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.