Sinking aluminum prices and a ballooning surplus of the metal have deepened the industry's worst crisis in years, intensifying pressure on high-cost smelters to embark on another round of production cuts to revive prices from their malaise.

The 25 percent drop since last September has pushed benchmark London Metal Exchange prices to six-year lows, and the unprecedented plunge this year in premiums, surcharges paid for physical delivery, to their lowest in 3-1/2 years are the biggest test for producers' margins since the 2008 financial crisis.

More than 10 percent of smelting capacity outside of China, or 3.5 million tonnes of production, is running in the red with a combined LME and U.S. premium of $1,800 per tonne, according to Wood Mackenzie data from second-quarter results. On Friday, three-month aluminum was at $1,621, with a U.S. premium of $175 a tonne.

The data illustrates the increasing pain across the sector as producers worry about growing exports from China and production costs such as power remain relatively high.

To have a meaningful impact on prices, producers need to cut capacity by another 1 million to 2 million tonnes, said Ed Meir, an analyst at INTL FCStone.

"It's been like death by a thousand cuts. Western producers have made cuts here and there, but collectively, it's not been a lot because China is more than making up for it," he said.

Alcoa Inc has closed or curtailed 170,000 tonnes of annual output this year as part of its review of 500,000 tonnes of smelting capacity announced in March, and United Co Rusal said in April it might idle 200,000 tonnes of capacity.

Last month, Century Aluminum, controlled by Glencore, announced plans to shutter its 244,000 tonne-per-year Hawesville, Kentucky smelter, blaming Chinese exports and weak prices.

But that is a rounding error in a market of 50 million tonnes of supply. The industry's worsening woes will be a hot topic at the Metal Bulletin aluminum conference in Vancouver this week.

HIGH-COST, LOW-IMPACT

Some of the highest-cost smelters - including two Alcoa plants in Spain, Klesch Group's Delfjiz plant in the Netherlands and Trimet Aluminum's Essen plant in Germany - are relatively small, together producing just 340,000 tonnes per year, the Wood Mackenzie data show.

The U.S. dollar's rise against a basket of major currencies has cushioned the blow of weak prices for smelters outside the United States, reducing the likelihood that their operators will shut them, industry observers said.

Trimet said all its smelters were profitable and running at full capacity, and that the company could compensate for fluctuations in the LME price because it produces value-added alloys and has long-term hedging in place.

An Alcoa spokesperson said the company has "aggressive productivity improvements underway" and was seeking ways to reduce raw material and power costs. Klesch did not respond to a request for comment.

CHINA - THE SWING FACTOR

Few expect any immediate respite from China, the world's top consumer and producer.

The country has cut some capacity in response to deteriorating market conditions, with Wood Mackenzie senior analyst Uday Patel estimating that 1.5 million tonnes of annualized production were eliminated at older, inefficient Chinese smelters between January and August.

But this is a drop in the ocean compared with the 3 million to 5 million tonnes of capacity China has added through modern smelters, he said.

"In China, production growth and demand growth are completely divorced," said Patel, noting that political factors such as the desire to keep workers employed drive output decisions more than questions of profitability.

Of the world's 50 highest-cost smelters, 37 are in China, and the average cost of production there this year will be $1,918 a tonne, 14 percent above the average cost of the rest of the world at $1,684 a tonne.

That will likely fuel criticism about growing exports, which Alcoa and Century Aluminum have blamed for weakening prices and triggered speculation that U.S. players may launch efforts to restrict exports through tariffs.

Alcoa has criticized the export of so-called "fake semis", and the U.S. Aluminum Association has called for the U.S. authorities to investigate cheap imports of semi-fabricated products.

"If China's not going to take price cues, then the ex-China countries will have to take matters into their own hands through protectionism," said analyst Jorge Beristain of Deutsche Bank. (Additional reporting and editing by Josephine Mason; Editing by Jonathan Oatis)