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The pricing policy of Landsvirkjun

This article focuses on the pricing policy of the Icelandic national power company Landsvirkjun. Although starting price in recent new contracts seems to have been between 25-35 USD/MWh, we may expect higher tariffs in the future. Due to rising cost of new power plants in Iceland, it seems likely that from now the normal starting price in new electricity contracts will be close to 35 USD/MWh, rising towards 40 USD/MWh.

Wholesale power company

Landsvirkjun produces close to 75% of all electricity generated in Iceland. The company sells most of this electricity directly to four large consumers; three aluminum smelters and one ferro-silicon plant. Landsvirkjun also has contracts with smaller consumers, such as other types of industrial plants and data centers. Finally, substantial part of the generation is sold in wholesale-contracts to other power companies, for resale on the general power market.

“Headline rate of 43 USD/MWh”

According to Landsvirkjun’s website the company is “committed to offering competitive electricity contracts, based on the European electricity market, by offer­ing long-term agree­ments, favour­able prices and an unparalleled security of supply.” Lands­virkj­un has since 2011 offer­ed 12 year power con­tracts with a head­line rate of 43 USD/MWh. Landsvirkjun has also expressed that the company offers electricity-contracts at a fixed real price of 43 USD/MWh, with discounts for selected greenfield projects.

New customers offered starting tariff between 25-35 USD/MWh

These general statements by Landsvirkjun do not make it very clear what tariffs Landsvirkjun offers. We can assume though, that Landsvirkjun aims at a price close to 43 USD/MWh, arguably indexed to inflation within European Union (and/or within United States / Canada, as Landsvirkjun sometimes refers to these countries as their competitive markets). Still, it is somewhat unclear what tariffs new customers may expect from Landsvirkjun.

What we do know, is that new customers of Landsvirkjun are offered power tariffs starting well below the said 43 USD/MWh. We also know that this lower tariff may extend for a period of at least five to seven years, as described in a presentation in 2012 by the current CEO of Landsvirkjun.

So what are the tariffs offered to new customers for the first five to seven years? According to information we have from the data centre services in Iceland, starting price in such contracts seem to be close to or somewhat below 35 USD/MWh. In larger contracts, such as with the new silicon industry in Iceland, Landsvirkjun seems to have been offering a starting tariff below 30 USD/MWh. In general we can assume that recent starting tariff to Landsvirkjun’s new customers has in general been somewhere between 25-35 USD/MWh (the transmission cost is not included).

Tariff in renegotiated large contracts is probably close to 30 USD/MWh

During the last few years Landsvirkjun has renegotiated with two of the aluminum smelters located in Iceland. According to analysis by Askja Energy Partners, the power tariff to the Straumsvík smelter is approaching 35 USD/MWh. Note that the transmission cost is included in this price, which means that the smelter in Straumsvík (Rio Tinto Alcan / ÍSAL) is currently paying Landsvirkjun close to or slightly below 30 USD/MWh (without the transmission cost). This tariff is linked to the US consumer price index  (CPI).

Landsvirkjun’s new tariff negotiated with the aluminum smelter of Norðurál at Grundartangi is set up by a very different method, as it is aligned to market price of electricity on the Nordic power market. The new tariff for Norðurál (Century Aluminum) goes into effect in 2019. When looking at the current monthly market price at the Nord Pool Spot we can assume that from 2019 Norðurál will be paying Landsvirkjun close to 30 USD/MWh when the transmission cost is not taken inro account. Thus it may be fair to say, that Landsvirkjun’s wholesale tariff in renegotiated large contracts is close to 30 USD/MWh.

Tariffs are sometimes linked to product prices

Tariffs in new power contracts by Landsvirkjun are probably in general indexed to price inflation (such as in USA or EU). Also it is likely that the contracts include fixed price increase after five to seven years, resulting in tariffs heading towards 40 USD/MWh (and possibly towards the advertised 43 USD/MWh). This, however, does not apply to renegotiated contracts with heavy industries such as aluminum smelters, where the tariffs are either aligned with the power price on the Nordic market or consumer price index in the USA.

In recent years, the management of Landsvirkjun has repeatedly expressed that the company wants to move away from power contracts having tariff linked to the price of aluminum (or other relevant products such as ferrosilicon). However, it seems clear that Landsvirkjun is sometimes still open to such product-pricing methods. According to information from the EFTA Surveillance Authority (ESA), the new silicon plant of PCC in Iceland seems to have its power price linked to the price of silicon metal.

