2nd UPDATE: Norsk Hydro CEO: Aluminum Needs More Discipline

LONDON, July 28 -- The aluminum industry needs to follow from the example of the steel industry and exercise far greater discipline in adjusting to the market supply-demand balance, which remains in oversupply with many smelters operating at below the cost of production, the chief executive of Norwegian producer Norsk Hydro ASA (NHY.OS) said Tuesday.

Svein Richard Brandtzaeg told Dow Jones Newswires in an interview in London that aluminum is facing overproduction of between 2% and 3%, at the same time as inventories hover near record levels in warehouses around the world.

"We should learn from the steel industry, which cut its capacity utilization to about 45%...I had expected when the market price of aluminum went down in 2009, that more capacity would be taken out to avoid the buildup of inventories and the overproduction we have seen--that's the reason we took our 26% of our capacity," Brandtzaeg said.

"It remains to be seen, but I'd expect that other aluminum players will also adapt to the market situation going forward. If not, it will solve itself as prices will be depressed and force high-cost producers to adapt in the end."

The company, which has taken about 442,500 metric tons of annualized production offline, curtailed capacity and cut output at several plants during 2009 as the global economic downturn took its toll on demand for aluminum.

"We have no plans today to curtail any further production and at the same time we have no plans to restart the capacity," Brandtzaeg said.

The main factors the company considers in its decisions about production are the supply-demand balance, and the price of aluminum, Brandtzaeg said.

"So with the oversupply situation we're seeing today, there is good reason for us not to restart," he said.

Brandtzaeg said he remains unconvinced that high levels of aluminum stocks, held officially in exchange warehouses as well unofficially outside the reporting system, will pose a big problem to the market.

Much of this metal is held in so-called financing deals, and came about because aluminum prices slumped as the global economic downturn took its toll on demand in key consumption industries, such as construction and automotives. Metal flowed into warehouses, pushing LME stocks to record highs.

At the same time, producers sold or pledged material to raise much-needed working capital from traders, banks and investors, who bought inventory at spot prices and sold futures one to two years forward in financing deals.

"The owners of this metal are making a living from the small margin between the contango, the interest rates and warehouse costs, and this gives them sufficient enough returns to hold these positions forward. In previous years, when we had high inventories, players released it back gradually into the market--they have no incentive to destroy not only their small margins but also the value of the metal," Brandtzaeg said.

Noting plans by industry participants to create a physical aluminum exchange-traded fund, Brandtzaeg said the products will "certainly be a tool that will be used."

"But for Hydro, we'll keep our focus on the supply-demand balance globally to avoid the build-up of inventories and we won't contribute to the oversupply situation," he added.

ETFs are investment funds that trade like stocks on exchanges and track stock sectors, commodities or other financial instruments. The aluminum ETF is expected to be listed on the Swiss and German exchanges, but will be backed by physical metal.