Why it may not be 'all or nothing' for the Tiwai aluminium smelter

Thursday, 31 October 2019

NZAS chief executive Stewart Hamilton makes the case for intervention to save the aluminium smelter in October.

Kiwis appear divided on whether the Government should step in to 'save' the Tiwai aluminium smelter near Bluff.

The smelter directly employed 793 Southlanders at the end of last year and received a $30 million taxpayer bail-out from the National government in 2013 to keep it open until at least 2017.

But Rio Tinto, which owns 80 per cent of the smelter, is once again cap in hand.

It is reviewing the future of the smelter, arguing it needs cheaper electricity to avoid a full or partial closure, with a decision expected by March.

**READ MORE:

The price the smelter pays for electricity is partly tied to the world price for aluminium.

* Rio Tinto's Tiwai Point aluminium smelter - should it stay or should it go?

* Bluff aluminium smelter could close taking power prices tumbling

* Green credentials, market opportunities highlighted as PM reopens Tiwai potline**

Some of the aluminium the smelter produces is unusually pure and commands a premium on world markets.

What does the smelter do?

It takes aluminium oxide (alumina) imported from Australia and smelts it into aluminium, about a quarter of which is highly pure and commands a price premium on world markets.

The smelter produces about 340,000 tons of aluminium annually, almost all of which is exported, mostly to Japan.

It consumes about 13 per cent of the country's electricity supply, with contracts in place to buy 622 megawatts of power from Meridian Energy, most of which comes from its Manapōuri hydro scheme in Fiordland.

Doesn't it already get a sweet deal for electricity?

Yes, but not as sweet a deal as is common overseas, it says.

The smelter is believed to pay about $55 a megawatt-hour (MWh) for the latest 50MW of electricity it contracted from Meridian last year, which is about a quarter of the price Meridian charges consumers for power.

It is believed to pay about the same, but perhaps a bit less, for the remaining 572MW it has contracted from Meridian.

The price of electricity under that main contract is based on a complex formula that is tied in part to the world price of aluminium – so if aluminium prices fall, the smelter pay less for electricity, and if they rise it pays more.

Its other costs look set to go down.

The price NZAS pays for electricity transmission will fall by $10m a year, next year, and may drop by a further $12m annually from 2024 as a result of regulatory changes.

But the latter drop is not as large as had been dangled in front of NZAS, which may explain its current tough talk.

Rio Tinto spokeswoman Jennifer Nolan says about 90 per cent of smelters around the world, outside China, get electricity at a cheaper price than Tiwai.

But data subsequently supplied by the company suggests that figure only relates to the price paid by smelters for hydro electricity, and not all power.

Craig Stent, head of equities at Harbour Asset Management, believes it wants to slice $10 to $12 a MWh off its costs.

Has the smelter been losing money?

The short answer seems to be 'no', or not up to this year at least.

Prime Minister Jacinda Ardern at the official re-opening of Potline 4 at Tiwai Point Aluminium smelter, Southland.

New Zealand Aluminium Smelters (NZAS) reported a thumping $220 million profit last year, but a $175m loss the year before.

The volatility appears to reflect the complex way the smelter accounts for its electricity costs under its long term contracts with Meridian.

In 2016 it reported a profit of $47m, and in 2015 a profit of $73m.

Rio Tinto says a better measure of smelter's true financial performance is the 'underlying profit' of its Pacific Aluminium subsidiary.

That was $22m last year – down from $75m the year prior (and $54m and $56m in the years before that).

Those figures will understate the smelter's performance because 20 per cent of NZAS' profits go to its other part-owner, Japan's Sumitomo Chemical Company.

That doesn't sound too bad, does it?

Well, no. The price of aluminium has fallen to about US$1750 (NZ$2780) a ton this year, down from an average price of US$2108 last year.

But prices in the two years' prior were lower at, US$1604 and US$1655 a ton.

The bottom line may be that Rio Tinto hasn't yet given politicians the ammunition they might need to sell a case for a hand-out or cheaper electricity to a pretty sceptical public – certainly not for any long-term intervention, at least.

Transpower estimates it would cost about $560m to fully 'rebalance' the grid to take advantage of any generation freed up from Manapōuri.

