Australia’s aluminium industry has no future without decisions
In our view, Australia’s aluminium industry is more competitive than is generally realised, particularly at the current exchange rate. There is evidence that in China even subsidised electricity prices are closer to $A60/MWh than $A40/MWh – and even then, subsidies in China are required at coal and electricity companies.
Unsubsidised generator gate electricity prices in China are over $A80/MWh, as you would expect when thermal coal is imported. And because of that, we completely disagree with the assertion of Alcoa’s president, Roy Harvey, who said in January this year of his company’s Victoria plant:
“It is a plant that operates very stably, it is a good technology, it just happens to be one of the most highest energy price markets on the planet.”
To put the most generous interpretation possible on those words, a lot has changed since January, because Victorian baseload futures – as shown in the following figure – fall away to just A$44/MWh by FY2024. And even though this is an illiquid market, and you can’t price an aluminium smelter long term contract, it hardly suggests high prices in Victoria.
And there’s more. If you convert that $A44/MWh in FY24 into US dollars, it translates into $US28/MWh. That’s about as cheap as it gets.
Even if the industry is in the middle of the pack on electricity costs, this does not mean it’s profitable. Like many other industries, aluminium prices are at levels that will lead to losses for many.
And there is no real future for the industry in Australia to be had from doing deals that extend the lives of smelters and perhaps associated coal fuelled power stations by a few years.
Even a cursory examination of China suggests that if smelting aluminium in Australia is to have a future, it needs to be more vertically integrated into electricity. It’s only that integration that can provide the power price certainty that is required for a viable future.
Vertically integrated does not necessarily mean explicit capital deployment, but can come from PPAs and dispatch rights.
Energy required for Boyne Island, for Tomago, and even for dear old Portland, could come from firmed variable renewable energy [VRE]. Given the falling cost of wind and solar, given the low cost of capital that strong credit ratings can provide, and given the scale, ~10% of total demand in the NEM, such an investment would undoubtedly be achieved at great prices by VRE standards.
Equally, there would be significant firming issues and for the VRE side transmission, etc. ITK has lots of ideas about this, but they are beyond the scope of this note.
We do think that a firmed price in the $60s (per megawatt hour) is potentially achievable and perhaps in the low $60s, or even very optimistically in the high $50s.
1.1 Could smelters be modulated to provide some of their own firming?
Smelters can perhaps be retrofitted for insulating heat exchangers. There is already a potline in Germany using such a technology.
The economics look to be worth further investigation, but good information on how well the process works is very scarce. It needs a smelter line in Australasia to do an experiment, Tiwai smelter in NZ recently closed a 48 pot line….
1.2 Goverment can add value by bringing supply and demand together
There is a role for government. Clearly governments are going to be asked to directly support some smelters, if not all.
Specifically, negotiations are afoot with Hydro Tasmania over Bell Bay, an old smelter if ever there was one, and with the more challenged Portland Smelter in Victoria. In our view, just providing directly subsidised power is not enough.
If the smelters are to stay it has to be done in the right way. Despite its subsidy, Portland loses around $A20 million a year and clearly this is unviable in the medium term. It’s either change or go.
If aluminium goes, various coal stations will close even sooner. That is good from a carbon perspective.
If aluminium stays, it provides the demand that provides the buffer between old coal and new renewables.
The point is that the future of aluminium is a driver for the future of electricity generation and government can provide the missing link between the two. Aluminium can help support Marinus link, help support Snowy enable more wind and more solar, and keep Yallourn going while all the new stuff is being built. Needs a plan though.
Seen from another perspective the difficulty the federal government has in supporting the energy transition is effectively likely to lead to the closure of the aluminium industry. Alcoa, globally, already has 70% of its production sourced from renewable and wants to make it 85%.
Australia won’t be part of that without the federal government stepping down from coal’s high horse.
Equally, the closure of the smelting industry will certainly lead to the closure of more coal-fired power stations due to their high variable costs and, in Yallourn’s case, lack of flexibility.
1.3 Every crisis is an opportunity
The ACCC will currently allow big business to sit a round a table and negotiate in a way that is not generally possible. This means the large electricity gen-tailers and the aluminium smelters may be able to discuss a shared vision of the future. It probably will never happen, but now is a time to do it.
1.4 Let’s do a formal study
Can this energy-intensive, export-oriented industry be viably powered by Australian wind and solar? Owners like Rio and Alcoa won’t spend the money to find out. But before the industry is left to hang out to dry, or even worse limps on in its present state, the least the government could do is fund a formal study to consider the issue.
Then policymakers would have a formal answer and be better placed to make decisions.
2. About Australia’s aluminium industry
2.1 Only aluminium
This note focusses solely on smelting, that is the conversion of alumina, to aluminium, and ignores the bauxite mining and alumina refining industries.
