London, 23 January 2012: Reuters

Global aluminium production grew by 7.4 percent to 43.4 million tonnes in 2011, according to figures released by the International Aluminium Institute (IAI). The twin drivers of that growth were China and the Gulf, where production grew by 10.3 percent and 27.5 percent, respectively.

Last year's growth dynamic is key to understanding this year's market dynamic, based as it is on producers' collective response to prices that are cutting into the global cost curve.

Analysts at Barclays Capital wrote last week that based on an average price of $2,090 per tonne so far in January, "close to 45 percent of smelters globally have seen their margins turn negative".

The list of producer cutbacks is lengthening. Norway's Norsk Hydro said earlier this week it would shut one potline with annual production of 60,000 tonnes at its Kurri Kurri smelter in Australia. The rest of the plant is under what bond markets would call "negative watch".

All the other voluntary cutbacks so far announced have come in Western Europe. True, Rio Tinto has cut output at both its Alma and Shawinigan smelters in Canada, but these are not exactly voluntary curtailments, reflecting rather a union lock-out and power problems respectively. What, though, of last year's twin drivers of global production growth?

CHINA: A MOVING TARGET

The latest figures from the China Nonferrous Metals Industry Association (CNIA) published by the IAI showed a modest monthly reduction in national run rates in December, equivalent to an annualised drop of 163,000 tonnes. Annualised production was running at 17.7 million tonnes in December, a full 1.5 million tonnes below the September peak.

But production stabilised over the last two months of 2011 after October's sharp drop, suggesting that the most vulnerable smelters may already have been pushed out by a combination of margin pressure and power rationing in parts of the country.

Anyone waiting for another similar-sized lurch downwards may be in for a long wait. Chinese aluminium prices are trading above those on the LME, and at over 16,000 yuan per tonne are not yet at the sort of distress levels that caused mass closures in the tail end of 2008.

True, there's always the potential for more power-related cutbacks over China's winter months, but at current price levels most China-watchers expect even margin-challenged smelters to tough it out.

Moreover, assessing production costs in China's huge smelter sector is a moving target. Quite literally, as capacity migrates from higher-cost to lower-cost parts of the country, particularly western and northern provinces such as Inner Mongolia, Xingjiang, Gansu and Ningxia.

The interaction of forced closures, voluntary closures and new start-ups is why China's aluminium production figures are so volatile. They will remain so, but for now there is nothing to suggest the sort of wholesale curtailments fervently hoped for by producers in the rest of the world.

GULF PLATEAUS

That means the non-China market will have to regulate itself in the face of slowing demand growth and weak prices. But not in the Gulf, where last year's explosive production growth rate reflected new capacity coming on stream. That capacity is lower cost than just about anywhere else, and its capital costs have to be recuperated.

So don't expect any imminent curtailments from the region's producers. That said, run rates in the Gulf appear to be plateauing at around 10,000 per tonnes per day, reflecting a pause in capacity expansion before the next wave of greenfield projects. The most notable will be the giant 740,000 tonne per year Ma'aden smelter in Saudi Arabia, due to enter production in 2013.

The leaves a 12-month breathing space for the rest of the Western World. With giant Russian producer UC RUSAL showing no inclination yet to cut production, that means the focus will remain on Western Europe.

The region's annualised production dropped from 4.1 million to 3.9 million tonnes in December. What happens there over the coming months holds the  short-term key to the aluminium market.

Ends --

By Andy Home, Reuters market analyst – for Commodities Now with permission.

The views expressed here are his own.