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Over down under? Australia's aluminum dilemma

Keywords: Tags  Australian aluminum industry, alumina market, Rio Tinto,

Something is happening in Australia. Once one of the most competitive locations for producing aluminum, Australia grew to become the world’s fourth-largest producer of the metal. But all that has changed as Rio Tinto puts its Australian smelters up for sale and competitors Alcoa Inc. and Norsk Hydro ASA are reviewing their loss-making smelters. While some of the operations will survive, others will be shuttered, and Australia’s reputation as a haven for aluminum production will be gone.

Opportunistic politicians claim that the demise of the local smelting industry is a direct consequence of a carbon tax scheduled to go into effect July 1 that will penalize energy-intensive industries, especially aluminum smelting. While the carbon tax won’t help, the loss of competitiveness is independent of the tax, and most industry spokesmen have consistently acknowledged that, arguing that their businesses are suffering from a combination of a sustained period of low metal prices, aging facilities, rising energy costs and a strong local currency.

Over the past decade, prices for most metals have risen to record levels—aluminum being a notable exception. Of all the metals traded on the London Metal Exchange, aluminum has been the worst performer: Since 2002, aluminum prices have grown 60 percent, while copper prices have skyrocketed by an amazing 540 percent. Lead, nickel, tin and zinc also have performed far better than aluminum.

Alumina, which accounts for a third of the cost of producing aluminum, has doubled in price, and the cost of other inputs, primarily power and labor, also have shot up, eroding smelter margins to critical levels.

Flattening aluminum prices have resulted from rapidly expanding Chinese production, and this is unlikely to abate anytime soon. China produced 18.1 million tonnes of aluminum last year, up sharply from around 4.3 million tonnes in 2002, and with China planning to add another 10 million tonnes of capacity over the next five years, aluminum prices are likely to languish for some time yet.

Australia’s aging aluminum smelters incorporate relatively inefficient technology. The country’s oldest smelter, at Bell Bay in Tasmania, was built in 1955, and while there have been continuous incremental improvements, the basic technology is unchanged. Smelters of this vintage are characterized by relatively low operating currents. Because metal production is directly proportional to current, the cells in newer, higher-current smelters are more productive, so fewer of them are required to produce a given volume of metal.

Bell Bay, with a line current of 120,000 amps, has 547 pots with an annual capacity of 177,000 tonnes; by comparison, Australia’s newest smelter at Portland, Victoria, which was built in 1986 and operates at 310,000 amps, can produce 345,000 tonnes from just 408 pots. Fewer, more-productive pots are more energy-efficient, and they also require fewer workers and much less maintenance.

With the exception of Portland and part of Boyne Island, Queensland, none of Australia’s smelters has a line current above 300,000 amps. More than half of China’s smelters, which have a capacity of 24 million tonnes, operate at above 300,000 amps, and with line currents in excess of 500,000 amps the latest generation of smelting technology is even more productive than the Portland smelter.

The 43-year-old Kurri Kurri smelter in New South Wales consumes 16.2 megawatt hours to produce 1 tonne of aluminum, whereas the more-modern Portland operation requires only 13.5 megawatt hours and the world’s most efficient smelters are below 13.0 megawatt hours, at which point Kurri Kurri has a competitive power disadvantage of $100 per tonne of metal.

Access to technology is not a problem for Australian producers, all of which are international companies and are currently firing up new smelters with cutting-edge technology in other parts of the world. Alcoa and Norsk Hydro have invested in the Middle East, and Rio Tinto plans to use its proprietary 600,000-amp technology in Canada.

Rising electricity costs have eroded the competitive advantage once enjoyed by Australia’s smelters. When they were built more than 30 years ago, Australia’s power utilities were part of large state-owned bureaucracies managed by engineers who supervised continual construction programs, which saw capacity far outstrip demand for electricity. With an abundance of electric power and promises to create much-needed jobs, aluminum companies were able to negotiate power tariffs that were far less than those paid by other large industrial consumers.

Often, the low power prices involved taxpayer subsidies. For example, the power contract for the Portland smelter reportedly involved a 30-year subsidy worth up to $6 billion. The tariff, which is linked to the aluminum price, was set to expire in 2014, but the contract was renegotiated in 2010 and extended until 2036.

Specific details of individual contracts have not been disclosed, but a 2000 study concluded that Australia’s aluminum smelters, which accounted for 15 percent of national electricity demand, paid an average of $13 per megawatt hour. At $9 per megawatt hour, Victoria’s Portland and Point Henry smelters were at the low end, while Kurri Kurri was estimated to be paying the most for its power: $16 per megawatt hour. In hindsight, these were very attractive tariffs, especially as other Western World smelters were paying more than $20 per megawatt hour. Assuming a power consumption of 14 megawatt hours per tonne of metal, Portland and Point Henry had a competitive advantage of $154 on their non-Australian competitors—this on a product that at the time traded at $1,500 per tonne.