Strong demand and rising costs of new power plants will push tariffs up

Due to strong demand for electricity, the Icelandic power market is currently a sellers-market. Furthermore, it is hardly possible to construct a new power plant in Iceland unless the electricity can be sold at an average price close to at least 35 USD/MWh. Of course this means that when offering a 12 year contracts, Landsvirkjun may be able to offer lower starting price if the tariff will rise towards 40 USD/MWh after approximately five years or so. But in general we can expect that due to the strong demand for electricity in Iceland and rising cost of new power plants in the country, the general wholesale power prices will in general not be lower than 35 USD/MWh and even soon be heading towards 40 USD/MWh. In fact the general wholesale price for electricity in Iceland in 2016 was close to 38 USD/MWh.

Electricity tariff to Elkem could double

With close to 1,100 GWh annually, the ferro-silicon plant of Elkem in Iceland is the 4th largest power consumer in the country. The power is supplied by the state-owned power firm Landsvirkjun. Elkem is a Norwegian firm, owned by China National Bluestar Group.

Current power contract of Landsvirkjun and Elkem was agreed two decades ago, at times when heavy industries were offered very low tariffs when locating in Iceland (as for example advertised in a brochure from the Icelandic government in 1995; note cover at left). The power contract is valid until 2019. Elkem and Landsvirkjun have still been unable to reach a new agreement, so it is not certain if Elkem will continue its Icelandic operations after 2019.

The most likely scenario seems to be a new contract where the power price will align with the market price on the Nordic electricity market (Elspot on NordPool Spot), as was the result in recent negotiations regarding the Norðurál aluminum smelter owned by Century Aluminum. According to current prices, this would result in approximately doubling of the electricity tariff paid by Elkem in Iceland.

Elkem buys 8% of the energy, but pays only 5% of the revenues

Most of the revenues from the electricity sales of Landsvirkjun are derived from the aluminum smelter of Rio Tinto (ÍSAL) in Straumsvík, which supplies Landsvirkjun with close to 1/3rd of it revenues although the smelter purchases only 1/4th of Landsvirkjun’s production.

The second most important customer of Landsvirkjun is the aluminum smelter of Alcoa, as can be seen on the table at left. When taken together, the other power firms in Iceland and the TSO Landsnet are Landsvirkjun’s third most important customer.

The sales to Elkem alone amount to about 8% of Landsvirkjun’s electricity sales, ie. when based on the amount of electricity. Although this is not a very high percentage of the total electricity generated by Landsvirkjun, it is of course important for the power firm to obtain increased revenues from Elkem, as Elkem now only returns about 5% of the income of the company. Actually the percentage for the net-income is even lower, as the power tariffs to heavy industries include the transmission cost (this part of Landsvirkjun’s revenues is forwarded to the TSO).

Power tariffs not to be lower than in Norway or Canada

Elkem has been paying the lowest electricity price of all the industrial companies in Iceland. The CEO of Landsvirkjun has previously said that the current tariff Elkem pays reflects very different economic environment from now, indicating that a sharp increase in the power price would be absolutely normal. Earlier this month (November 2017), the CEO also pointed out that now “there is no reason why the price of electricity should be lower in Iceland than in the markets of [Canada and Norway].” This is a very clear statement, expressing that Elkem may be able to get a new contract where the power price will be aligned to the market price in Norway or Canada, but not lower tariff than that.

Landsvirkjun probably wants more than 100% price increase

In 2016, Elkem paid Landsvirkjun close to USD 18 million for the electricity (estimates by Askja Energy Partners). In a new contract that would come into effect in 2019, Landsvirkjun is probably aiming for a tariff that would mean extra USD 20 millions added to Elkem’s power bill. The total annual power cost of Elkem would then rise to approximately USD 38 millions (those figures include the transmission cost).

As it is possible and even likely that Elkem’s new tariff will be linked or aligned to the Elspot price on the Nordic power market, the power price would of course fluctuate. The given figure of USD 38 millions assumes that the Elspot price will be close to 30 EUR/MWh. If/when the price will become higher, the tariff of Elkem would rise. Probably the only option for Elkem to receive a more positive tariff for the company in Iceland after 2019, is to expand its operations in the country. For example it will be interesting to see if Elkem offers Landsvirkjun and the Icelandic government to move some of its solar-silicon production from Norway to Iceland.

NB: All figures on revenues in the table above are approximate / rounded. More precise figures are available only to customers of Askja Energy Partners

Electricity statistics update 2016

The Icelandic National Energy Authority (NEA) has published statistics regarding the electricity industry in 2016. You can access the publication in English on NEA’s website (link to the pdf-file). Here are some of the key numbers:

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TOTAL ELECTRICITY GENERATION:          18,549 GWh (2016)

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ELECTRICITY GENERATION SHARE BY SOURCE:

Hydro Power 13,470 GWh          73%
Geothermal Power     5,067 GWh         27%
Other 11 GWh            0%
Total 18,549 GWh        100%

NB: 2016 is the fourth year the NEA publishes data for generated wind power in Iceland. Electricity generated by wind power (9 GWh) and fossil fuels (3 GWh) was to small amount to be measured as a percentage on the scale of the table above. The combined wind- and fossil fuels generation amounted to 12 GWh, which was less than 0.001% of all electricity generated in Iceland in 2016.

