News of China's Shandong province planning to cap its aluminum and alumina output capacity from November 2017 to March 2018 has increased the risk of price volatility, the State Development and Investment Corporation said in a report Friday.

Reforms on the supply side would favor prices in the long run, SDIC said.

"Market players are waiting for news on an estimated 1 million mt/year of aluminum smelting capacity in Inner Mongolia that has breached state rules. This, plus the government's circulars [on outdated aluminum capacity shutdown and output cuts] has resulted in speculative activity," SDIC said.

"Market players are still having very strong bullish sentiment, playing more and more long and short games, so resulting in aluminum prices fluctuating," it added.

Following the Shandong branch of the Ministry of Environmental Protection issuing a circular on July 28 on capping smelting capacity, aluminum futures on the Shanghai Futures Exchange were volatile this week.

SHFE's most active September contract rose Yuan 305/mt Wednesday, closing at Yuan 14,765/mt ($2,215).

But at Thursday close, the contract was Yuan 14,590/mt, down Yuan 50/mt from Wednesday. Aluminum futures averaged Yuan 12,215/mt in 2016, SHFE data showed.

Shandong is to cap its alumina, refined aluminum and carbon sector output for four months from November 15 this year to March 15, 2018, to cut emissions.

It was asked to limit alumina output by over 30%, aluminum production by around 30% and carbon emissions by more than 50% in the period, the Ministry of Environmental Protection said last week.

Production lines that do not meet the emission standards will be asked to suspend operations, the local branch of the ministry said.

SHFE ALUMINUM PRICES LIKELY TO HIT YUAN 16,000/MT IN H2

Due to the shutting of domestic aluminum capacity that do not meet standards and capping output in the winter, state-owned metals consultancy Beijing Antaike said in mid-July that prices were likely to rise further in the second half of the year.

SHFE three-month aluminum futures could rise to Yuan 12,500-16,000/mt in H2, it added.

"Output cut news in Shandong, Inner Mongolia and Xinjiang will support price hike in H2, with prices likely rising further to Yuan 16,000/mt or above," an analyst in Zhejiang Province said.

He agreed with investment bank GF Securities' commodity report issued Wednesday that said the cap on output in Shandong province might shut 860,000 mt/year of refined aluminum and 1.85 million mt/year of alumina capacity.

Shandong has more than 100 aluminum producers located in Zouping county and the Beihai and Binzhou Economic and Technological Development Zone with an annual aluminum output valued at Yuan 500 billion by the end of the 13th Five Year Plan period (2016-2020), data from China Nonferrous Metals Industry Association showed.

China added new aluminum smelting capacity of 305,000 mt/year in June, lifting the national smelting capacity to 44.978 million mt/year as of end-June, data from Titanium Valley Nonferrous Metal Exchange Center showed.

The exchange is a government funded business service platform that deals with nonferrous metals trading, warehousing and logistics.

China is forecast to add around 5 million mt/year of aluminum smelting capacity in 2017, mainly in Shandong and Guizhou province as well as Inner Mongolia and Guangxi, data from Antaike showed.