For reference, it’s two tonnes of alumina to make one of aluminium and Australia is the world’s largest producer of bauxite, the original precursor product.
2.2 About 12% of NEM consumption
Aluminium smelting remains the largest source of electricity consumption in the NEM, representing 12-14% of utility-scale generation output in each of Qld, NSW and Victoria. In Tasmania, Bell Bay represents 31% of consumption.
Broadly speaking the industry employs less than 3,500 people and even allowing for a GDP multiplier and a regional context it’s a relatively modestly-sized workforce given the industry revenue (about $US2.7 billion a year)
2.3 Aluminium price history
There probably is a bit of a downward trend in the aluminium price, but considering the growth in China’s production, the price has, in our view, been reasonably steady.
The AUD/USD exchange rate has helped Australian prices and as electricity and labour are priced in AUD, the exchange rate has been helpful for profits.
Those prices are for LME cash, but most prices also include a premium, sometimes over $100/t for “deliverability” and a smaller premium for value-add product.
2.4 Australia in world context
Australasia produces about 3.3% of world production with all global growth in the last 20 years coming from China. China now represents about 62% of all production.
3 Aluminium costs
3.1 Three cost pots
ITK puts the cost of making aluminium into three buckets; electricity, alumina, and everything else. Everything else includes other consumables such as carbon and also includes labour.
Broadly speaking, alumina, the precursor to aluminium, is a global commodity and its price, in the medium-term, is closely tied to the aluminium price.
3.2 Electricity is the main differentiator of global costs
As such, the main differentiator of relative aluminium costs, historically, has been the electricity price and electricity efficiency.
Aluminium smelters, in general, tend to be located in cheap power geographies. Power can be cheap for one of two reasons. Firstly, it actually is cheap to produce, or, secondly, governments can make it cheap by subsidising production.
In turn, the subsidy can either be in the contract price for electricity or it can be in the cost of the power station.
The figure below shows, for selected regions and using 2018 data, the latest published, the fuel mix and the share of self generation, ie dedicated power station.
So the key point from one perspective is that China’s aluminium is produced by captive, coal-fired power stations.
If, like ITK, you believe that decarbonsiation will become a more powerful force then, like so much else in China, the dependence on coal-fired electricity becomes a liability rather than an asset.
It already is, in the sense that since China moved to being a net coal importer, the costs of coal-fired electricity have risen.
This is hidden in the aluminium industry but will play out over time. That’s no use to the Australian industry if it all closes over the next decade
4. Aluminium subsidies globally
Recently the subsidies in the global aluminium industry have received some attention, including by the OECD. In what follows, we paraphrase the 2019 OECD Aluminium subsidy analysis.
Essentially, the top 5 producers globally receive 85% of all support, but most producers receive some support. In China, financial subsidies represent the main form of support.
The support in China has also led to Chinese producers focusing on semi-fabricated exports, rather than direct exports of aluminium.
This makes China look like a bigger consumer of aluminium than it actually is.
Again, paraphrasing and quoting from the OECD report, we can look at some examples of electricity subsidies:
“In Québec, energy subsidies take the form of published government decrees specifying the conditions under which individual aluminium smelters get to purchase electricity from the provincial state-owned power company, Hydro Québec.
For certain smelters (but not all), the prices derived from those decrees can be USD 0.01-0.02 per kWh below those paid by other large industrial users of electricity in the province. The lower prices are generally awarded to aluminium producers as quid pro quo for additional investments in Québec.
In China, QPIG was able to obtain electricity from the province at cheaper rates; for 2016 that rate was lowered to CNY 0.28 per kWh (A$ 62 at current exchange rates) instead of the prevailing CNY 0.33 per kWh (a gap of about USD 0.01 per kWh). “
It’s maybe worth noting that at current exchange rates the subsidised price for QPIG is comparable with unsubsidised forward baseload electricity in Australia.
In FY19, Hydro Quebec reported an average price for large industrials of $C45 MWh (about $A50 MWh) Quebec produces around 2.8 mt of aluminium and after doing some sums we think that the subsidised price in Canada is around $A46 MWh at current exchange rates.
Alternatively we can see the subsidy in both China and Canada at around $US10/MWh relative to the local aluminium price.
4.1 China electricity in general is implicitly subsidised
Other work we do suggests that the electricity price for most consumers in China is any event itself subsidised in the sense that the large state-owned businesses don’t earn a return on capital but are supported by debt. And that’s with power prices around the equivalent of $A80 MWh.
Similarly, some aluminium producers in China benefit from access to subsidised coal.
Most aluminium smelters in China obviously pay lower prices due to captive power plants, but you have to ask what the costs of those captive power plants really are if the very large IPPs need A$80/MWh, and even then are basically little more than break even.