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ELECTRICITY POWER CAPACITY:  

Hydro Power  1,988 MW
Geothermal Power     665 MW
Wind Power         3 MW
Fossil Fuels     117 MW
Total Power Capacity 2,773 MW

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ELECTRICITY CONSUMPTION SHARE:

Energy Intensive Industries 77%
General Consumption     18%
Other (losses)     5%
Total 100%

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You will find more Icelandic energy data in our special data-section.

Icelandic wind power becoming highly interesting

So far, less than a handful of modern wind turbines have been constructed in Iceland. It has simply been more economical to harness geothermal- and hydro resources for power generation. This situation may be changing, as it is becoming economically interesting to harness Icelandic wind energy. In this article we take a look at some hydropower projects that are currently being considered in Iceland, comparing them to the cost of utilising wind energy. It turns out that harnessing the Icelandic wind may indeed becoming a very interesting investment.

Astonishing cost decline of wind power

Hreyfiafl-wind-power-cost-development_2009-2017_Lazard-LCOE-version-11

LCOE for onshore wind. Analysis by Lazard.

It has been called “the fastest and most astonishing turnarounds in the history of energy“: In some areas, building and running new renewable energy has become cheaper than just running existing coal and nuclear plants.

As Iceland is or at least has been quite special, by generating all its electricity through harnessing fairly low-cost geothermal- and hydropower sources, one might wonder if the declining cost of wind and solar will have any consequences for the Icelandic power sector? The answer is not very complicated. Due to Iceland’s northerly location, solar power is not becoming a real competitive option in generating electricity in Iceland. On the other hand, Iceland offers numerous locations with very high wind capacity factor. Thus, the declining cost in the wind power industry may soon drive important changes in the Icelandic power sector, where wind farms will become a lucrative business.

Several small [expensive] hydropower plants being prepared

Several small hydroelectric projects (with a capacity below 10 MW) are currently being prepared in Iceland. These include 9.9 MW Brúará hydropower station in South Iceland, 9.8 MW Svartá hydropower station in Northern Iceland, 9.3 MW hydroelectric plant in glacial river Hverfsfljóti in Southwest Iceland, and 5.5 MW Hólsvirkjun hydropower station in Northern Iceland. The combined capacity of these four stations would be close to 35 MW. With an estimated cost well above 3 million USD pr. each megawatt, all those projects will be quite costly and probably more costly than harnessing Icelandic wind energy.

Somewhat larger project is the 55 MW Hvalá River hydropower station, to be constructed in the faraway Northwestern part of Iceland (Vestfirðir or West Fjords). This power plant will be quite costly and the transmission cost will be high, as the project is far away from the current transmission system. However, due to the high reliability of the Hvalá station with its mountain reservoirs, the project can be seen as quite sensible. On the other hand, wind farms may also offer quite strong reliability, such as if constructing three 30-40 MW of wind power in different locations in or close to the West Fjords. By locating the wind farms adjacent or close to the current transmission lines, such a project might be less costly than the somewhat expensive Hvalá hydroelectric station with its high transmission cost.

Icelandic wind power becoming competitive

According to a recent study published by the federation of energy and utility companies in Iceland (Samorka), the levelized cost of energy (LCOE) for upcoming Hvalá River hydropower station is expected to be 49.70 USD/MWh (and then the transmission cost is not included). In comparison, in its most recent “levelized cost of energy analysis” 
(LCOE), financial advisory and asset management firm Lazard now estimates the LCOE for wind farms in good locations in the USA as low as 30 USD/MWh (as explained on the slide at top of the article).

Slide by IIT Comillas and MIT.

It is also interesting that according to a new study by the universities IIT Comillas in Madrid and MIT in Boston, wind farms in Iceland could generate electricity at LCOE close to or even below 35 USD/MWh. This low cost beats all planned geothermal projects in Iceland and is lower cost than most of the hydropower projects under consideration, making the development of wind farms in Iceland highly interesting.

However, it is still interesting to invest in new geothermal- and hydropower plants in Iceland, as they in general offer very reliable power production. Iceland is an isolated power market with no interconnectors to other countries, and thus the country has to rely on domestic access to spare capacity when the wind would not be blowing well enough.