Is the smelter facing some big new costs, perhaps?

It seems not. An upgrade is needed to the electricity switching equipment at one of its four potlines, potline 1, which Meridian believes will cost NZAS $60 million (more on that later).

In the longer term, bigger investments may be required to keep the smelter open beyond 2030.

But there doesn't seem to be a 'crunch point' looming in terms of capital expenditure.

Deputy Prime Minister Winston Peters has suggested 'fresh eyes' may be required.

NZAS estimates it would have to spend $256m to close and clean up the smelter site if it shut down tomorrow, so there would be costs either way.

So is the closure threat a bluff then?

Who could tell?

The 'market' seems to think Rio Tinto could be for real.

The value of electricity companies, including Meridian, plummeted by more than $2 billion in the hours following the announcement of its review of the smelter, as investors worried that would flood the market with cheap electricity.

'There will be no more financial assistance from taxpayers for Rio Tinto,' Energy Minister Megan Woods says.

Meridian Energy chief executive Neal Barclay said he thought the review was a 'serious move', but added that closing it would be a 'massive call', particularly given the clean-up costs.

Would electricity get cheaper for me if the smelter does close?

Probably, but not immediately.

National grid operator Transpower estimates it would take 'three summers' and cost $110m to build the transmission infrastructure that would be needed to ensure the power freed-up from the Manapōuri hydro scheme could be delivered to customers across the South Island.

It estimates it would take five to eight years and another $450m to fully 're-balance' the grid so the surplus power could be efficiently distributed across the whole country.

That raises the prospect that it could be logical for Meridian to cut a cheaper short-term deal for electricity for the smelter, so it could stay open for a few years longer, while Transpower built the infrastructure needed to send power from the Manapōuri scheme north.

Partially closing the Tiwai smelter appears to be an option, though Rio Tinto says that would still require a fresh break on electricity prices.

That might also give the Government time to work on options to lessen the impact of the closure on jobs in Southland.

Is it 'all or nothing' for the smelter?

The smelter directly employed 793 workers at the end of last year.

By no means. In fact, a partial closure may be the most likely outcome.

NZAS doesn't buy all its electricity at the same price and Rio Tinto has raised the prospect that it could scale back its operations by relinquishing 172MW of the electricity it has contracted from Meridian.

That might see it close potline 1, thereby also avoiding the $60m it would otherwise need to invest to keep that line open.

Nolan says the smelter would still need cheaper electricity to make a partial closure viable, but that may be a 'bluff' that ministers and Meridian are prepared to call.

Rio Tinto won't speculate on how many jobs might be lost in the partial-closure scenario.

'We can't anticipate what this would look like this early in the strategic review process, but obviously jobs would be affected,' Nolan says.

What is the Government likely to do?

Deputy Prime Minister Winston Peters has made comments that could be interpreted as being sympathetic to the case for government intervention, but Energy Minister Megan Woods has so far been quite staunch.

The fact that Rio Tinto is publicly threatening to close the smelter suggests that any initial appeals that were previously made behind closed doors for long-term assistance have come to naught – and it would be naive to think there might not have been such discussions.

Are there other ways the electricity could instead be consumed locally, in Southland?

Maybe, with 172MW perhaps being a more manageable surplus than 622MW.

Meridian Energy spokeswoman Claire Shaw said it was 'well-documented' the dairy industry used coal boilers in the South Island to dry milk into milk powder.

Those boilers could be replaced with electric boilers to cut greenhouse gas emissions.

'Earlier this year Synlait commissioned its first electrode boiler at its Dunsandel site,' she notes.

Woods has been upbeat about the prospect of New Zealand using renewable energy to derive hydrogen from water, which could then be exported to power fuel cells.

But neither the electrification of process heat, nor a 'green hydrogen' industry, might give the best 'bang-for-the-megawatt' when it comes to creating local jobs.

There may be other options.

The uptake of electric vehicles, which require far fewer components than conventional cars, is changing the economics of car manufacturing, for example, raising the prospect that car assembly could come back to New Zealand.

Perhaps the region that schooled Burt Munro, the creator of the 'world's fastest Indian', and Rocket Lab founder Peter Beck, the entrepeneur that got New Zealand into the space industry could pull another rabbit out of the hat.