UPDATE 3-Norsk Hydro Q2 sunk by energy costs, outlook weak

(Adds analysts, CEO, context)

By Wojciech Moskwa and Camilla Bergsli

OSLO, July 22 (Reuters) - Aluminium group Norsk Hydro posted an expected sharp drop in second-quarter operating profit due to soaring energy costs and painted a bleak picture with input prices on the rise and demand threatened by economic malaise.

Norsk Hydro (NHY.OL), one of the world's biggest integrated aluminium groups, remained upbeat about aluminium prices which have not kept up with surging input costs.

Shares in Norsk Hydro initially lost as much as 4 percent but regained some ground after Chief Executive Eivind Reiten said a lag in the impact of rising aluminium prices on Hydro results had grown, improving prospects for future results.

The $15 billion group said operating profit tumbled 44 percent year-on-year to 1.62 billion crowns ($319.3 million) in April-June, meeting an average forecast from a Reuters poll of 12 analysts reduced after last week's profit warning.

At 1139 GMT, Norsk Hydro stock was off 1.7 percent at 62.00 crowns on a gently rising Oslo bourse .OSEBX. The stock has lost 20 percent over the past month.

"The company's outlook may be less bad than some feared," said Fondsfinans analyst Kjetil Bakken.

Reiten said the lag from the impact of rising aluminium prices, caused by hedging, had a negative second quarter effect of 250 million crowns.

Aluminium prices for three-month delivery on the London Metal Exchange MAL3, stood at $3,075 per tonne on Tuesday, about 10 percent off record highs hit earlier this month.

Norsk Hydro said it has priced 83 percent of its third-quarter production at $2,856 per tonne and expects to achieve an average price on total third quarter production about $250-300 higher than that in the second quarter.

"UNPRECEDENTED COSTS"

Norsk Hydro said the aluminium industry was experiencing an "unprecedented increase in the cost of key components", driven by higher prices for energy and natural resources including alumina, the raw material needed for aluminium.

"Strong commodity markets are expected to increasingly impact input costs for the aluminium industry," it said.

Norsk Hydro said its access to self-generated hydropower in Norway and long-term power contracts in most other locations have lessened the impact of soaring energy costs.

"As a result we don't expect a sharp increase in our energy costs in the short to medium term. However, we expect further increases in other variable costs, in particular the cost of carbon," it said.

But as it ships alumina to Norway and other processing plants in relatively low energy cost areas, it faces an "increase in the freight cost for alumina going forward".

Hydro said it expects variable costs, excluding alumina and power, to increase by about 200-250 million crowns in the second half of 2008 compared to the second quarter.

"We also expect to see pressure on fixed costs," it said.

Hydro expects aluminium prices to remain high due to increasing energy and raw material prices but said there was "uncertainty regarding market demand" as "economic indicators point to weaker industrial development in the western world".

The company said global consumption of primary aluminium was estimated to grow about 8 percent in 2008, on the lower end of its previous forecast of 8-9 percent growth.

It expects slowdowns in markets for rolled products, extrusion, automotive and semi-fabricated products, with demand in Europe softening and the U.S. failing to mount a comeback.

Norsk Hydro has expressed ambitious plans to grow through investments and acquisitions, and Reiten said turmoil in international financial markets may be favourable for the majority state-owned company with a nearly $2 billion war chest.

"I believe that being in a situation where you can raise money almost overnight, will be of greater value over the next 12 months than over the last 12," Reiten told reporters.

Norsk Hydro said its $5.6 billion Qatalum project in Qatar was on schedule and within budget at the end of June but faced challenges from cost pressures and performance of sub-contractors. (Editing by Louise Ireland/Elaine Hardcastle)