For wind farms to be competitive in Iceland, they need to be cheap enough to make it an interesting option to increasing the output from the robust system of the Icelandic hydro reservoirs (such process of adding new turbines to conventional hydropower stations has already started in Iceland). By such methodology it will be possible to add substantial capacity in the power system without constructing expensive new hydropower reservoirs or geothermal stations. Also, low-cost Icelandic wind power could be harnessed to save water in the current reservoirs, and/or work as pumped hydroelectric storage. Due to such interesting possibilities, it is likely that wind farms will soon be constructed in Iceland even without any connection with foreign power markets. Of course an interconnector like IceLink would make Icelandic wind power even more interesting to harness.

One wind farm instead of four hydroelectric plants?

Earlier we mentioned the four fairly small hydroelectric projects (each below 10 MW) currently being prepared in Iceland. When comparing how much wind power would be needed to offer equal generation as the four hydropower stations, it seems quite clear that harnessing the Icelandic wind would be less costly and have less negative environmental impacts.

The total power capacity of the said four hydropower stations (Brúará, Svartá, Hverfisfljót and Hólsvirkjun) will/would amount to approximately 35 MW. Some of them would have the advantage of offering quite stable generation all year around, while a project like the 9.3 MW Hverfisfljót hydropower station would be harnessing glacial water where the flow in winter is very low. This means that the yearly capacity-factor of the Hverfisfljót station will probably be quite low; even under 50%.

Of course a wind farm would deliver more fluctuating production than the combined four hydropower stations, thus needing more backup power. And in the long run, hydropower is probably almost always the lowest cost option (due to very long life time), at least if the environmental damage by dams and head-race canals of the hydro projects are not taken into account.

It is not simple to estimate how much Icelandic wind power would be needed to generate a similar amount of electricity as the four hydropower stations. Probably a well-located Icelandic wind farm(s) with a capacity of approximately 70-80 MW could generate as much electricity annually as the four hydropower stations of totally 35 MW. The cost of the hydroelectric stations would most likely be close to USD 120 million. The cost of 70-80 MW wind farm in Iceland could be substantially lower; probably below USD 100 million.

When also having regard to the environmental impact, the option of wind power in Iceland becomes even more attractive. Besides the wind farm(s) of 70-80 MW being less costly than the four hydropower stations of 35 MW, the wind farm offers the chance of avoiding severe environmental damages to some of Iceland’s wild and free running rivers. For example in the case of the Hverfisfljót hydropower project, the waterfalls in the river-canyon would become close to dry substantial part of the year. However, the key issue for harnessing Icelandic wind power is the declining cost in wind energy technology. Which now is making wind power a real option in the Icelandic energy sector.

NB: Icelandic wind power development firm Hreyfiafl has same ownership as Askja Energy Partners. Hreyfiafl aims to have its first wind farm in Iceland in operation within five years from now. Icelanders can follow the process through the Twitter-account of Hreyfiafl.

Þeistareykir geothermal station in operation

Iceland’s newest power plant is the 45 MW Þeistareykjavirkjun in Northeast Iceland. The owner and operator of the plant is the Icelandic national power company Landsvirkjun.

The silicon-metal plant of PCC.

The construction of this first phase of the power plant started in the spring of 2015. Most of the generation will be transmitted to a silicon metal plant of PCC. The PCC silicon plant will utilize a total of 52 MW in the start. According to the power contract with Landsvirkjun, PCC will gradually increase its power demand up to 58 MW. Annual energy delivery is expected to start at 456 GWh and then gradually increase to 508 GWh per annum within the next 4 years (article 3 of the power contract).

As the 45 MW phase of the Þeistareykir plant will only generate 360-370 GWh annually, Landsvirkjun must also deliver power from other power plants to PCC. However, Landsvirkjun is already constructing next phase of Þeistareykir, adding another 45 MW. This second phase of the geothermal plant is scheduled to become operational in next April (2018), making the total capacity 90 MW. At this stage, the additional capacity can only be utilised by power consumers in the Northeastern part of Iceland, as the national transmission grid has several bottlenecks.

Þeistareykir geothermal plant.

This most recent geothermal project is believed to be the most economical of all the upcoming geothermal power projects in Iceland. According to information from Landsvirkjun, the cost of this first 45 MW phase is close to USD 200 millions, which accounts for approximately USD 4.5 millions pr. MW. With a second phase, the total cost for the 90 MW plant is expected to be close to USD 330 millions. Then the cost of each MW will be close to USD 3.7 millions.

RTA smelter the most important source of income

In 2010 the power contract of Rio Tinto Alcan and the Icelandic national power company Landsvirkjun, regarding the Straumsvík aluminum smelter, was negotiated. This new contract turned out to be a major step towards increasing profitability in the Icelandic electricity sector. In this article we discuss the importance of the contract from 2010.

Landsvirkjun referred to a paper from CRU

By 2010 there already were three large aluminum smelters in Iceland. The oldest of the three was a plant at Straumsvík in Soutwest Iceland, owned by RTA/ÍSAL. This smelter was originally constructed in the late 1960’s. and until 2010 it had been paying the lowest power tariffs in Iceland.

