The world’s leading primary and fabricated aluminum manufacturer, Alcoa (NYSE:AA) has decided to cut back its production capacity by 12 percent. The Pennsylvania based firm stated that two reasons were behind this move. First, the company will be restructuring itself through a series of measures. This move is part of its restructuring exercise to enhance the operational efficiency. Second, aluminum prices have dropped by almost 27 percent from their peak. This has significantly hurt the bottom line of the company, probably in the short term mainly.

This Bellwether under Turbulence

Aluminum demand is often considered one of the most important indicators in terms of world economic health. Since aluminum is used in a wide range of industries, right from construction to aerospace, a drop in its demand indicates that things are going to be bumpy in the near future. Aluminum was trading at $2,803 per ton on the London Metal Exchange in May of 2011. But as of now, it is being traded at the rate of $2,020, a drop of 27 percent.

Apart from the dip in demand, input costs have been rising consistently. Caustic soda, coke and pitch, all of which are used for smelting aluminum ore are all costlier than they were earlier. A decreased demand and higher production costs are making it nonviable for the company to remain profitable. According to analysts, $2,500 is the ideal price range for the producer to stay profitable, which at the moment looks difficult. Apparently, not even volume can make up for this price differential.

Bottom Lines Hurt

Analysts expect that Alcoa’s fourth quarter earnings for 2011 would be lower than expected and in all probability the company will be declaring losses. Around 7 percent of the cuts will be made on the home turf, despite America being the largest producer of aluminum in the world. Plants which have been put in suspension mode in the U.S. will be the first to go. The Tennessee plant will be the worst hit plant since around 215,000 tons of production will be stopped from here. Another 76,000 ton production cut will come from plants in Texas. The remainder 5 percent cut will come from plants outside the U.S., the details of which are yet to be worked out by the company.

As far as job cuts are concerned, there will not be any in Tennessee and Texas since the plants are already closed. Whatever job cuts may occur will be at the plants that will be affected outside the U.S. The entire exercise is expected to cost the company around $165 million which will trim around 15 to 16 cents from each publicly traded share of the company.

A Similar Situation in the Far East

The Chinese counterparts of Alcoa are also in a similar situation. High input costs, in particular those related to power is making the margins of these companies thinner. The companies thus have no option but to cut production. Canadian smelters are in a better condition since power used by those plants are derived from hydro powered stations, which is comparatively cheaper to operate. This just means the Canadian companies have less energy costs.

China, which is one of the major importers of aluminum from the U.S. is experiencing a slowdown. Considering the fact that the manufacturing hub of the world is slowing down, the demand is bound to drop.

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