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COLUMN-China, the aluminium giant that's still growing: Andy Home

(Repeats JULY 20 story. No change to text.)

By Andy Home

LONDON, July 20 (Reuters) - If you're wondering why aluminium prices on the London Metal Exchange (LME) are hovering around six-year lows, you need look no further than the latest production report from the International Aluminium Institute (IAI).

While the market is waiting for producers to respond to the gloomy price environment by cutting back more production, the IAI figures show them doing precisely the opposite.

Global (Shenzhen: 300465.SZ - news) output grew by 10.3 percent in the first half of this year, the fastest rate of growth since 2010, when many smelters were reactivating capacity idled during the depths of the global financial crisis.

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To be fair, some producers such as Alcoa (NYSE: AA - news) have been trimming back higher-cost production but their efforts have been swamped by the aluminium production juggernaut that is China.

With growth of 18 percent in the first half of this year, China now accounts for a staggering 56 percent of global production.

The dominance of China over the global production chain seems set to grow further over the coming years.

That promises little short-term relief to producers just about everywhere else, but it also puts a longer-term question-mark over the security of supply in a metal that is still gaining market share in key manufacturing sectors such as automotive.

******************************************************* Graphic on H1 2015 production by region: http://link.reuters.com/vew25w Graphic on production in China and the RoW: http://link.reuters.com/wew25w *******************************************************

A WORLD OF TWO HALVES

China isn't the only country ramping up new capacity this year.

The regional breakdown of first-half production trends shows that output of aluminium actually rose fastest elsewhere in Asia.

India, in particular, seems to be taking over from the Gulf as the driver of higher output outside of China.

Vedanta Resources (Other OTC: VDNRF - news) is currently ramping up two plants, the 325,000-tonne per year Korba II smelter and the first 312,500-tonne per year potline of the Jharsaguda II smelter. The latter is designed eventually to produce 1.25 million tonnes per year.

But elsewhere production is either plateauing, in the case of the Gulf and Europe, or falling, most dramatically in Latin America as a result of what looks like the terminal decline of Brazil's once mighty aluminium production base.

And then there is China.

The IAI, or rather the China Nonferrous Metals Industry Association, which supplies the IAI with Chinese production figures, has revised higher its estimate of output in the first five months of this year.

But in truth that only accentuated the already strong underlying trend of accelerating output growth. Annual production growth exceeded 20 percent in both May and June.

Even China can't consume aluminium at that sort of rate. Alcoa, in its Q2 financials presentation, forecast Chinese consumption to grow by more than 9 percent this year, a figure that would be positive for any metal other than aluminium.

MORE PRODUCTION, MORE EXPORTS

There is nothing to suggest any imminent change of direction within China's giant aluminium smelter sector.

A new generation of bigger, lower-cost smelters is coming on stream in the northwestern province of Xinjiang.

Production in Xinjiang has mushroomed from just 64,000 tonnes in 2008 to 4.8 million tonnes in 2014, more than last year's entire North American output, according to analysts at CRU.

Not only are Xinjiang producers bringing more capacity on line this year, but several of them still have bold expansion plans which could take output to over 9 million tonnes by 2019, CRU says in a piece of research titled "Will smelters in Xinjiang continue to expand capacity?"

CRU's answer appears to be yes, given the simple fact that these are some of the lowest-cost plants in the world thanks to captive coal-based sources of power, the single most important cost input in the smelting process.

"If Xinjiang continues to expand, and if the market is to get back into balance, marginal cost producers in southwest China will need to close their operations," CRU argues, noting that "the smelters in Guangxi, Guizhou, Sichuan and Henan without captive power plants are most vulnerable."

But older smelters are too often given survival life-lines by local governments unwilling to see such important sources of employment and industrial output close.

The result is a chronically oversupplied domestic market, which relies on exports of semi-manufactured products as an escape valve.

Some of those "products" are not products at all, Alcoa recently highlighting the flow of "fake semis" into the international market-place.

But most of them are legitimate products which are displacing non-Chinese demand for Western production.

The collapse of physical premiums in the West might, it has been argued, reduce the attractiveness of such exports. However, Chinese prices have also been falling with the Shanghai Futures Exchange price consistently underperforming the LME price for at least a year or so.

The mechanics of China continuing to produce too much aluminium look too hard wired for now to expect anything other than continuing domestic oversupply. The resulting domestic price weakness seems set to continue and as long as it does, metal exports in product form are unlikely to stop or even drop.

BAD NEWS

That's very bad news for non-Chinese producers, who face the unpalatable prospect of cutting their own output further only to see any resulting gap filled by Chinese supply -- a process that would of course lead to China taking an ever greater share of global supply.

And that may turn out to be bad news for consumers as well.

The current combination of too much production, too much legacy stock and weak prices is of course beneficial to consumers, particularly in terms of aluminium's price advantage relative to other raw materials.

But how would they feel if China's dominance of primary aluminium production just carries on growing?

China, after all, is not the stable producer that it might appear to be.

Too many aluminium smelters are consuming too much power in a country chronically short of power.

Even (Taiwan OTC: 6436.TWO - news) those new smelters in Xinjiang have a problem. They may have the captive power, but they don't have the bauxite to make the alumina to make the metal.

For that matter, China as a whole doesn't have sufficient raw materials to supply its smelter system, which is why it has historically imported large amounts of the bauxite from Indonesia and, after that country's ban on exports, from Malaysia.

The inefficiencies of China's aluminium production sector are masked by the patchwork of subsidies to loss-making plants, whether in the form of off-balance-sheet loans or capped power rates.

Those inefficiencies are currently depressing global prices. One day, however, they may generate a supply shock that the West would have no cushion against because by that stage too much of its own capacity will have been closed.

An unlikely scenario? Possibly, but one that comes into sharper focus as China's share of global production increases with each passing month. (Editing by Mark Potter)