In preparing for the negotiations for a new power contract, Landsvirkjun commissioned the consultancy company CRU Group to review and assess the existing preliminary agreement with RTA (which had been reached shortly before Iceland’s banking crash in 2008). According to the information provided, CRU established that out of 184 aluminium smelters worldwide, Iceland provided the 14th lowest price and 3rd lowest out of 32 smelters in Europe (as explained in a report by EFTA Surveillance Authority, published in 2011). This meant that of the 184 aluminum plants worldwide, about 170 plants were paying higher power tariffs than the smelters in Iceland!

With regard to this information, the management of Landsvirkjun claimed that the power tariff in a new contract would need to change substantially from the then very low present tariff. This claim was a.o. based on less favourable credit rating of Landsvirkjun (following Iceland’s banking crash in 2008), high cost of capital, limited access to credit, and the considerable increased power price in the US and in Europe in the past years. Furthermore, the management of Landsvirkjun expressed it would be unacceptable risk for the power company to continue having the power price linked to aluminium prices.

The new tariff approaching 35 USD/MWh

The new power contract, which was ready in 2010, introduced a very different criteria for the price of the electricity. According to the old contract the base tariff was extremely low, compared to other similar contracts, and this old tariff was linked to the price of aluminum on the London Metal Exchange (LME). The new contract signed in 2010 had a starting price close to 30 USD/MWh and the tariff changes according to the US Consumer Price Index (CPI). Currently, the tariff to the Straumsvík smelter is now most likely approaching 35 USD/MWh, which is approximately double the tariff according to the old contract. Included in the power price is transmission cost (in Iceland average transmission cost to heavy industries is normally close to 6 USD/MWh).

The new power contract with RTA/ÍSAL will expiry in 2036. According to a special price equilibrium mechanism prescribed in the contract, the power tariff shall be revised once during the contract period (in 2024). This mechanism’s objective shall be “to keep a similar competitive position of the Straumsvík smelter as it was at the time of signing the new power contract” in June 2010. Also, Landsvirkjun is given the opportunity “to ensure that its power remains competitive in line with other energy producers” supplying power to the aluminium industry.

Fundamental difference from other contracts with smelters in Iceland

This new contract between Landsvirkjun and RTA/ÍSAL is the main prerequisite for Landsvirkjun’s positive operating profit in recent years. Now close to 1/3rd of Landsvirkjun’s revenues from electricity sales comes from the RTA/ÍSAL smelter in Straumsvík, while the smelter accounts for only 1/4th of Landsvirkjun’s electricity generation. These figures say a lot about the importance of the contract for Landsvirkjun; note the table below (and also note the graph above showing power tariffs of Landsvirkjun to aluminum smelters 2007-2016).

This proportion (1/3rd of revenues for 1/4th of power) is almost exactly the opposite of what applies to Landsvirkjun’s contract with the aluminum smelter of Alcoa/Fjarðaál in Eastern Iceland. That deal, which is from 2003, returns just 1/4th of Landsvirkjun’s electricity revenues although it accounts for about 1/3rd of all the energy sold by the company. This ratio explains clearly how much higher power tariff is paid by the RTA/ÍSAL smelter than the Alcoa/ Fjarðaál smelter.

The power tariff to the Alcoa/Fjarðaál smelter is linked to price of aluminum. To reach the current power price of the Straumsvík smelter of RTA/ÍSAL, aluminum prices would need to increase to about 2,800 USD/ton. Which is very far from the current price for aluminum, now close to 1,950 USD/ton (while the average price in 2016 was close to 1,600 USD/ton).

It is impossible to say if price of aluminum will ever reach 2,800 USD/ton in the near future. What is clear though, is that Landsvirkjun’s recent contract with RTA/ÍSAL has substantially decreased the risk for the power company and hugely increased its revenues and strengthen its profits and its financial situation. Thus it is no surprise that the contract has been referred to as “a miracle” for Landsvirkjun. For recent information in the media on power tariffs to smelters in Iceland, note this article by Aluminium Insider (“Is Winter Coming for Iceland’s Aluminium Smelters?”)  and this brand new article in the New York Times about electricity cost for smelters in Iceland. More detailed information about electricity prices according to Landsvirkjun’s power contracts, can be obtained from our consultancy services.

Joint statement from UK–Iceland Energy Task Force

In October 2015, the governments of UK and Iceland agreed to create a special Energy Task Force to look at the benefits of a subsea interconnector between the two countries. The project is referred to as IceLink.

Following their work, the energy task force issued a statement on 12th July 2016, stating that their work was concluded and they would leave the decision to continue the work of the energy task force with their respective governments. The text of the statement (unsigned) can also be seen on the website of the Icelandic government. The title of the statement is “Joint statement from UK – Iceland energy task force“, and it reads as follows.

