By Greg Peel

Aluminium is the costliest of the standard base metals to produce, with final smelting requiring significant inputs of water and power. Power has proven the aluminium smelting industry's biggest problem, being the greatest contributor to a 30% increase in production cost over the past two years.

The rising cost curve has lifted the price at which many global smelters turn margin-negative, such that recent price pressure has seen a much higher cut-off price than was experienced in the 2008-09 period of aluminium price weakness. Barclays Capital notes 1.6Mt/y of capacity has been cut back over the past month. We have entered 2012 with 45% of global (ex China) smelters experiencing negative margins based on London Metals Exchange pricing. Were costs back at 2008-09 levels, only 4% would be in the same predicament. If aluminium prices do not rise significantly Barclays suggests 3.6Mt/y of capacity is at risk of closure.

One would expect China's aluminium capacity to be worse off, given 80% of the world's top 20% most expensive smelters are located in China. However the current Shanghai Futures Exchange aluminium price is trading at a premium to the LME price of some US$500/t (latest LME spot US$2219/t), meaning only 250kt/y or 1% of Chinese capacity has been idled due to low prices, Barclays notes, with another 750kt/y idled since the September quarter due to power shortages.

Yet as quickly as China's smelters are idled, further new smelters are being ramped up. December saw a 15.5% year-on-year rise in Chinese aluminium output ? below the 2011 peak but not showing any sign of price-related reductions.

The result is that forecasting aluminium prices into 2012 is a difficult task. If prices fall, smelters shut down to reduce supply and hence prices are supported. If prices rise, smelters come back on line again to increase supply and price rises are curtailed. Barclays notes recent production cuts have reduced the size of the expected 2012 surplus to 284kt from 743kt in 2011 and this provides a well defined level of aluminium price support at US$2000/t.