Posts from the ‘Aluminum Industry’ Category

Higher electricity tariffs for smelters in 2017

The Icelandic national power company Landsvirkjun supplies three aluminum smelters with power. The graph below shows how the electricity tariffs in this business have developed in the past ten years. As clearly can be seen on the graph, the electricity tariffs paid by the three smelters were somewhat higher in 2017 than the year before.

The main explanation for the higher tariffs in 2017 is the rising price of aluminum. Two of the three smelters buying electricity from Landsvirkjun have their power tariff linked to the price of aluminum at the London Metal Exchange (LME), while the tariff to the third smelter (Rio Tinto / ÍSAL) is linked to US consumer price index (CPI).

In 2017, as ever since the re-negotiation of 2010, the aluminum plant of Rio Tinto (ÍSAL) in Straumsvík paid the highest power tariff. The lowest price was paid by the smelter of Century Aluminum (Norðurál), while the smelter of Alcoa (Fjarðaál) paid slightly higher tariff than Century.

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 14^th lowest price and 3^rd 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 1/3^rd of Landsvirkjun’s revenues from electricity sales comes from the RTA/ÍSAL smelter in Straumsvík, while the smelter accounts for only 1/4^th 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 (1/3^rd of revenues for 1/4^th 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 1/4^th of Landsvirkjun’s electricity revenues although it accounts for about 1/3^rd 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.

Power tariffs to the Century smelter at Grundartangi

The Norðurál smelter of Century Aluminum, at Grundartangi in Southwest Iceland, enjoys the lowest electricity tariff to aluminum smelters in Iceland. The only company in Iceland paying lower electricity tariff, is the ferrosilicon plant of Elkem, also located at Grundartangi.

All the three largest power companies in Iceland supply the Grundartangi aluminum smelter with electricity. The pricing arrangements in all the contracts are quite similar. All the contracts have the power tariff aligned to the price of aluminum on the London Metal Exchange (LME). In 2016, all the three power companies selling electricity to the Norðurál smelter where receiving an average price close to 20 USD/MWh (as shown on the graph at left). Note that transmission cost is included in the price shown on this graph.

For comparison, the graph also shows the power price from Landsvirkjun (LV) to the ÍSAL smelter of Rio Tinto Alcan (RTA) at Straumsvík in Southwestern Iceland. Of all the three aluminum smelters in Iceland, the Straumsvík smelter pays the highest electricity tariff. Which is not surprising, as the Straumsvík smelter has the most recent power contract. More information about recent power contracts with aluminum smelters can be seen here.

Most of the power consumed by the Norðurál smelter is generated by Reykjavík Energy, utilizing geothermal sources  (unfortunately Reykjavík Energy has been faced with major difficulties in sustaining its geothermal power production). Reykjavík Energy is called Orka náttúrunnar (ON) in Icelandic. It is a subsidiary of Orkuveita Reykjavíkur (OR), which is mostly owned by the city of Reykjavík.

The second largest power supplier to the Norðurál smelter is the national power company Landsvirkjun. Landsvirkjun generates most of its electricity in hydropower stations. In 2016, the company concluded a new agreement with Norðurál/Century, which will change the pricing method (the new agreement goes into force in 2019).

The third company selling power to the Norðurál smelter is the privately owned HS Orka, where Canadian Alterra Power is the major shareholder. Like Reykjavík Energy, HS Orka mostly relies on geothermal sources for its power generation.

As mentioned above, the cost of transmission is included in the power prices on the graph above. Each of the three power companies has to pay the transmission cost forward to the Icelandic Transmission System Operator (TSO), which is Landsnet. The graph at left should make it more clear what amount (price) the power companies are receiving for each megawatt-hour (MWh) of electricity sold. On this graph, we highlight the part of the tariff that is the transmission cost (the grey part of the columns). Finally, note that readers should presume a confidence interval (uncertainty limits) of 5% regarding the Landsvirkjun-tariffs presented, and a 10% confidence interval regarding tariffs from Reykjavík Energy and HS Orka.

New power tariffs to Aluminum smelters

As we explained in a recent article, the Icelandic national power company Landsvirkjun has signed a new contract with the Century Aluminum smelter in Iceland (Norðurál). In this article we will compare the power tariff in this new contract with three other recent power agreements with smelters in Iceland and Canada.

In our comparison we analysed information about four recent power contracts. They are, in addition to the new Norðurál-contract, a contract between Landsvirkjun and ISAL/RTA regarding the smelter at Straumsvík in Southwestern Iceland, a contract between Hydro Québec and Alcoa/RTA regarding the Bécancour smelter in Québec in Canada, and finally a contract between Hydro Québec and Aluminerie Alouette regarding the Sept-Iles smelter, also in Québec. These four contracts were concluded in the period 2010-2016 and they came / will come into force in the period 2010-2019 (as shown on the graph below).