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The idea of an electricity interconnector between the UK and Iceland has been explored on various occasions in recent years. At a meeting between Prime Minister David Cameron and Prime Minister Sigmundur Davíð Gunnlaugsson in Reykjavík on 28 October 2015 it was agreed to explore further the possibility of an interconnector with initial discussions between the two Governments which should be concluded within six months.

Subsequently, a UK – Iceland Energy Task Force was established to carry out the discussions. The Task Force agreed that the discussions should be an early stage exploration of the issues which will inform decisions by Ministers on the extent of further work. The proposed areas for discussion between the two Governments were identified as interconnector models, regulatory treatment, financing and general impact assessment.

The objective of the UK – Iceland Energy Task Force was to consider whether further investigation of an interconnector between the UK and Iceland might have merit through identifying common ground between the two parties. It was a mutual understanding between the parties that the Task Force should conclude its work in May 2016.

Over the course of recent months, the two parties exchanged information on work already conducted, or in progress, concerning a possible interconnector between Iceland and the UK. The UK gave presentations on the UK electricity system, UK energy policy, interconnector projects, interconnector regulatory approaches and renewable support mechanisms. Iceland presented an overview of the work streams being carried out in relation to an interconnector and an overview of the Icelandic energy sector and energy policy, along with other issues related to the concept of an interconnector.

A large part of the discussions within the Task Force was on project economics, regulatory treatment and general impact assessment. Iceland presented a recent Cost Benefit Analysis and Impact Assessment, that they had commissioned on their own behalf, on an interconnector between Iceland and the UK. The UK delegation provided valuable feedback and comments on this report.

The Task Force discussed the potential mutual economic benefit for both parties in the project and the eligibility of support schemes. The Task Force acknowledged that a renewable export business model, with an appropriate support mechanism, could provide a viable business case and be compatible with a competitive market for low carbon electricity production. The interconnector‘s project costs could also be subject to an element of competition.

The Task Force acknowledged that the UK – Iceland interconnector concept is in many aspects different from other interconnector projects and that revised regulatory models may need to be considered as part of a further phase of work.

The Task Force agreed that a decision on whether to undertake a second phase of work is outside the scope of the Task Force. However, if a decision is taken to continue with a second phase of work, this could include further government-to-government discussions and investigation into regulatory approaches, revised regulatory models and a possible joint cost-benefit analysis to better understand the project economics and assumptions.

The Task Force is of the opinion that the work conducted in the last six months achieves the mandate of the group and should provide valuable information in order to assist in any decision making on the next steps of the potential UK – Iceland interconnector.

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NB: Iceland had general elections in October 2016, and now the country has a new government. Since then, there have been no formal talks between the governments of Iceland and UK on the IceLink cable project. This is not surprising as it is unclear what will be the energy policy of the UK after the Brexit.

Alcoa’s tariff in Iceland renegotiated before 2028

The heady days of cheap power prices in Iceland may be nearing an end. With 4,600 GWh annual consumption the Fjarðaál aluminum smelter of Alcoa in Iceland is the largest electricity consumer in the country. The smelter has been enjoying one of the lowest power tariff to aluminum smelters worldwide. However, there are indications that the Icelandic national power company Landsvirkjun and Alcoa will renegotiate the power price no later than 2028. The result is likely to be a significantly higher tariff and a major increase in Landsvirkjun’s revenues and profits after 2028.

One-third of Landsvirkjun’s power generation

For Landsvirkjun the power contract with Alcoa is of major importance. This one contract covers about 1/3 of all the electricity Landsvirkjun generates and about 1/4 of all the power generation in Iceland. This one contract has a fundamental impact on the profitability of Landsvirkjun and thus a major impact on average returns in the Icelandic electricity industry.

Construction of the Kárahnjúkar dam.

The power contract of Alcoa and Landsvirkjun was signed in early 2003, the contract period being 40 years from the first delivery of power. To supply the power, Landsvirkjun constructed the largest hydropower station in Europe (Russia and other former republics of the USSR excluded). The Alcoa smelter in Iceland began operating in mid-2007, reaching full capacity some months later. The power contract covers the period until 2048.

It is known that the power contract includes provisions offering the option of revising the power tariff as early as 2028. When having regard to recent development of power prices to aluminum smelters in Iceland, there is a reason to expect that the power tariff to Alcoa in Iceland will increase dramatically already in 2028.

Development of electricity tariffs might justify huge price increase

The power contract between Alcoa and Landsvirkjun is confidential, but documents from the Icelandic Parliament (Alþingi) have shown that 18 years after Landsvirkjun started the energy supply to the Alcoa smelter, the contracting parties shall negotiate a revised energy tariff. The new tariff shall be decided according to market development and shall be in force the second 20 years of the power contract (2028-2048).