So in total if there are 40 million tonnes of aluminium production in China and 70% is “captive” at 13.5 MWh/t, that’s around 378 TWh of captive electricity right in line with the scale of say Huaneng and Datang. And presumably with a similar underlying cost structure.
Essentially, the total subsidy to aluminium is, in ITK’s view, spread out along the value chain.
4.2 China local policy incentivise sales over profits
The OECD report notes that local government retains 25% of proceeds from VAT. VAT is levied on sales and not on profits. Local government does not retain any share of income tax.
As such, even in the absence of any other factor, there is a significant incentive for local govt to promote sales irrespective of profits.
Of course this applies to industry in general and not just to aluminium.
4.3 China exports semifabricated
China has a surplus of aluminum smelting capacity over true demand and yet exports face a 15% tax, so Chinese producers have resorted to exporting say bars, rods and profiles even to the extent where the receiving company remelts them to ingots for re-export.
In any event, China is now 25% of world export trade in semi-fabricated aluminium production.
The main point is that there is a surplus of aluminium capacity in China, so it’s sold cheaply to fabricators who then use the cheap fabricated product to penetrate the world market.
Australia’s main market is Japan, and our main advantage is we aren’t China.
4.4 A bit more on Chalco
In the past couple of years our understanding is that policy in China has tried to slow down the previous headlong rush into aluminium.
In its 2019 Annual Report Chalco, the world’s largest aluminium producer referred to government policy saying that new smelters can only be built to replace older smelters that close down.
Chalco’s 2018 20F stated:
“An average of approximately 1.912 tonnes of alumina and 13,408 kWh of electricity was required to produce one tonne of primary aluminum ingots in 2018. Alumina and electricity, the two principal components of costs in the smelting process, accounted for approximately 43% and 33%, respectively, of our unit primary aluminum production costs in 2018. Apart from alumina and electricity, we also require carbon anodes, carbon cathodes, fluoride salt and cryolite for our smelting operations.”
Chalco itself looks looks heavily geared with modest profitability. The low ebitda margin is because of high sales in the low margin trading division.
5 Aluminium and the NEM looking forward
5.1 Demand, demand management, peak power
As the electricity system is reconfigured aluminium’s role is being re-examined. The answers don’t necessarily change but different questions can be asked.
Firstly, it’s clear that if aluminium production closes down there will be a >10% reduction in electricity demand.
Unless there are new sources of demand, such as electric vehicles or, more distantly, hydrogen production, there will be an excess of generation and more power stations will close.
Yallourn, Gladstone and Vales Point are, in ITK’s view, the most vulnerable stations.
Unlike power stations aluminium smelters are not formally bound to give notice of closure three years in advance. Also it’s relatively easy, although not necessarily cost-effective, to wind down production gradually
Secondly, as currently configured, aluminium smelters are interruptible for a couple of hours on a few occasions during the year. Definitionally, if all smelters did that at once, peak NEM demand could be reduced by over 10%. The value and best way to make use of this capability is under constant review.
Nothing else in the NEM offers this instant, relatively easy to execute and coordinate source of demand management. For instance, it’s possible to imagine data centres being built that consume as much power as aluminium, but it’s questionable whether they can be throttled back in the same way without incurring greater economic costs.
And in any case those data centres will likely never exist in Australia, due to metadata laws.
Thirdly, it’s probably possible, at a cost, to retro-fit smelter pots to make their power flow much more flexible. In the view of the proponents of these systems, the smelter becomes a source of energy storage, or at least demand management is taken to a whole new level.
There is, at the moment, only one large-scale operation of this kind in the world and that’s by the Trimet Group in Germany which we look at further along.
Fourthly, there is the potential for aluminium smelters, particularly Boyne Island, Tomago and Portland, to become vertically integrated powered by firmed wind and solar.
Of course Boyne Island already is linked to Gladstone Power but the arrangement is imperfect.
In VRE terms the very large loads and implied long-term PPAs will produced very low cost of capital for supplying firms and there is the possibility, at least at current exchange rates, of the smelters remaining in the middle of the global cost curve and transitioning back to the lower half of that curve.
However this needs to be investigated more formally.
5.2 Interuptibility and damage to pots
Traditional aluminium smelters are interruptible. However, the extent of the interuptibility is limited in general and the more modern the smelter the lower the duration of the interuptibility.
When aluminium pots cease receiving power the alumina solidifies. If this happens in an unplanned fashion the pots cannot be recovered after a certain length of time, typically about four hours for modern (300 – 400 kA) pots or three hours for the latest technology, such as at Tomago.
The modern pots have high heat loss through their sides with lower manning.
