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.

———————————-

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.