UPDATE 1-China eyes cheaper electricity for aluminium firms

By Polly Yam

HONG KONG, Nov 19 (Reuters) - China's electricity producers have started cutting the fees at which they sell power to aluminium producers, smelter and power sources said on Wednesday, which could help smelters avoid further output cuts and boost flagging demand for electricity.

The aluminium industry in the world's biggest producer and consumer of the metal uses around 6 percent of the country's electricity output, but has been cutting back sharply in the face of lower prices.

Provincial governments are keen to maintain local aluminium production to save jobs as the economic slowdown bites, smelter officials said, while power firms are facing sharply lower demand.

The country's industrial output slumped to a 7-year low in October and demand for power has slowed since late summer, with power production falling in October for the first time in a non-holiday month for a decade.

While power prices are state controlled, some provincial governments have already cut prices to smelters, and others are planning cuts. Power producers submitted a proposal to the central government on Wednesday to be allowed to do the same.

Power producers had asked the State Council, China's cabinet, to formally allow local power plants to make deals with aluminium smelters directly at fixed prices, which would be lower than prices set by Beijing, a source at a power group involved in submitting the proposal said.

"We will ask the government to allow local power plants to sell electricity to aluminium smelters directly through regional grids," the source said.

"Such prices should be lower than official ones," he added.

Smelter officials said power fees of aluminium smelters in Guizhou and Yunnan provinces are expected to be cut by 0.03-0.05 yuan per kilowatt hour from December, about 10 percent of the current levels. Fees to smelters in Ningxia and Inner Mongolia had already been reduced.

China produced 1.09 million tonnes of primary aluminium in October, down 0.9 percent on the year for the first fall in years. The output consumed about 15.232 billion kilowatt hours of electricity, 5.8 percent of China's total output.

About one million tonnes of aluminium production capacity, including 720,000 tonnes at Chalco (2600.HK)(601600.SS), has been shut since Oct. 23 when production costs surpassed prices in China by more than 2,000 yuan per tonne at 15,500-16,500 yuan.

For a factbox of China's aluminium cuts, click on [ID:nSP381417]

But production costs have fallen to around 13,000 yuan per tonne now, given lower prices of raw materials such as coal and alumina, the main material for aluminium production, smelter officials said. The costs could fall to around 12,000 yuan in coming months.

Spot aluminium traded at about 13,680 yuan on Wednesday, making production profitable.

"Smelters will not cut more production, given falling costs," a senior executive at a large aluminium smelter said.

But smelters are unlikely to resume production at the shut capacity until the first quarter of next year, given weak domestic demand and high restart costs, smelter officials said.

By Reuters calculations, restarting a modern Chinese smelter with capacity of 100,000 tones a year cost around 53 million yuan in mid-October.

Fears of a global economic slowdown prompted by the financial crisis have reduced orders for aluminium products from buyers both overseas and in China.

About 800,000 tonnes to 1 million tonnes of primary aluminium ingots, more than 70 percent of China's October output, are estimated to be sitting at private and public warehouses, and smelters' yards, while aluminium inventories in LME warehouses jumped another 81,975 tonnes on Wednesday to 1.7 million tonnes, the highest since January 1995.

"Chinese smelters won't cut more production. But overseas smelters may do, given weak demand in the global market," the Guizhou smelter source said.

Aluminium for delivery in three months on the London Metal Exchange MAL3 has fallen 21 percent since the end of September to $1,905 a tonne on Wednesday, down 44 percent from the July record high. ($1=6.83 yuan) (Editing by Michael Urquhart)