Standard pot life is 6 years. The life is shortened by 100-500 days if pot is fully stopped. The loss of the Portland potline is a good example. Pots were restarted over the course of 6 months. Tomago’s more recent pot retrofit makes the cells more vulnerable to damage as the cost of lower average consumption.
5.3 Power modulation via heat exchanger retrofit
For some years there have been investigations into retrofitting heat exchangers to aluminium pots.
The idea is to manage pot heat via insulation and then at required times the power supply can be turned down and the heat retained. Production falls or rises but pots are supposed to be undamaged.
Although Energia Potier has developed a process “Enpot”, the first semi commercial operation is in Germany by the Trimet Group at its Essent smelter using their own heat exchanger process developed with Birgische Universitat Wuppertal. A May 2019 Trimet press release had this to say:
“With the conversion of a total of 120 furnaces in hall one of the Essen plant, 25 percent more or 25 percent less electricity can be consumed for up to 48 hours without interrupting aluminium production. The energy requirement can also be reduced to zero for up to an hour, if necessary…….A total of 36 million Euros was invested in the conversion.”
Remember, 20% less power is 20% less production. Enpot also states that the reduction or even increase over the base case can be sustained indefinitely.
However, here at ITK we just think that is too easy. We think smelter owners would quickly adopt the technology if it was as good as claimed. Still it may be capable of being developed.
A question automatically arises as to whether that is the full cost because Trimet has been looking at the process for 6 years..
Trimet continues to describe the process as a “trial” . On the other hand other information suggests that the Trimet capex included control systems upgrades and other costs some of which may not scale up with more pots. In short we are still making a spreadsheet on a very few scraps of information.
5.4 Modulation value when electricity prices are $A120/MWh?
Nevertheless we can use the Trimet numbers to estimate the capital cost of aluminium smelting storage.
Let’s use the case of Portland which has, I think, around 410 pots over 4 relatively short potlines of 750 metres each.
The reasons for choosing Portland, are that its current subsidised power agreement expires in 2021 and secondly its located in a region which will have over 50% renewable energy supply by the mid-2020s. We calculate the following gross margin opportunity costs.
There are several ways to evaluate these opportunity costs, and they are just constructed on the thinnest of assumptions.
If the smelter ran primarily of VRE, then smelter modulation could be one source of firming as compared to firming provided by hydro (pumped or otherwise), gas, coal or batteries;
The modulation could be used for simple arbitrage.
To do that requires an estimate of future opportunities which is an exercise beyond the scope of this piece, but we can look at the past 12 months.
We caution that we expect, and its priced into the futures market, significant changes in Victorian electricity prices compared to the past couple of years but still, and unlike China, the history is regarded as factual.
And if the last 12 months was a guide to the future, and it isn’t, then we estimate a 10% modulation might have earned about $158,000 per pot per year.
However, that is likely an overestimate because Portland being so large relative to Victoria that if all its pots were modulated there would almost certainly be a pool price impact.
6 How aluminium is made
This reference section is taken directly from a mininglink article.
The first stage in the smelting of aluminium is the manufacturing of anodes to be used during the smelting process.
Anodes are large blocks of carbon that behave as electrical conductors to assist the smelting process. The Portland aluminium smelter makes around 15,000 anodes each month that weigh about one tonne each.The anodes are manufactured from recycled anode butts that are returned from previous smeltings, petroleum coke and pitch.They are mixed in heated containers and poured into moulds. Once they are formed they are able to be transferred to the carbon bake.
The carbon bake takes place when the anodes are placed into a furnace and baked to a temperature of 1120 degrees Celsius for two weeks. This process bakes the pitch in the mixture resulting in a solid block of carbon able to withstand extreme temperatures in the smelting pots.
When ready the anodes are moved to a rodding room where they are mated to a copper rod using molten cast iron. These rodded anodes are then taken to the potrooms where they are placed into the smelting pots. The Portland aluminium smelter has four 750 metre potrooms that house 103 smelting pots each. It is here where the aluminium is produced.
Alumina is fed into the pot, a graphite lined steel furnace, where it dissolves into molten cryolite, or bath, which is also called aluminium fluoride. A high electric current, at low voltage, is passed through the pot by means of the anode. This causes the alumina solution to separate its aluminium element from the oxygen. The oxygen immediately reacts with the carbon anode and becomes carbon dioxide and eventually bubbles away. The separated aluminiun collects at the bottom of the pot. Electricity maintains the pot temperature at 960 degrees Celsius.
The aluminium is then siphoned from the pot and taken to the ingot mill where it is casted.
David Leitch is a regular contributor to Renew Economy. He is principal at ITK, specialising in analysis of electricity, gas and decarbonisation drawn from 33 years experience in stockbroking research & analysis for UBS, JPMorgan and predecessor firms.