano-Shushenskaya, have been able to maintain uninterrupted production. Sudden power losses can be disastrous for smelters, damaging production lines as molten metal freezes in the pots and requiring months of repairs. UC RUSAL has avoided this worst-case scenario. Secondly, the potential loss of future metal production remains exactly that…potential. The 500,000-tonne loss estimate came from Artyom Volynets, US RUSAL's director of strategy and corporate development. What he actually said was that "we consider that no less than 500,000 tonnes of aluminium production -or maybe even more -- could be under threat." [ID:nLI441123] The emphasis in that sentence should probably not be on the tonnage figure but on the words "could be under threat." How much aluminium tonnage is lost, or indeed whether any is lost at all, will depend on whether the Russian authorities and the Siberian power companies can work out a way of compensating for the absence of Sayano-Shushenskaya during the imminent peak-usage winter months. Reading between the lines of UC Rusal's statement on Monday, it is clear that lowering the run rate at the company's smelters is only one of the options on the table. Thirdly, global aluminium production is currently rising. Yesterday's combined figures from the International Aluminium Institute (IAI) and the China Nonferrous Metals Industry Association showed global aluminium output rose for the fourth consecutive month in July to the tune of an annualised 217,000 tonnes. The impact of production cuts in the non-China world is fading. Non-Chinese production fell for the ninth consecutive month in July but the annualised month-on-month decline of 73,000 tonnes was the smallest yet. Chinese production, meanwhile, rose for the fourth consecutive month in July with the pace of increase from restarts and new capacity ramp-ups once again more than offsetting lower output in the rest of the world. These two trends of rising Chinese capacity utilisation and fading non-Chinese cutbacks look set to continue in the short term. Fourthly, the global market is saddled with high visible stocks and still seems to be in surplus, albeit a slowly contracting one. The rate of build in LME warehouse stocks has slowed over the last couple of months. From over 400,000 tonnes per month at the start of the year, it has fallen to 170,000 tonnes in July and to just 58,500 tonnes so far this month. However, the warranting of 31,000 tonnes of metal at LME warehouses in Detroit earlier this week underlines the continued poor state of demand despite all the positive talk of automotive restarts and associated restocking in the U.S. Moreover, Shanghai stocks are now rising again fast, up another 17,000 tonnes in the most recent week. And there is plenty of anecdotal evidence that off-market, privately-held stockpiling is coming back into vogue, which may mean that LME stock developments are misrepresenting the true state of supply-demand balance (again). FEELING THE SQUEEZE UC RUSAL has played its part in reducing production to match the collapse in global demand that followed the financial crisis of September 2008. The company said in its H1 2009 results that group aluminium production fell by 10 percent year-on-year to 1.98 million tonnes and that total cuts this year should amount to 500,000 tonnes. That means that the company could compensate for any losses in Siberia by reactivating capacity elsewhere. However, UC RUSAL's exposure to the loss of power from Sayano-Shushenskaya is not so much the number of metal units lost but the cost of those metal units. The company's production cuts have been carefully targeted to achieve the highest possible cost savings as it looks to improve profitability at a time of low historic prices. Average production costs fell by 27 percent in H1 2009 relative to December 2008. Included in that figure is a 20 percent cut in power costs. But a look at the distribution of the production cuts is highly instructive. The biggest cuts of 39 percent were made at UC RUSAL smelters in Nigeria, Sweden and Ukraine. Cuts of 33 percent were made at its plants in the Urals. The core Siberian smelters saw production cut by just 4.5 percent in the first half of the year relative to H1 2008. That's because they are the lowest-cost smelters in the company's portfolio, particularly the brand-new 300,000 tonne-per-year Khakassia smelter, which has just completed its full ramp-up. In other words, UC RUSAL could easily replace any lost units in its Siberian heartland but only at the risk of reversing its drive to lower costs and boost margins. Even more worrying for the company is what the dam disaster at Sayano-Shushenskaya could mean for power prices in Siberia itself. Russian Prime Minister Vladimir Putin has just ordered his government to prepare a draft decree to regulate wholesale electricity prices in response to a spike in spot prices and the prospect of a series of price hikes by other higher-cost, coal-based power suppliers in the region. Just how long the Russian government can stall the impetus towards higher Siberian power prices is a highly moot point given the expected four-year repair time at Sayano-Shushenskaya and the uncertain time-table of the much-hyped Boguchansk mega hydro project being built by UC RUSAL and RusHydro. The biggest impact of Monday's tragic events will be felt in Siberian power prices not lost tonnes of aluminium. That's bad news for UC RUSAL, since the crown jewels in its smelting crown are all located in Siberia, but less bad news for the international aluminium market, at least for now. (Editing by James Jukwey)