Tiwai Point smelter's future rosier despite global aluminium glut

Tiwai Point aluminium smelter's future is healthier, with the Rio Tinto-controlled plant believed to be breaking even because of a lower New Zealand dollar and falling alumina prices.

These are the key conclusions of a research note by broking firm First NZ Capital (FNZC) in an assessment of the prospects for the New Zealand electricity sector this year.

"Tiwai remains an uncertainty for the industry," the note says, with options to cancel existing electricity contracts triggering in April and January next year ahead of possible closure in early 2018 or a staged reduction in output.

"Surprisingly perhaps, we think the risk of an early 2018 exit remains low despite bombed out aluminium prices."

The smelter uses 13% of all the electricity generated in New Zealand. Its closure would create potential for over-supply and the early closure of more fossil fuel-fired power stations than has already been announced.

Noting December comments  by Rio's head of aluminium, Alf Barrios, that he would not tolerate running smelters that were free cashflow negative, FNZC says it believes there is "wiggle room from low alumina prices and a softer New Zealand dollar," and the potential to defer capital expenditure from usual levels of about $US90 per tonne to around $US60 per tonne.

"Our figures suggest it's possible Tiwai is operating at a cash neutral margin. Significant New Zealand dollar appreciation and even lower aluminium prices will need to transpire before we become more concerned about exit risk. At present, both seem unlikely."

Credit Suisse economists have lowered their forecast for premium aluminium prices to an average $US1660 a tonne this year, rising gradually to $US1970 per tonne by 2019, against an assumed cost of production per tonne at Tiwai of $US1650 per tonne, including $US60 per tonne of annual capex.

While the world's most efficient smelters are believed to be producing metal at about $US1450 per tonne, "more than half the world's smelters output is thought to be losing cash at current prices."

While positive cashflows at Tiwai Point don't necessarily equate to a profitable operation, other factors are also in play in its owners' considerations, including the $225 million cost of returning the smelter site to its original condition if it closed and the potential for cuts to its electricity transmission charges of up to $60 million, based on controversial proposals from the Electricity Authority which may conclude early this year.

In the meantime, a greater fall in the price of a key input, alumina, than the fall in the price of finished metal is also likely to be helping the smelter's economics, FNZC says.

Its forecasts "imply a $25 million cash positive position, which then continues to improve in subsequent years ... even after allowing for a step up in electricity charges."

That said, FNZC expects New Zealand Aluminium Smelters, the Rio subsidiary that operates Tiwai Point, will want to renegotiate its electricity contracts, as it did before the partial privatisation of its main supplier, Meridian Energy [NZX:MEL], in October 2013.

FNZC ranks Contact Energy the most attractively priced electricity company share in the New Zealand market, saying it is "trading below fundamental value and multiples indicate it's cheap relative to its closest peers", Meridian and Mighty River Power (MRP).

Meanwhile, MRP's quarterly operational data shows it failed to gain from a 0.9% increase in national electricity demand in the last three months of 2015, losing 1000 customers from the September quarter. Electricity sales prices fell 1.5% and sales volumes dropped 7% compared to the December 2014 quarter.

"A reduction in overall customer sales volumes reflects the highly competitive market across both residential and commercial," MRP says.

"The average electricity price to customers was $110.94/MWh, lower than (the) prior comparable period. This was due to additional discounted offers to customers and Mighty River Power absorbing increases in lines and transmission costs for its customers on fixed-price contracts."

(BusinessDesk)