ANALYSIS-China setting up for aluminium supply bubble

By Polly Yam and Tom Miles

HONG KONG/BEIJING, April 7 (Reuters) - On the surface, China's aluminium smelters have little cause to complain about intensifying pressure from provincial governments to step up production.

After all, domestic prices have outperformed the global market because of a Beijing-backed buying plan and investment in the power sector, while discounted electricity rates have taken pressure off the cost side of the equation for some smelters.

Trouble is, a rush to restart production now may sow the seeds of an even worse price collapse unless Beijing imposes restrictions to turn back a surge in imports, expected to soar beyond 100,000 tonnes in March, 10 times recent monthly averages.

Whether Beijing and provincial governments decide to prick the supply bubble will be key to deciding how long the world aluminium market remains sunk under the weight of surplus stocks.

"If the State Reserves Bureau and the provincial governments don't buy as they have said, there will be a surplus," said Wang Feihong, a senior aluminium analyst at state-controlled research group Antaike.

"If the reserve-buying plans materialise, there will not be a surplus, even if smelters start one million tonnes of capacity in the second quarter."

But soaking up today's surplus may just prompt more tomorrow.

Provincial governments in Henan and Shanxi are leading the push to get idle smelters back to work, with 700,000 tonnes of annual production capacity already coming back on line, smelter officials told Reuters last week. [ID:nHKG349996]

"The local government has pressure in terms of GDP targets so they urged the smelters to start up to achieve these targets. At the moment the government is thinking about GDP and employment first," said Bonnie Liu, an analyst at Macquarie in Shanghai.

At the height of the cuts, China shut in over 4 million tonnes of annual capacity. And 2-3 million tonnes of newly-built, relatively low-cost capacity has never been put into operation.

In Henan alone, another 700,000-1 million tonnes of idle and new capacity may start up in coming months, analysts warn.

"The production cuts should be kept for the rest of this year," said Wang. "Many people, including us, have assumed consumption will recover in the second half of this year. But nobody can say for sure it will happen."

SWIMMING IN ALUMINIUM

The world is already awash with the metal. The London Metal Exchange's warehouses hold a near-record 3.47 million tonnes, enough to supply the world for over a month.

This overhang has seen LME aluminium prices MAL3 fall 4 percent this year, against hefty rises for copper and oil and a 13 percent gain for aluminium SAFc3 traded in China.