July 5 (Bloomberg) -- Alcoa Inc. and Norsk Hydro ASA are shutting aluminum smelters in Germany and building new plants in Iceland, where production costs are lower, adding to the gloom in Europe's biggest economy and giving a boost to the North Atlantic island of 293,000 people.

Alcoa, the world's biggest aluminum producer, is spending $1.1 billion on a smelter in Iceland after government-owned Landsvirkjun Hf agreed to supply power for 40 years. Oslo-based Norsk Hydro, the world's No. 3 aluminum company, also is considering an Icelandic smelter, said Jon Harald Nilsen, head of the aluminum unit.

``The only place where it's possible to build more capacity in Europe is Iceland,'' Nilsen said in a June 21 interview from Oslo.

Germany, where Norsk Hydro three years ago spent $2.8 billion to buy VAW AG, the aluminum unit of E.ON AG, is being hurt by record high power prices. As many as 4,000 jobs may be at stake, according the German Aluminum Association. Power, which accounts for a third of the cost of making aluminum, is about 30 percent cheaper in Iceland than in other locations, according to Lloyd O'Carroll of BB&T Capital Markets in Richmond, Virginia.

Other winners include Qatar, while companies including Alcoa are also cutting back in the U.S.

Iceland's economy grew 2.9 percent in the most recent period, while German economic growth was 1.1 percent. For all of 2005, Iceland's $14 billion economy may expand 6.6 percent, Sedlabanki, the central bank, said last month. The German economy will probably grow about 1 percent this year, the Bundesbank predicts.

Aluminum Prices Slide

Aluminum companies are also moving to cheaper locations as prices for the metal, which is created by dissolving powdery alumina and used to make everything from beverage cans to fighter jets, have declined 14 percent from an all-time high March 29.

``It's an untenable position'' for the companies, said Ed Johnson, a money manager at Palm Beach Springs, Florida-based National City's Bank Armada fund. ``They're priced into energy as a buyer and they're priced into the aluminum they supply.'' Johnson said he sold his entire 2.2 million holding of Alcoa shares last month.

Alcoa, based in Pittsburgh, Norsk Hydro and other aluminum companies may spend a combined $75 billion to move capacity to low- cost countries in the next 10 years, according to Kenneth Bern, vice president of strategy and business development at Norsk Hydro.

Alcoa alone is shedding 6,500 jobs to close plants in the U.S. and Germany this year, it said June 23. Norsk Hydro said on June 28 it will shut a German smelter and cut production in Norway, losing 870 jobs. Europe's aluminum industry employs more than 236,000 people, according to the European Aluminum Association.

Gulf States Winning

Gulf states are also among the winners. Norsk Hydro plans to invest $1.5 billion building a smelter in Qatar, home to the world's third-biggest natural gas reserves. Montreal-based Alcan Inc., the world's second-biggest aluminum maker, last year agreed to take a 20 percent stake in a $2 billion smelter project in Oman, in a venture with Oman Oil Co. and Abu Dhabi Water & Electricity Authority.

``If you're thinking about smelters, you have to think about the next 20 years or 30 years,'' said O'Carroll, in a telephone interview. ``But you've got to pay for that capital cost.''

Aluminum makers are moving to cheaper power-generating countries to increase production partly in anticipation of surging demand in India and China, the world's two fastest-growing major economies. Both countries consume less than 10 kilograms per person, compared with more than 60 kilograms per person in the U.S. and Germany, Bernt Reitan, president of the Alcoa's primary aluminum division, said at a conference in Reykjavik on June 14.

`Too Steeply'

Record crude oil and natural gas prices, combined with a 10- fold increase in state taxes in Germany, Europe's largest energy market, have driven power prices there to an all-time high. Power for delivery in 2006 jumped to a record 43.40 euros ($52.56) on June 24, compared with 21 euros at the end of 2000, according to European power brokerage GFI Group Inc.

Power prices are ``going up too steeply and too fast,'' Wulf Bernotat, Chief Executive of Dusseldorf-based E.ON, the world's largest publicly traded utility, said June 30. But ``we are not there to help out the poor industry whenever the government asks us to. All have to accept these are market prices.''

Icelandic power is cheaper because the country generates so- called geothermal power tapped from hot springs. A geothermal field in Iceland's volcanic north near the Arctic Circle would offer sufficient energy to power a smelter capable of producing 250,000 metric tons a year of aluminum, Bjarni Bjarnason, Chief Executive of Landsvirkjun, said in Reykjavik on June 13.

Shares, Earnings

Rising power costs and the prospect of one-time charges for moving smelters have hurt aluminum companies' shares even as earnings rise for now. Shares in Alcoa have dropped 16 percent this year while Alcan's have declined 28 percent. Norsk Hydro, which mainly sells oil and gas, has gained 26 percent as prices of those commodities surged.

Alcoa's net income climbed for a third straight year in 2004 to $1.3 billion, while Alcan posted a threefold gain in profit to $920 million. Norsk Hydro's income increased for a third successive year in 2004, to about $1.8 billion.

Alcoa is scheduled to announce first-half earnings on July 7. Net income probably dropped 21 percent to $628 million, according to the median forecast of 17 analysts surveyed by Thompson Financial.

Expiring Contracts

Alcoa plans to cut annual costs by $1.2 billion starting at the end of next year, said Reitan. In addition to the project in Iceland, it's considering new smelters in Trinidad & Tobago and Brunei.

Companies are accelerating moves to cheaper power centers as existing contracts end. Alcoa and Norsk Hydro plan to shut their joint Hamburger Aluminium-Werk GmbH smelter in Germany as a power contract expires at year-end. Alcan's agreement to participate in Oman came before power contracts run out this year at its smelters in France, Germany and the Netherlands.

``It's the first question you ask as an aluminum producer'' when planning the future, Richard Evans, an executive vice president at Alcan, said in an interview in Reykjavik on June 15. ``Will I have a 30-year to 40-year power contract at competitive rates?''

Oman's government has said it expects the project to contribute more than 2 percent to the country's gross domestic product after it starts operating in 2007. Oman is seeking international investors in oil-related projects to make up for a four-year decline in crude production as fields age.

The benefits of the smelter moves may take years to bolster the companies' share prices, O'Carroll said.

``They're doing the right things'' by moving their operations, said Johnson at Bank Armada. But ``it's not going to get stocks moving tomorrow.''

To contact the reporter responsible for this story: Matthew Craze in London at mcraze@bloomberg.net

Last Updated: July 4, 2005 19:06 EDT