Only Landsvirkjun and Alcoa know how much scope the contract offers in changing (raising) the electricity price. What seems to be the ruling factor regarding this, is how the electricity market will evolve during the period from 2003. Having in mind the recent development of power tariffs to aluminum smelters in Iceland, it seems possible that no later than 2028 the price of electricity to Fjarðaál may more than double from the current tariff.

Such a price increase would have enormous positive impact on the overall profitability of Landsvirkjun. This scenario is, however, subject to various conditions and such a sharp price increase may not go through if aluminum prices will be very low.

The Icelandic electricity market is changing

Few years ago new competition arrangement was introduced in the Icelandic power market. The new legislation meant a major structural change, making the power market focused on financial sustainability (profits) rather than politics, i.e. now each power contract with heavy industries like aluminum smelters must fulfil minimum conditions of financial return. Otherwise the contract may be invalid due to illegal state support.

Possible development of Icelandic power tariffs.

Because of these structural changes, power tariffs in new contracts in Iceland have been rising substantially. Older contracts like the one between Landsvirkjun and Alcoa, ensure the smelter almost risk-free tariff while the power company bears most of the risk.

To give a clear example, we can refer to the current power price Alcoa is paying to Landsvirkjun and compare that price to more recent contracts Landsvirkjun has negotiated with two other aluminum smelters; those of Rio Tinto Alcan (Straumsvík smelter) and Century Aluminum (Norðurál smelter). During 2016, the average power tariff to the Alcoa smelter was close to 20 USD/MWh (the tariff is linked to the price of aluminum at the LME). At the same time the Straumsvík smelter of RTA was paying Landsvirkjun close to 34 USD/MWh, according to a new contract from 2010 where the tariff is fixed and  linked to US consumer price index; CPI.

The smelter of Century Aluminum in Iceland (Norðurál) pays Landsvirkjun according to an old contract from 1999, where the tariff is extremely low. During 2016, Century and Landsvirkjun renegotiated the pricing method. From 2019, the power tariff to Century will be closely aligned with the power price at the Nordic power market (Elspot at Nord Pool Spot; NPS) . Of course nobody knows for sure what the power price will be at the NPS in 2019, but Landsvirkjun is obviously aiming for moving the Icelandic power market towards the power markets in Northwestern Europe. Which would result in very interesting changes for electricity generating companies in Iceland. We at the Icelandic and Northern Energy Portal, will soon be writing more about the opportunities these changes will create for Icelandic power companies. Stay tuned.

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NB: The power tariffs to aluminum smelters quoted in this article are based on research by Askja Energy Partners Ltd. The figures given in the article are not exact and they are based on several assumptions we do not guarantee to be correct. However, we are of the opinion that the mentioned tariffs are very close to the real negotiated tariffs.

Study on energy security in Iceland

The universities IIT Comillas in Madrid and MIT in Boston have completed a research project on the mechanisms of the Icelandic electricity sector. The project was managed by Mr. Ignacio J. Perez-Arriaga, pro­fess­or at MIT.

The project was twofold. Firstly, the current electricity market regime was examined and suggestions made for improvement. Secondly, a simulation of future operation of the power system was conducted, in which a number of scenarios were evaluated in terms of cost and energy security.

Although it was concluded that the operation of the Icelandic transmission system is in many aspects very good, there are certain things that need to be taken into consideration (as explained in Icelandic on the website of the national power company Landsvirkjun):

  1. There is a lack of clear legislation on acceptable norms in terms of energy security. Also, the legislation needs to be clearer on which agency/department is responsible for how to achieve such criteria for energy security, and what tools the responsible party should have to ensure the criteria can be achieved.
  2. Public energy security is not sufficiently guaranteed by the existing power trading system. In their report, the researchers propose how to improve this situation.
  3. Further delays in strengthening the Icelandic transmission system will make energy security in Iceland unsafe. Thera are bottlenecks in the system between regions. Those bottlenecks may contribute to a local energy shortage. The south-west corner of Iceland is at the greatest risk for such shortages. There are different ways to strengthen the transmission and each of them has its advantages and disadvantages.
  4. Wind power is likely to be a competitive alternative to hydropower and geothermal energy, in order to ensure sufficient supply. Opportunities may also be found in negotiating increased flexibility in delivering power to energy intensive industries.
  5. A submarine power cable between Iceland and Europe would better ensure the energy security in Iceland. To make such a project economical, financial assistance would be needed from outside Iceland [for example in the form of similar framework as the British Contracts for Difference; CfD].