Each of the four contracts are different from the others. Both of the Canadian contracts are long-term and the price of the electricity in both of them is linked to the price-development of aluminum at the London Metal Exchange (LME). However, these two Canadian contracts are based on different prerequisites, as one of them (the Aluminerie Alouette contract) involves an obligation for conducting an engineering study for a potential later expansion of the smelter.

The two Icelandic contracts do not include any price-link with aluminum. The contract with ISAL/RTA from 2010 has a fixed starting tariff, linked to US consumer price index (CPI). The tariff in the more recent contract with Century’s Norðurál is linked to power price at the Nordic power market (Elspot on Nord Pool Spot; NPS).

The contract with ISAL, which was concluded and came into force in 2010, is a long-term contract of 25 years. The contract with Norðurál, agreed in 2016, will come into force in 2019 and only has a duration of four years. The contracting parties, Landsvirkjun and Norðurál, have offered no explanation about why the time-period of the new contract is so short, but an obvious reason is the new tariff being strongly aligned with spot market price of electricity on NPS (as explained in our last post).

The graph at left shows a.o. the approximate average tariff to the Straumsvík smelter of ISAL/RTA in 2016 (the tariff can be expected to rise steadily, as it is linked to the US CPI). The power price paid by Bécancour and Alouette depend on the development of aluminum price, and the blue columns reflect the average base-tariff for these two Canadian smelters in 2016 (when average aluminum price was close to 1,600 USD/ton). The light-blue part of the tariff shows how the Canadian tariff will rise if/when aluminum price becomes 1,900 USD/ton, as recently happened.

We should add that when there is a premium paid for aluminum, as has been the norm most of the time in recent years, the Canadian tariffs will increase, according to a certain formula in the two contracts. Note that the Canadian tariffs shown on the graph are as when the premium is zero. If/when there will be a premium, the power tariffs to the said Canadian smelters will be somewhat higher.

Due to limited information, it is still not possible to claim with precision what is the new base-tariff for the Norðurál smelter at Grundartangi in Iceland (which goes into force in 2019). We do, however, know that the new tariff will be linked or aligned to the electricity price on NPS. EFTA Surveillance Authority (ESA) has stated that “Norðurál’s payments to Landsvirkjun for the electricity each month will be tied to the market price for power in the Nordpool Elspot power market (Elspot System Price reference used)“. ESA also says that “pricing mechanism and the risk associated with using the Nordpool Elspot power prices is […] in line with standard commercial practices of competing power companies in the Nordic countries”, and that the “alignment […] with the Nordpool power prices, allows Landsvirkjun to sell power at the same prices as competing companies in the Nordic countries.”

With regard to the above mentioned statements by ESA, we can assume that the new tariff to the Norðurál smelter will be similar or even the same as the tariff paid by industries in the Nordic market. Furthermore, the statements by ESA strongly imply that the new base-tariff to Norðurál is actually the same as the spot price for electricity on NPS (or at least very close to the spot price). Thus, the new tariff to Norðurál shown on the graph above is the same as the average spot price on NPS in 2016 (Elspot) – with certain part of the transmission cost added (the part of the transmission cost which is not included in the Elspot-price).

Of course it is possible that the new base-tariff for Norðurál from 2019 may be somewhat lower than the full Elspot-price, as power companies on the Nordic power market may sometimes offer its largest customers a discount from the spot-price on NPS. However, when having regard to the statements of ESA, and with regard to Landsvirkjun’s tariffs to ISAL/RTA, it seems unlikely that the new contract will be offering Norðurál large discount from the Elspot-price.

Finally, note that the assumed new tariff to Norðurál shown on the graph(s) includes the transmission cost that the aluminum firm has to pay to the Icelandic TSO; Landsnet. And note also that Norðurál will continue to pay its current very low tariff to Landsvirkjun until 2019 (when the new power contract enters into force).

The power tariff Norðurál is currently paying Landsvirkjun happens to be one of the lowest electricity price enjoyed by any of the world’s two hundred-plus aluminum smelters (Norðurál also buys substantial amount of electricity from two other Icelandic power firms, where the average price is only slightly higher than the tariff it pays to Landsvirkjun). Last year (2016), the average price Norðurál paid for the electricity from Landsvirkjun was well below 20 USD/MWh (transmission cost included), as shown on the graph at left (the red column). So it is obvious that the new contract, coming into force in 2019, will increase Landsvirkjun’s revenues substantially – unless we will experience extremely low prices for electricity on the Nordic Elspot power market during 2019-2023.