* Rio Tinto smelter must stand on its own feet after rejecting subsidy offer-NZ
* Rio believes it can reach a electricity price cut with local power company
* NZ electricity supply glut looms if smelter shuts
WELLINGTON/SYDNEY, April 2 (Reuters) - Rio Tinto's loss-making aluminium smelter in New Zealand, which wants a government break on its electricity bill to stay afloat, must learn to "stand on its own two feet," New Zealand Prime Minister John Key said after the firm rejected a short-term subsidy offer.
The 350,000-tonnes-per-year smelter in Tiwai Point in southern New Zealand is a victim of dire market conditions caused by weak demand and high Chinese production that's sent world aluminium prices into free fall since mid-February.
Commodities analysts say it could be years before conditions for producers improve and only after hundreds of thousands of tonnes of excess capacity is eliminated.
The New Zealand smelter falls under the recently formed Pacific Aluminium unit of Rio Tinto, designed to bundle 13 underperforming aluminium assets for closure, sale or spin off into a separate entity for an in-specie distribution to Rio Tinto shareholders.
Rio Tinto took an $11 billion writedown in 2012 because of losses in aluminium.
Key said Rio Tinto rejected the government's offer for help for the Tiwai smelter because the company was seeking a longer term price break than the government subsidy would provide.
"We have no interest in a long-term subsidy. If it can't stand on its own two feet, it shouldn't be there," Key told a New Zealand television network.
Pacific Aluminium has been holding talks directly with the state-owned electric company that supplies the smelter, Meridian Ltd, and said it believed a new deal could eventually be struck.
"We are of the view that a commercial agreement can be reached in relation to the NZAS (New Zealand Aluminium Smelters Ltd) electricity supply contract," Pacific Aluminium said in a statement emailed to Reuters."Our electricity contract negotiations with Meridian have progressed more in the past two weeks than in the previous nine months."
The 41-year-old smelter at the bottom of the South Island is the country's biggest power consumer, using around 15 percent of national output, and exports around NZ$1 billion ($837 million) worth of aluminium a year.
London Metal Exchange three-month aluminium prices stood at $1,900 a tonne on Tuesday, down 13 percent from its 2013 peak of $2,174 on Feb. 15.
A 17-year contract was signed by the smelter in 2007 and came into effect in January.
Meridian said last week there was a major gap between the two sides, and it doubted a new agreement could be reached.
Rio countered that they believed a deal was still possible. The company has previously raised the prospect the plant could be closed.
Last month, Pacific Aluminium's Gove alumina refinery in Australia narrowly averted closure with the loss of 1,400 jobs after reaching an 11th-hour deal over cheap gas supplies for 10 years.
"We know Rio can be a ruthless negotiator, but it's important the government remains involved in the smelter's negotiations with Meridian," Ged O'Connell, assistant secretary of the Engineering, Printing and Manufacturing Union, said.
"Whether the Government likes it or not, these negotiations are political and that means the buck stops with the Prime Minister," O'Connell said.
Power suppliers fear if the smelter closes it would create a glut of electricity and drive down power prices nationwide.
That in turn could jeopardise Key's plans to partially privatise Meridian and two other state-owned power companies: Mighty River Power Ltd and Genesis Energy, which is slated over the next three years.