China's winter heating season has arrived and the aluminium market is still struggling to work out what impact it will have on the country's production.

Capacity will certainly close as part of the government's drive to improve air quality in the region around Beijing. But potential offsets both from earlier "illegal" capacity closures and from higher output in unaffected parts of the country make the exact calculations fiendishly difficult.

In London three-month aluminium is trading around $2,120 a tonne, some way off the five-year high of $2,215 hit earlier this month.

That suggests the market is taking a slightly more relaxed view about the size of the looming production hit, particularly in light of rapidly building stocks on the Shanghai Futures Exchange.

However, attention is now turning to the knock-on impacts of the winter industrial capacity cuts on key raw materials in the aluminium smelting process, particularly alumina and carbon anode.

Both have recently jumped in price and both featured heavily in last week's discussions, both on and off-stage, in Oman.

Carbon anode was already a ticking time bomb for aluminium smelters, but one over which they have little control.

The disruptive impact from alumina price volatility, by contrast, is to some extent a self-inflicted injury after a collective shift in pricing methodology.

Graphic on relative price performance by aluminium and alumina:

END OF THE NATURAL HEDGE

The London aluminium price has climbed by almost 25 percent this year.

Alumina, the key metallic input to the smelting process, has jumped by almost 50 percent to about $465 a tonne.

It, too, is reacting to the potential for significant capacity closures in the most smog-prone parts of China.

As with the metal link in the supply chain, nobody is quite sure how much alumina will be lost over the coming winter heating months. Alumina demand, meanwhile, is a function of smelter operating rates, embedding the alumina price between two "known unknowns".

Until very recently, alumina price volatility wasn't a big deal for aluminium smelters, even though it is one of their most important costs along with power.

That's because, outside China at least, most of them had alumina supply contracts linking the price to that of primary aluminium.

It was, as Ali Al-Baqali, deputy chief executive at Aluminium Bahrain, told ARABAL delegates, a natural hedge.

And now that natural hedge has gone.

Led by Alcoa, the smelter sector has largely dropped any linkage between alumina and aluminium pricing over the past five years.

Alcoa now prices about 85 percent of its third-party alumina sales using some form of alumina price index, according to the company's third-quarter results.

So do most other producers. At a stroke, the global smelter sector has lost control over one of its most important production costs.

In theory, it could use the CME's new alumina contracts to hedge its exposure.

In practice, however, the contracts are too illiquid to allow wholesale hedging. One contract hasn't traded at all, while the other one, indexed to Platts' assessment of the Australian market, has recorded cumulative volumes of only 541,000 tonnes since its launch last year.

The London Metal Exchange (LME) has committed itself to studying a possible alumina contract but it will face the problem that the industry itself hasn't decided on a benchmark price.

Smelters typically contract to buy alumina using a ratio of three different price assessment indices, a hotchpotch formula that will bedevil any easy hedgeable solution.

CARBON TIME BOMB

You can't make aluminium without alumina and you can't make it without an anode either.

And, according to Robert Dickie, senior consultant at U.S. research house Harbor Aluminum Intelligence, "there is no viable alternative to the carbon anode", produced from petroleum coke and liquid pitch.

This part of the aluminium supply chain is also being upended by China's environmental winter cuts.

But it has been tightening steadily for several years, with analysts warning as long ago as 2015 of a pending supply crunch.

China is one of the world's major producers of carbon anode but, even before this year's round of seasonal cuts, it was directing ever-increasing amounts to meeting domestic demand, cutting exports in the process.

The world outside of China has been scrambling ever more desperately for replacement supply.

"There's just not enough coke," Ritchie says.

With petroleum coke accounting for only a very small part of oil refiners' revenues and most of that coke not the right sort of material for making carbon anodes anyway, there is little prospect of any supply response any time soon.

A market rebalancing will have to come from the demand side.

What this means is that smelters must "blend, blend and blend" low-sulphur anode coke with other forms of fuel coke, said Yasmin Brown of Jacobs Consultancy.

Unfortunately, none of the speakers appearing on the raw materials panel at the conference could produce any evidence that this is actually happening.

Too many procurement and research and development departments still operate in their own mutually exclusive silos.

RAW MATERIALS CRUNCH

Such has been the market's fixation on Chinese aluminium production that these equally unstable components of the smelting process have tended to be overlooked.

The Chinese winter cuts have exposed underlying pricing and supply stresses in both the alumina and carbon anode sectors.

And since both are core but currently unhedgeable cost components, there are plenty of implications for aluminium pricing, adding another layer of complexity to an already multi-dimensional puzzle.

But the implications may well prove even more significant than a flow-through into metal ingot pricing.

With all eyes on China and how its producers fare over the next few months of mandated capacity closures, there is growing speculation about potential smelter restarts in the rest of the world.

Right now, however, to judge by the mood at last week's conference, there is little chance of any would-be restart sourcing sufficient carbon anode to re-energise its potlines.