Alcoa Inc. (AA) Chief Executive Officer Klaus Kleinfeld said in January China’s aluminum industry would cut 1.1 million metric tons of unprofitable capacity “pretty soon.” So far that prediction isn’t close to coming true.

China’s aluminum industry, the world’s largest, saw output rise 18 percent in the first two months of the year, according to International Aluminum Association data. That’s helped to boost global supplies and create a surplus of the metal while curbing prices, which are down 22 percent from a year ago.

 

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Klaus Kleinfeld, chief executive officer of Alcoa Inc. Photographer: Scott Eells/Bloomberg

 

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Aluminum billets cut to various lengths move along the production line at the Alcoa Inc. Mt. Holly plant in Goose Creek, South Carolina, U.S. The company has announced plans to shut plants in Texas, Tennessee, Spain and Italy this year, eliminating 12 percent of its capacity, or 531,000 tons. Photographer: Stephen Morton/Bloomberg

Declining prices and rising energy costs have eroded smelting margins, prompting New York-based Alcoa and its Norwegian competitor Norsk Hydro ASA (NHY) to announce 771,000 metric tons of capacity cuts this year. China’s smelters are avoiding that fate because they don’t appear to be paying market rates for power, said Ken Hoffman, an analyst at Bloomberg Industries. Chinese plants owned by local governments are resisting closures in order to preserve jobs, said Lloyd O’Carroll, an analyst at Davenport & Co.

“If production is not economic, at some point it will be shut down,” O’Carroll, who is based in Richmond, Virginia, said in an interview. “The question is how long will it take.”

Alcoa, the first company in the Dow Jones Industrial Average to report quarterly earnings, will publish its results after the close of trading today. It will post a first-quarter loss of 4 cents a share, according to the average of 19 analysts’ estimates compiled by Bloomberg.

Aircraft Demand

That would be the first time the company has reported two consecutive quarterly losses on an adjusted basis since 2009, when commodity markets were still reeling in the aftermath of the global financial crisis. Alcoa has fallen 46 percent in the past year, the most in the DJIA. Libby Archell, a spokeswoman for Alcoa, declined to comment.

To be sure, improved demand from U.S. auto and aircraft manufacturers and Chinese government stimulus will mean aluminum prices will be higher in the fourth quarter compared with a year earlier, O’Carroll said in a March 27 report. He also sees production cuts eventually whittling down the oversupply of aluminum, creating a deficit of 600,000 tons next year. Demand in the U.S. and Canada rose 6 percent in January, the Aluminum Association said yesterday.

Alcoa isn’t wholly reliant on aluminum smelting, which accounted for about a third of its 2011revenue. The flat-rolled and engineered products segments generated 53 percent of sales.

New Smelters

The company is building cheaper, more efficient capacity in Saudi Arabia. Kleinfeld, 54, said in January he plans to move Alcoa to the 41st percentile on the aluminum industry’s so- called production cost curve by 2015, from 51st.

The company has announced plans to shut plants in Texas, Tennessee, Spain and Italy this year, eliminating 12 percent of its capacity, or 531,000 tons. Norsk Hydro shut a 60,000-ton line at its Kurri-Kurri smelter in Australia and cut 180,000 tons at a German plant in January.

About one-third of Chinese capacity, or 5.7 million tons, is “bleeding money” and won’t be able to afford power prices, Kleinfeld told analysts in a Jan. 9 conference call to discuss Alcoa’s fourth-quarter results.

Energy was the second-largest single cost in aluminum production in 2010, after bauxite, accounting for 26 percent of expenses, according to data compiled by Bloomberg. Crude oil prices averaged 8.9 percent higher in the first quarter from a year earlier.

‘Strategic Good’

Still, Chinese aluminum output climbed to 3.07 million tons in January and February, from 2.59 million tons a year earlier. Investors will be paying attention today to the gap between Kleinfeld’s prediction and what’s going on in China, said Kuni Chen, an analyst at CRT Capital Group inStamford, Connecticut.

“The one thing they’ll need to address is that you have not seen any production cuts or production discipline out of China,” Chen said.

China will add another 2.9 million tons of output in 2012 as it builds plants at a faster rate than it shuts older ones, said O’Carroll, who has a buy rating on Alcoa and predicts a first-quarter profit of 7 cents a share.

“Aluminum is a strategic good for China,” said Hoffman, who is based in Princeton, New Jersey. “This helps China maintain and even increase capacity and production.”

Soaring Inventories

Global aluminum use will be 43.9 million tons in 2012, assuming Chinese consumption of 17.6 million tons, said Andrew Cosgrove, an analyst at Bloomberg Industries in Princeton, New Jersey. Supply will be 46 million tons, resulting in a 2.1 million-ton surplus, he said.

In addition to this surplus, inventories at warehouses monitored by the London Metal Exchange have more than tripled since Lehman Brothers Holdings Inc. filed for bankruptcy in September 2008. The stockpiles averaged 5.05 million tons in the first quarter, 11 percent higher than a year earlier, according to LME data.

Aluminum for delivery in three months on the LME averaged $2,219 a ton in the first quarter, 12 percent lower than a year earlier. The metal closed at $2,109 on April 5, the last trading day inLondon.

There may be more production cutbacks outside China this year. Oleg Deripaska, the CEO and largest shareholder of Russia’s United Co. Rusal, said in December that falling prices may prompt smelters to shut down 3 million tons of capacity globally.

Rusal, the world’s largest aluminum producer, has dropped 56 percent in the last year in Hong Kong trading. Aluminum Corp. of China Ltd., the country’s biggest maker of the metal, has fallen 52 percent. Norsk Hydro has declined 37 percent.

“China’s structural problem is really the world’s problem,” Hoffman said.

To contact the reporter on this story: Sonja Elmquist in New York at selmquist1@bloomberg.net

To contact the editor responsible for this story: Simon Casey at scasey4@bloomberg.net

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