(The opinions expressed here are those of the author, a columnist for Reuters.)
LONDON, Oct 1 (Reuters) - Global aluminum production is contracting this year.
Cumulative output in the first eight months of 2019 slid by 0.6% to 42.5 million tonnes with production down in both China, the world's dominant producer, and the rest of the world, according to the International Aluminium Institute (IAI).
If the trend continues, this will be the first year since 2009 to see a simultaneous production decline in both halves of the aluminum universe.
Visible inventory, meanwhile, has fallen to multi-year lows. Total stocks registered with the London Metal Exchange (LME) last week slipped below 900,000 tonnes for the first time since 2008, while Shanghai Futures Exchange stocks are at two-year lows.
None of which has done much for the aluminum price. LME three-month metal has this morning touched $1,713.50 per tonne, its lowest since January 2017.
The problem is that the aluminum market doesn't believe that falling production and stocks are anything other than fleeting trends.
The collective focus is now on the problem of demand weakness.
CHINA PRODUCTION PAUSE
Production outside of China was down by 0.45% in the January-August period.
Signs of rising output in both North America and Russia, thanks to the restart of the Becancour smelter in Canada and the ramp-up of the Boguchansk plant in Siberia, are currently being offset by production weakness in Latin America and Western Europe, down by 13% and 7% respectively.
The real supply-side story, however, has been playing out in China.
Chinese production has fallen by 0.75% so far this year, a highly subdued performance from a country that was expanding aluminum output at a double-digit pace as recently as 2017.
Although weak margins have played a role in constraining production growth, national run-rates have taken two unexpected hits.
China Hongqiao Group, the world's biggest aluminum producer, last month slashed its 2019 production guidance by up to 300,000 tonnes, or almost 5%, to reflect the impact of flooding from Typhoon Lekima on some of its operations in Shandong province. The consensus is that other producers have also been affected.
Xinfa Group, another top producer, has closed 500,000-tonnes of annual capacity after an explosion at a plant in the northwestern Chinese region of Xinjiang.
Commodity research company CRU expects China's production to slide by 0.5% over the course of 2019.
However, next year looks very different, CRU forecasting production to rise by 5% as the current supply hits fade and new capacity comes on line.
Neither CRU nor other analysts are expecting any significant impact from the coming winter heating season restrictions on heavy industry.
THE DEMAND PROBLEM
Although the expected recovery in production next year is moderate by the standards of the Chinese aluminum sector, the real worry is now about the state of demand, both in China and everywhere else.
Aluminum has enjoyed many years of high demand growth relative to most other industrial metals but this year usage has been hit hard by the downturn in the global automotive sector, which accounts for around 30-40% of all demand for the light metal.
CRU is expecting demand outside of China to contract by 1.1%, the first year of negative growth since the global financial crisis.
"The extent of the weakness is staggering," say analysts at JP Morgan. They are penciling in a 3.5% contraction in North American demand this year, partly reflecting greater usage of scrap by product manufacturers. ("Metals Quarterly," Sept. 23, 2019)
Growth in China itself is expected to brake sharply from 4% in 2018 to just 1.6% this year, according to CRU. Here also automotive weakness is the main culprit, but sluggish demand from the property and power grid sectors is in the mix as well.
That means the domestic market is likely to move into significant supply surplus in 2020.
And, if history is anything to go by, that means more exports of Chinese semi-fabricated aluminum products, which is how Chinese surplus normally manifests itself.
Chinese export growth has slowed this year to just 4% in the first eight months from 24% in calendar 2018.
The aluminum market is betting that without an improvement in demand the export gates will reopen next year, unleashing more product in a western market that is already suffering from negative demand.
You can start to see why current low visible stocks are not preventing the price slide.
This is partly a problem of optics.
What is visible in terms of LME inventory has long been overshadowed by the amount of aluminum sitting in off-market storage.
While the steady multi-year drawdown in LME stocks chimes with assessments by CRU and other analysts that the global primary aluminum market has been in supply shortfall, it has also been driven by the exchange's multiple rule changes forcing faster load-out and by a disincentive to deliver fresh metal onto LME warrant.
LME time-spreads have been trading in persistent contango through 2019, a structure that facilitates stocks financing. As of Monday's close, the LME three-month price was valued at a $20 per tonne premium to cash metal.
Since the profits from financing are enhanced by lower storage costs, there is a natural trend towards keeping the metal away from higher-cost exchange storage.
There is almost certainly less "out there" than there used to be, although as ever it's hard to count what lies in the off-exchange shadows.
But accumulating signs of physical market weakness, falling physical premiums in particular, suggest the trend may be reversing.
LME stocks have bounced back off last week's lows with 66,125 tonnes of metal being placed on warrant over the last seven days.
Such activity isn't abnormal on the LME aluminum contract, which has seen such flurries of "arrivals" many times in the past.
This time, however, it's spooked a market that is on the look-out for signs of demand weakness and resulting surplus metal.
The aluminum market narrative is changing. Just a few months ago everyone was talking about a supply deficit.
Lower global output rates and falling stocks seemed to be evidence of a market that was finally re-balancing after many years of oversupply.
The irony is that before those bullish trends really started flowing through to price, aluminum's previous stellar demand profile has started cracking.
That places the focus firmly back on whether producers, particularly Chinese producers, can hold their supply discipline.
The current price says they can't and won't. (Editing by Mark Potter)