But after three decades of economic growth, the power surplus has disappeared and cash-strapped state governments can no longer afford massive subsidies and the now-privatized power companies want to sell their output at market rates. Average Australian smelter tariffs are now very close to the non-China world average of $35 per megawatt hour, so local smelters no longer have a significant power cost advantage—and any advantage they do have will erode as legacy power subsidies expire.

A rapidly escalating exchange rate is another factor contributing to the demise of Australia’s aluminum industry. From a trough of Australian 65 cents to the U.S. dollar in February 2009, Australia’s dollar has steadily strengthened (see chart, page 22) and since March 2011 has consistently remained at near-parity with the U.S. dollar. For an industry that exports 85 percent of its production, the stronger currency has been disastrous. Australian-sourced inputs account for more than 90 percent of the cost of producing aluminum, so the stronger currency alone has had the effect of increasing dollar-denominated production costs by more than 50 percent.

Australia is a classic example of "Dutch disease," a term coined in the 1970s to explain the decline of the Dutch manufacturing industry following the discovery of offshore gas. A boom in natural resource exports results in a currency appreciation, to the detriment of such sectors as manufacturing, in which prices are set internationally. Exporters of manufactured products cannot raise their prices to compensate for a stronger domestic currency. In Australia, booming mineral exports have driven up the currency to the disadvantage of manufacturers, including aluminum producers.

Between them, Australia’s six aluminum smelters directly employ 6,000 people—less than 1 percent of the nation’s manufacturing industry work force. But despite its relatively small work force, the industry has plenty of political leverage, especially in an economy that has shed 10 times that number of manufacturing jobs over the past three years due to eroding competitiveness caused by a skyrocketing Australian dollar. The industry’s geographic dispersion further enhances this political leverage: each of the six smelters is in a regional center where unemployment is above the national average and where there are few, if any, alternative employment opportunities.

Four of the smelters are in federal government-held electorates, one of which is represented by a cabinet minister, so the industry has a voice at the highest level of government. But while industry stakeholders have the government’s ear, it is by no means clear that it can do much to help. In 1983, Australia floated its currency so its value fluctuates according to supply and demand on international money markets. Floating the dollar has strong bipartisan support, so it is unlikely the government would rescind the decision and manage the currency so as to support aluminum industry employment. The government also is powerless to influence the price that smelters receive for their metal. Aluminum is an undifferentiated global commodity, so consumers will purchase from the lowest-cost supplier.

Technology and power prices are other areas in which government intervention is not possible. The formerly state-owned power companies have been privatized, and the new owners require a commercial return; while they will offer discounts to aluminum producers, they are unlikely to be as generous as existing government subsidies. Short of offering to rebuild the smelters with new technology, there is little that government can do to redress the industry’s technical disadvantage. In any case, given the strong currency and rising power prices, it is questionable if new technology alone would make the industry profitable.

Subsidies are probably the only support that the federal government can offer, but financial support would create other problems for a government that has staked its political credibility on balancing the national budget. Then there is the question of where to draw the line: Should assistance be extended to other industries, especially the more labor-intensive auto industry, which also is bleeding financially due to the strong dollar? The aluminum industry itself has demonstrated that subsidies are no guarantee that jobs will not be shed: Over the past 20 years, Bell Bay has increased the amount of subsidized power it consumes while concurrently reducing its work force by 50 percent.

Heated debate will continue, but in an open, globalized economy there is little that governments can do to resist fundamental economic forces, so it is inevitable that Australia’s aluminum industry will contract. The two older and higher-cost smelters at Bell Bay and Kurri Kurri are likely to close sooner rather than later. Portland will continue to operate, and its sister smelter at Point Henry could receive metal-price-related support such that at the bottom of the price cycle it continues to survive with support being removed in an upturn.

The remaining smelters, Boyne and Tomago, are owned by Rio Tinto, and the company has included these plants in a sale process that includes other aging high-cost aluminum assets it no longer wants. The "for sale" signs have been up since last October, but it is unlikely that a buyer will be found, so the most likely outcome will be an in specie distribution to existing shareholders. Such a distribution would relieve the company of its Australian aluminum problems, but shareholders would need to pray for an upturn in metal prices and a fall in the Australian dollar. Both possibilities appear remote. 

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