Excess capacity in aluminium smelting will drag on for years to come, even while losses weigh on producers, as political pressures in China and Russia to keep jobs and push self-sufficiency prevent or delay plant closures.

Rio Tinto acknowledged a gloomy outlook for the sector this week, when it slashed the book value of its Alcan unit by $9 billion.

Rio Chief Executive Tom Albanese warned margins may continue to be squeezed in the medium term. The current environment in the aluminium industry is tough ... I can't predict when the price will recover.

In China, which accounts for 40 percent of global output, local authorities are wary of closing smelters that lose money but provide jobs, while the central government continues to drive an overall capacity expansion to maintain self-sufficiency.

Election politics in Russia also have halted at least one planned shutdown.

Throughout the sector, furthermore, smelters that consider closures are often hampered by long-term contracts to buy power and raw materials.

Companies are losing money on 30 to 40 percent of global output, analysts estimate. Margins have been hammered by five years of surpluses and rising input costs, particularly for power.

Benchmark aluminium prices on the London Metal Exchange have crumbled by a third since hitting a peak in July 2008 of $3,380 per tonne.

Producers including Rio, Alcoa and Norsk Hydro have cut global capacity by around 1.3 million tonnes as prices slumped in the second half of 2011 to reach below $2,000 per tonne, but more cuts are needed to bring the market into balance.

Analysts in a Reuters poll last month expected further market surpluses of 600,000 tonnes this year and 415,000 tonnes in 2013.

Earlier in the week, the head of rival BHP Billtion was even more downbeat, saying the world's largest mining group had halted investment in aluminium and had to review the future of its business.

There is no sense in letting something hang ... on the balance sheet if it doesn't want to be there, CEO Marius Kloppers said.

It's something that we've got to review. It's clearly not something that's an issue now, but I do think I have to note the aluminium reductions (in profitability) are structural. It's not a cyclical thing.

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Graphic on aluminium price and stocks

http://link.reuters.com/fuf35s

Graphic on 2011 Aluminium production

http://link.reuters.com/ben26s

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CHINESE PRESSURE

The elephant in the room is China with its many ageing and high-cost operations.

In China, there is some political pressure at a local level to continue some high-cost plants running, especially if they are in a small city where they are the largest employer, said Paul Adkins, managing director of Beijing-based aluminium consultancy AZ China.

Chinese aluminium prices are not low enough to cause widespread shutdowns and authorities are keen to remain self-sufficient in the metal, he added.

Albanese said Rio had been taken by surprise by an increase in smelting capacity in western China, where stranded coal is being used to generate cheaper electricity for smelters.

China's annual production capacity of primary aluminium may jump 60 percent in the next four years, an official at a state-backed industry association said last November.

In our opinion, the Chinese government has been unsuccessful in controlling aluminium capacity growth, Macquarie said in a note earlier this month.

Macquarie estimated that nearly 80 percent of Chinese producers were not profitable, based on total cost of production including administration, finance and depreciation.

The cost of shutting down capacity is high, however, so most smelters will strive to maintain existing output, it added.

RUSSIAN POLITICS

In Russia, home to top global aluminium producer UC RUSAL <0486.HK>, political considerations have also come into play.

Prime Minister Vladimir Putin, seeking to return to the presidency next month, intervened in December to prevent an archaic 67-year-old smelter from closing.

There is sensitivity, especially in an election year that we're in now, said analyst Erik Danemar at Deutsche Bank in Moscow.

There are limits to how quickly RUSAL can move and also how much they can move. But over time the government is also reasonable over what needs to be done.

RUSAL, which accounts for about 10 percent of global production, said last month it might cut output by 6 percent over the next 18 months.

Its European operations could take the brunt of any cuts since they are less profitable than the Siberian smelters, which have access to cheap hydroelectric power.

The European operations are probably breaking even, maybe making a little money if they get a good premium, Danemar added.

(Additional reporting by Melanie Burton in Shanghai, Polly Yam in Hong Kong, Manolo Serapio in Singapore and Melissa Akin in Moscow, editing by Jane Baird)

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