Unless you ride a horse to work and detest baked potatoes, chances are great that you come into contact with aluminum on a regular basis. If we follow the adage to invest in something we know, then aluminum could fit the bill for many a Fool. However, while we may be familiar with many of the metal's applications, the industry has been anything but easy-to-follow lately. Let's take a few moments to make some sense of it all.

Demand is hotter than a smelter
As recently as April, aluminum giant Alcoa (NYSE:AA) forecast growth in global demand of 8.5% in 2008, well above the average 6% growth rate for the previous 10-year period. Led by an anticipated 24% surge in China, this overall global growth stands in stark contrast to the declining demand seen for the U.S. and Europe. However ...

Global production is getting crushed like a can
The number of supply disruptions recently reported has been daunting:

  • Last week, Aluminum Corporation of China (NYSE:ACH), a.k.a. Chalco, warned of a heavy decline in first-half earnings for 2008 versus 2007, revealing that production was significantly affected by severe snowstorms in China this past January.
  • At least two aluminum smelters in China's Sichuan province experienced production disruptions related to the May 12 earthquake.
  • Recent fires and explosions halted natural gas output at Apache's (NYSE:APA) gas facility in Western Australia, affecting production at Alcoa's complex of three refineries there. As a result, Alcoa has invoked a force majeure for supply contracts there. Apache estimates that full capacity will not return until December.

These are disconcerting events, because China and Australia collectively account for about half the world's production of alumina (the material that smelters convert to aluminum metal), with about 15% of the world's total coming from Alcoa's Australian operations alone.

If that's not enough for you, here's some more bad news:

  • Kaiser Aluminum (NASDAQ:KALU) reported a fire at its smelter in Wales, reducing operations to 1/3 capacity at present
  • Both Rio Tinto (NYSE:RTP) and Swiss producer Glencore cited energy costs in recent production cutbacks.
  • Supply shortfalls from a dedicated power unit adjacent to Alcoa's Rockland, Texas facility have prompted the company to cut its normal production output by half.

And last but not least, power supply shortages that plagued South African gold miners earlier this year did not spare aluminum production, either. BHP Billiton (NYSE:BHP) operates two aluminum smelters in South Africa. Worse yet, its alumina operations in Western Australia were also affected by the Apache incident.

How are the stocks looking?
When Fools consider all these production disruptions at once, a very clear picture emerges of a serious supply shortfall in the making. According to John Mothersole, senior economist at Global Insight, the "global surplus has now basically evaporated." At about $1.43 per pound, aluminum prices have risen roughly 30% since January, but they're only about 15% higher than prices for this time last year.

At this point, I believe we have not begun to see the full price impacts from the still-emerging picture of a production shortfall. Add in the rampant increases in production costs -- energy makes up a huge percentage of the cost of aluminum production -- and I see a long-term trend of much higher aluminum prices taking shape. There appear to be many parallels to what we observed within the steel industry, but the aluminum story is still developing, which could present some timely opportunities for Fool who arrive early.

Conservative Fools might consider sticking with diversified material producers like Rio Tinto and BHP Billiton, because they will benefit from any aluminum upside without the fear of major impacts to the overall bottom line from production disruptions.

For pure aluminum plays, I believe Alcoa will be a very attractive option for investors, but not quite yet. Shares appear elevated somewhat from speculation about a possible bid from Brazil's Vale (NYSE:RIO). However, I anticipate at least some short-lived punishment of Alcoa shares, once the full measure of the production disruptions and cost increases is understood.

My top long-term pick in the sector, however, is Chalco. Although China's recent move to raise energy prices cuts into the competitive advantage that previous controls had provided, the move is a prudent one for China. Chalco retains one other crucial advantage over the competition: It's in China.

With 24% growth coming from the domestic market, Chalco has incredible pricing power, because its shipping costs are vastly lower than competitors' costs when shipping to China. Shares may struggle a bit more as the country rebuilds from the spate of natural disasters, and profits may disappoint in the short term, but I view any such weakness as a Foolish buying opportunity.