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London - What is the sound of one hand clapping?
It's supposed to be a question without an answer, a test posed by the master to the disciple in the Zen journey towards enlightenment.
But it's also as good a description as any of the current state of global aluminium production.
The one hand clapping is that of the non-China world, where producer discipline has tamed supply sufficiently to drag the market into a state of deficit.
Such enlightenment has taken several years to achieve and marks only the very first step towards correcting the mistakes of the past. These still weigh heavily over the aluminium price in the form of millions of tonnes of accumulated surplus.
Absent, though, is the second hand.
The Chinese aluminium smelter sector remains profoundly ill-disciplined with older zombie smelters kept alive by local governments and new capacity still coming on stream.
The Shanghai aluminium price is accordingly bombed out to the point that at least half of the country's total operating capacity is running at a loss, according to some estimates.
Only an accelerating outflow of semi-manufactured products, some of which challenge the definition of what is a "product", is preventing things from getting even worse.
This polarity of global aluminium production is nothing new. It's been going on for ages now, but it is becoming ever starker.
Holding the line
Production of aluminium outside of China totalled 24.43 million tonnes last year, according to figures from the International Aluminium Institute (IAI).
That represented a year-on-year decline of 0.7%. It was the third consecutive year of falling output.
Annualised run-rates in December were 24.60 million tonnes, representing a 1.2-million tonne slide from the October 2011 high of 25.92 million tonnes.
That headline reading, though, masks the true scale of cutbacks across most of the non-Chinese world, since output in one region, the Gulf, has been rising fast on a combination of expansions at existing plants and the ramp-up of the new 740 000-tonne per year Ma'aden smelter in Saudi Arabia.
Gulf production growth, however, is now tailing off at an annualised rate just north of the 5-million tonne level.
Meanwhile, output declines in regions such as Europe, both Western and Eastern, North America and Oceania have also pretty much run their course.
Indeed, the sharpest fall in production last year, a near 20% contraction, took place in Latin America, where Brazil's once mammoth smelter sector is still being whittled down by the toxic cocktail of low prices and high energy tariffs.
It's no coincidence that the last announced cutback, in October last year, was Brazil's small 50 000-tonne per year Ouro Preto plant.
With higher-cost smelters now collectively shuttered, attention has inevitably turned to the possibility of restarts.
Some moribund capacity will likely creep back in Western Europe in particular. The Delfzijl smelter in the Netherlands is being resurrected by Klesch and the Voerde plant in Germany has been saved by Trimet. Both had previously been bankrupt.
So far at least, however, bigger players such as Alcoa and Rusal show no signs of reactivating idled capacity.
Nor is there much new capacity due to come on stream now the Gulf expansion growth spurt has passed its peak.
India is a potential exception, although operators have to navigate the tricky waters that are the government's rules on the allocation of bauxite and coal concessions. Coal is the primary source of power for India's aluminium smelters.
Through the looking glass
The situation could not be more different in China itself.
Production last year rose by 7.7% to 24.38 million tonnes, according to the National Bureau of Statistics. The complementary production figures from China's Nonferrous Metals Industry Association (CNMIA) aren't out yet but the two data-sets were closely aligned through the first 11 months of 2014.
They also have something else in common. They are serious undercounts of the true state of aluminium production in China.
To be fair to the IAI, which publishes the CNMIA figures, it now includes a 300 000-tonne per month estimate for unreported Chinese production. That's a whopping 3.6 million tonnes per year, equivalent to last year's production in the whole of Western Europe.
And that's about right, according to China specialists AZ China. They estimate national production last year was somewhere in the region of 27.5 to 27.7 million tonnes.
The twin drivers of higher production were continued expansion of capacity in China's northwestern province of Xinjiang and around 2.0 million tonnes of restarts thanks to discreet but effective power subsidies from local governments.
The combination will overwhelm closures of obsolete capacity again this year with production likely to rise further to 29.0 million tonnes, according to AZ China.
The title of their Jan. 9 research note, "Oversupply to drown China's aluminium market", pretty much says it all about the chances of Chinese producers reaching the same state of enlightenment as their western peers.
This polarisation is plain to see in the performance of aluminium prices on the London Metal Exchange (LME) and the Shanghai Futures Exchange (SHFE).
Relative to the start of 2014, the LME price is up almost 4% and the SHFE price is down by over 13%. And that's without taking account of the still super-strong physical premium structure in the Western world.
Chinese smelters seem set for more financial pain. Speaking in Reuters Base Metals Forum this morning, Paul Adkins of AZ China suggested industry leader Chalco is looking to form a consortium to channel metal away from the SHFE and directly to consumers as a way of propping up prices.
The chances of this working appear painfully slim. A similar attempt to exert collective muscle over the aluminium fluoride market unravelled in double-quick time.
The real significance of the latest development is probably the state of desperation it reflects.
The safety valve
The main safety valve for Chinese smelters remains the leakage of domestic surplus into the international market-place in the form of semi-manufactured products.
While there is still a 15% export tax on primary metal, semis still attract a VAT rebate.
Disconcertingly for non-Chinese producers, such exports have been steadily increasing thanks to the gap between domestic and international prices. December's implied tally from the preliminary figures released on January 15 was a fresh all-time high.
And really disconcertingly for non-Chinese producers, it is now widely accepted by analysts that some of this outbound flow is metal that has undergone minimal cosmetic transformation to classify as a "semi" and therefore qualify for the tax rebate.
That means not only are Chinese semis displacing demand for products outside of China, they are partly displacing demand for primary metal as well.
AZ China's Adkins suggests that Beijing may be getting wise to this sleight of customs hand, increasing the level of inspections of outbound cargoes. Simple market forces may also limit future growth in Chinese exports to what is an increasingly saturated Asian market.
Those non-Chinese producers still holding the line on production cutbacks can only hope so.
Until then they will be clapping the price higher with only one hand.