This project by IIT Comillas /MIT was funded by the Icelandic National Energy Authority (NEA), the Icelandic TSO Landsnet, and the national power company Landsvirkjun. Presentations from the project can be found on the website of the NEA.

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Prof. Pérez-Arriaga, who was head of this research project on energy security in Iceland, has been a consultant for governmental agencies or electric utilities in more than 30 countries. Prof. Pérez-Arriaga is a member of the Spanish National Academy of Engineering and a Life Fellow of the IEEE. He has published more than 200 papers, been principal investigator in more than 75 research projects and supervised more than 30 doctoral theses on the aforementioned topics. He is a permanent visiting professor at MIT (2008-present) in the Center for Energy and Environmental Policy Research (CEEPR), where he teaches a graduate course on power system regulation, engineering and economics. He was a review editor of the 5th Assessment Report of the Intergovernmental Panel on Climate Change (IPCC).

It should be noted that in October 2015, Mr. Pérez-Arriaga gave a lecture on “the challenge of Energy Security Supply in Iceland”, at the Reykjavík University Arctic Workshop. In his presentation Mr. Pérez-Arriaga referred numerous times to graphs and data from the Icelandic and Northern Energy Portal / Askja Energy Partners, which of course is the main source on Icelandic energy issues. Video recording of the lecture can be seen on Livestream (the presentation starts at 19m:30s, right after an introduction by the President of Iceland).

Rising power prices in Iceland

Electricity demand in Iceland is growing and most of the low-cost options in the geothermal- and hydropower sectors have already been harnessed. Thus, it is not surprising that wholesale electricity prices on the Icelandic power market have been rising. What is no less important for the Icelandic power sector, are the rising tariffs in special contracts with heavy industries in Iceland.

Heavy industries, like aluminum smelting, ferrosilicon production etc., consume close to 80% of all electricity generated in Iceland. The older power contracts with heavy industries offer the industrial companies the electricity at very low price. The chart at left shows the industrial tariffs in Iceland in 2016 (average tariff through the year). Note that the tariffs shown include transmission cost. The most recent contract is of course the one with the RTA smelter, while the oldest contracts with Elkem and Century Aluminum where negotiated two decades ago.

It is likely that the average general industrial tariff in Iceland will rise in the coming years. Icelandic power firms are already in the process of increasing price of electricity to industries in Iceland. The contract between the national power company Landsvirkjun and the RTA smelter at Straumsvík in 2010 was the first real step in this development. In 2010, the tariff to RTA increased substantially and is no longer linked to price development of aluminum. Instead it aligns with the US Consumer Price Index (CPI).

Another important step in increasing revenues from electricity sales to heavy industries in Iceland was taken in 2016, with a new power contract of Landsvirkjun and the Norðurál smelter of Century Aluminum. This new contract will become effective in 2019. From then, the tariff to Norðurál will become aligned with spot price on the Nordic power market (Elspot on Nord Pool Spot). Landsvirkjun is also re-negotiating the power tariff with the ferrosilicon plant of Elkem, which has been paying very low price for the electricity. The expected power price Century and Elkem will be paying according to the new contracts are shown by the arrows on the graph below. However, note that negotiations between Landsvirkjun and Elkem are still ongoing and it is of course possible no agreement will be reached (and then Landsvirkjun would probably be selling the power to other interested companies).

More steps towards rising average power price in Iceland will be taken after 2020, when several old contracts with heavy industries will run out. This applies to a couple of contracts Reykjavík Energy and HS Orka have with the Norðurál smelter (owned by Century Aluminum). This development towards higher power tariffs will probably also affect a very large power contract Landsvirkjun has with the Alcoa aluminum smelter of Fjarðaál, where the tariff is to be re-negotiated no later than 2028 (as can be seen highlighted on the graph at left).

Due to the new contract with RTA in 2010 and some other recent contracts with other smaller power intensive firms in Iceland, the average power tariff in new contracts with heavy industries in Iceland is already rising. This development can be expected to continue, resulting in a general power price to heavy industries in Iceland moving towards approximately 30-35 USD/MWh when transmission cost not included; close to 35-40 USD with the transmission cost. This is shown by the lower green limit on the graph above. Other large customers, i.e. less power-intensive industries and services such as large data centers, will also be experiencing rising tariffs; probably around 40 USD/MWh when transmission cost is not included and close to 45 USD/MWh with transmission cost, as shown by the higher green limit on the graph above.

The development so far is already a clear sign of rising power prices in Iceland. The rising tariffs reflect the necessity to increase return on capital invested in Icelandic power production, which so far has in general been very low, as explained in a recent report by Copenhagen Economics (the slide at left is from a presentation by Copenhagen Economics). Also, rising levelized cost of energy (LCOE) for new power plants in Iceland will push the electricity tariffs up. So rising power prices in Iceland can in fact be explained with simple economics.