NEW YORK (Reuters) - Kentucky state lawmakers are set to decide whether to let U.S. aluminum producer Century Aluminum Co (>> Century Aluminum Co) buy power on the open market in its bid to save its money-losing smelter in the Bluegrass state from closure.

With metal prices low and production costs high, U.S. aluminum producers struggle with razor-thin margins. In its attempt to cope, Century has taken the dramatic step of pushing for legislation that would exempt smelters from a state law requiring consumers to take power from only one supplier.

"We're losing money every month. What the bill would do is get me out from under that exclusive service contract," said Michael Early, Century's energy director, in testimony last month before Kentucky's House Natural Resources and Environment Committee.

The bill could have bigger implications for the troubled U.S. aluminum industry, where high-cost electricity for aging plants has challenged many producers to seek ways to operate more efficiently, especially as benchmark aluminum prices have come down by more than 30 percent in less than two years.

Century's drive for the legislative change coincides with Ormet Corp's (>> Ormet Corp) filing for bankruptcy protection at its Ohio aluminum facility, crippled by high costs.

Reuters data shows U.S. aluminum output has fallen by 20 percent over the past decade to 2.03 million tonnes last year, and the number of smelters has dropped by more than 30 percent to 10 plants over the same period.

At current aluminum prices, close to 4.3 million tonnes of production outside of China is unprofitable, according to Barclays base metals analyst Nick Snowdon. That is about 8 percent of global output.

The Kentucky situation may force aluminum makers who cannot lower their production costs in the United States to shift operations to other parts of the world, as some have done already.

Alcoa Inc (>> Alcoa Inc), for example, cited high power costs when it permanently shut two potlines at its Rockdale, Texas smelter, and construction of its greenfield capacity is under way in the Middle East, where power is cheaper. Aluminum capacity in the Middle East has risen to over 3 million tonnes.

CRITICAL DECISION

Century, majority owned by Glencore International (>> Glencore International Plc), wants to bypass its existing energy provider, Big Rivers Electric Corp, and buy electricity on the spot market for its Hawesville, Kentucky, smelter. Wholesale prices are 25 percent lower than the fixed rate set in its 15-year power contract.

When that deal was signed in 2009, however, spot energy prices were significantly higher. Power accounts for about 40 percent of the Kentucky plant's production costs, higher than the industry average of 30 percent.

Without lower-priced power, the Monterey, California-based Century said it will shut the Hawesville plant in August.

The nearby Sebree aluminum smelter, owned by Rio Tinto Alcan , could also close unless it lowers its energy costs.

While Rio Tinto is not involved in the Kentucky legislation, it has been watching closely from the sidelines. It uses the same energy supplier as Century. Rio Tinto also gave notice that it will end its power contract for its 194,000-tonne-a-year Sebree smelter in January 2014, following a proposed hike in electricity rates.

Shutting the two smelters, with combined output of 440,000 tonnes of aluminum a year and representing more than a fifth of U.S. primary production, would have ramifications beyond Kentucky's borders. A tighter aluminum supply would push up the metal's price, and in turn, increase costs for carmakers, beverage companies, construction sites and many other industries.

"I think it will be a pretty critical decision, not just for these facilities, but for the broader outlook for broader market fundamentals," said Barclays analyst Snowdon, who expects global oversupply of 1.8 million tonnes.

Within Kentucky, closing Century's 244,000-tonne-per-year Hawesville smelter will result in an estimated loss of $800 million a year in state revenue and 750 jobs.

WHOLESALE VS FIXED PRICE

Despite its closure notice, Century appears determined to work out a viable operating plan for the Hawesville smelter. It took its power issue to the state government after failing to negotiate new terms that would allow it to tap the open market.

The Big Rivers utility, which gets 70 percent of its revenue from Hawesville and Sebree, opposes the legislation, saying long-term contracts protect companies from wild swings in spot prices and would push up rates for its remaining customers.

Still, negotiations for power deals continue with both Century and Rio Tinto even as Kentucky's House considers the energy bill. Even if it passes the House, the bill would need approvals by the state Senate and the governor's office.

Century said in its testimony that it is committed to staying in Kentucky for the next 20 to 30 years, so much so, that it is in talks to buy the Sebree plant, which Rio Tinto deemed a non-core asset in late 2011.

"The board is so strong (on Kentucky) that we're in negotiations presently to buy the neighboring plant, the Sebree plant from Rio Tinto Alcan," John Hoerner, vice president of North American operations for Century, said last month.

Rio Tinto Alcan's spokesman has said the company is exploring all possible options for Sebree, but declined to comment on Hoerner's statement.

Some North American aluminum makers have found ways to cut costs. In Canada, many plants use cost-effective hydro power. Other producers have contracts in which electricity prices fluctuate with the London Metal Exchange aluminum price. At around $1,960 a tonne, LME aluminum is well below its all-time high of $3,380, hit in 2008, and that, in turn, brings their energy expenses down.

(Editing by Josephine Mason, Nick Zieminski and Jan Paschal)

By Carole Vaporean