METALS INSIDER: Aluminium output rising-too fast, too soon?

LONDON, July 29 (Reuters) - The latest figures from the International Aluminium Institute show that global production rose for the third consecutive month in June and at an accelerating pace. While production cuts in the developed world lose momentum, their impact is being swamped by the flood of restarts in China. At the same time there is evidence that the market's supply-demand dynamics are starting to turn but is rising production still a case of too much too soon ? PRODUCTION CUTS IMPACT FADES The following chart shows the annualised monthly change in aluminium production in the non-China world and in China, using figures from the International Aluminium Institute (IAI) and the China Nonferrous Metals Industry Association respectively. http://communities.thomsonreuters.com/ClientFiles/7f8d6e1b-e8ea-4e4b-a050-001c237cf2eb/20090729globalalprod.gif Two trends are immediately clear. Firstly, production cutbacks in the non-China world are now rapidly losing intensity. Annualised production fell by 110,000 tonnes in June. It was the eighth consecutive monthly decline, bringing the total to 2.63 million tonnes, but it was also the lowest monthly decline. That should not be entirely surprising. Most producers started responding to the Q3 2008 price collapse in the following quarter. Most of them announced a gradual ramp-down of capacity scheduled to last through the first half of this year. That process now seems largely complete. Recently there have been no further curtailment announcements. Quite the opposite, in fact, with minor restarts of capacity announced by Trimet in Germany [ID:nL36002] and by Rio Tinto in New Zealand [ID:nL8676778]. Secondly, Chinese production rose in June for the third consecutive month with the pace quickening to 934,000 tonnes annualised. A combination of the Chinese government's "strategic" purchases of the light metal in Q1 2009 and a subsequent accelerated return to manufacturing growth has lifted domestic prices, encouraging both restarts and the firing-up of new capacity. National production in June was running at an annualised 12.5 million tonnes, its highest level since October last year. Production in China is now rising much faster than production outside of China is falling, which is why global production of 35.6 million tonnes annualised in June was the highest it's been this year. SHORT-TERM POSITIVES In the short term the aluminium market may be able to absorb more metal production, both in China and elsewhere. Chinese smelters may be churning out more aluminium but, crucially, the metal is staying in China, at least for now. The country's exports evaporated in the first half of this year to the extent that China became a net importer to the tune of almost a million tonnes in the Jan-June period. Net imports were still running at a strong pace in June and there is no reason to expect them to have disappeared overnight in July. There is always a lag between metal being booked for import and it actually clearing Chinese customs. That said, imports should start to tail off fairly quickly as domestic production continues to ramp up. That will be a negative for those Western producers who have benefited from the import surge in the first part of 2009. The geographic breakdown of Chinese imports in H1 suggests it was pretty much all of them. [ID:nHKG184783] But there are signs that Western producers will by then be benefiting from a pick-up in non-Chinese demand as the market moves from a de-stocking to a re-stocking cycle. Producer stocks of unwrought aluminium outside of China were just 1.24 million tonnes at the end of June. That's the lowest they've been since the IAI started collating this information in 1973. Klaus Kleinfeld, chief executive of U.S. producer Alcoa, said earlier this week that industry inventories are at lows that "we've never seen before". [ID:nN27542683] So aggressive has been the continued de-stocking that it outpaced the rise in LME inventories in June, meaning the first monthly fall in global reported stocks since June last year. A shift to re-stocking, even though it may be modest, is already feeding into rising physical premiums both in the U.S. and Asia and into increased demand for LME metal as evidenced by rising cancelled tonnage in the exchange's warehouse system. The price impact has been amplified by the growing awareness that much of the huge tonnage sitting in LME warehouses is "locked" into financing deals and not available for immediate delivery. LONG-TERM NEGATIVES The problem is that re-stocking will be a one-off event and of limited resonance unless underlying demand growth in sectors such as automotive and construction kicks back in forcefully. At the moment there is very little prospect of that happening before the end of the year. As Logan Kruger, chief executive of U.S. producer Century Aluminum told the company's Q2 analysts conference call, "de-stocking has reached a bottom but demand has yet to show any meaningful indications of growth". Therein lies the real danger of rapidly accelerating Chinese production. China, remember, is more than self-sufficient in aluminium, even when its economy is booming. If Chinese production continues rising at this pace through Q3, and most commentators both inside and outside China expect this to be the case, it will be only a matter of time before the country returns to its historical role of net exporter. This may take the form of primary metal. It is equally possible that net exports will be in the form of semi-manufactured product, particularly given smelters' continued lobbying for increases in export tax rebates. Either way a shift back to net exporter risks accentuating over-supply in the rest of the world. Combined with high visible inventory, whether it is available for immediate delivery or not, the market's prospects do not look propitious relative to the other LME metals. Century's Kruger warned that "we remain convinced that the industry must take additional supply side actions for a global balance to be achieved". [ID:nN23333172] It is evident that such supply side action will not be coming from China's huge smelter sector. It will be up to Western producers to respond (again). Century, which has already cut production at its U.S. plants, said it is reviewing again its own smelter run rate. Many others may want to do the same in light of China's fast-recovering aluminium production.