Patrick Smellie reports in the NBR that Meridian are unlikely to reach an agreement with Rio Tinto on renegotiating the 18 year electricity supply agreement for Tiwai aluminium smelter.
I guess it’s time I should weigh in, and support Meridian in standing firm. I’ve helped lead a turnaround of an aluminium smelter or two, and have seen the impacts of poorly constructed electricity agreements. I’m also the founder of PowerKiwi, and we market electricity on Meridian owned Powershop – but I don’t see that as very relevant here.
Rio signed the long term contract in 2007, and it started this year, with Rio locked into the first 3 years. But already Rio want to renegotiate. The implied or expressed threat that Meridian either renegotiates the price down or Rio will close the plant. Add in the fact that Meridian is owned by the Government, and that Rio closing would cause job loses, then we’d expect Rio to have the upper hand.
Aluminium smelters are basically a way to export electricity, but the technology and scale has increased over the years, and the Rio argument is that Tiwai is now a high cost producer in an oversupplied market. This does happen in the mining and smelting industries, which are global and subject to huge numbers allocated to investments in boom and bust cycles.
My outside in take is that I’d love to send in a team to take over and bring the mojo, quality and cost back. I’ve seen this done successfully before (and helped), and know plenty of people who would enjoy the challenge. That’s assuming the plant is relatively poorly run, but it was seen as a benchmark site 10 years ago, begging the question of whether it is now fundamentally uneconomic. Even with the best workers in the world, if the plant is structurally uneconomic then there is little to do. I have seen elsewhere, however, that many workers will excellent opportunities to continue in the industry offshore. Others may struggle in the short term, and regardless of the result they will need to country’s support to move on and up.
My second take is that Rio may not have done their numbers properly – and that HQ may well be allocating too much of the revenue to their own books, and allocating too much cost to Tiwai. The low tax payout that an NBR commenter mentioned would seem to argue for that suspicion. So my recommendation is that Meridian should be demanding that Rio open the books and treat the economics of the plant as a stand alone business. Make sure, for example, that the prices for buying alumina and selling metal are based on the LME price, not some internal price. I suspect from industry experience that the results will be startling, and a buyer may become quite enchanted with the economics.
And thirdly aluminium smelting is a huge CO2 emitter, and the much larger modern plants would be emitting less per tonne of aluminium produced, so long as the power source was also renewable. Regardless, those modern plants will keep producing, and closing this plant is net good for the world, and helps NZ reduce our share of CO2e emissions.
I also suspect that Meridian will earn more by putting the electricity on the spot market rather than this extraordinary low priced long term contract. Certainly in the medium to long term – and I assume that they have the models to back this up. While some new power lines do need to be built, abandoning Tiwai supply will also save our economy from having to build major new power plants for for a while, and reduce emissions from the large thermal plants we have to use more fully at the moment.
The only negotiating tool that Meridian really has is load shedding, which is switching down or off power to the smelter at peak times. I suspect those sorts of clauses are already there in the existing contract. However it’s a false saving for the plant, as too much of that switching and the pots where the aluminium is produced will become unstable, the energy efficiency will drop and less aluminium will be produced per unit of power. In short the plant will become even more uneconomic, and even risk more pot line freezing incidents. Maximising aluminium production needs stable pot lines, and it’s very hard to keep pot chemistry stable without stable electricity supply.
Finally I believe the fundamentals of the The Mighty River Power IPO proposition are still the same – MRP is a producer of electricity with essentially zero costs from hydro and geothermal assets, and one gas powered plant. It’s a buy and hold forever kind of deal, and short term price fluctuations will prove immaterial for lasting value, while there will be less short term need for cash to be allocated to building power plants in NZ.
So I hope Meridian and the government stand firm against Rio here. Close or sell the plant, but please don’t negotiate prices down. And if you do close – well I’ll buy it for $1.