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Chapt er 5Ow nersh ip m odels
SummaryIn this section we consider four potential ownership models that we believe are available to the
Greenland government. A brief introduction into the mechanics of each option is followed by a
comparison between them based on the risk factors involved and their potential implications for
the success of the project. This comparison will form the basis for our recommendation.
It is worth noting that although some benchmark examples are outlined in the introduction,
the nature of the Greenland project is such that only tentative links may be drawn between these
examples and the problem at hand, and therefore our final recommendation is based on risk
management considerations alone. The remote location of the power source makes it impossible
to consider the energy supply outside the context of the smelter. Equally, the proposed smelter
has been purposely located in Greenland for cheap power that it cannot source elsewhere. There
is therefore an even stronger mutual dependence than usual between the smelter and its
dedicated power source. Added to this are the logistical peculiarities of building a three-plant
network and preparing an adequate flat location for the positioning of the smelter in a harsh
environment.
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Inextricably linked, or stranded individual assets
there is no alternativecustomer for the powergenerated by the plants
Greenland was chosen as
smelter location preciselyfor cheap energy
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1. The ow nership optionsThe following four options were identified on the basis of our perception of the Greenland
Governments aims, expectations and potential budget. The merits of each alternative will be
discussed from a risk management perspective in the next section.
1.1.Water r ight s Selling the water rights for the area to Alcoa would effectively mean no active involvement
in the project on behalf of the GHR. Alcoa would remain responsible for building the
infrastructure it requires, both for the smelter and for the power plants.
The GHR would incur no significant costs under this alternative. GHR can nevertheless generate both income and a market-related profit, through a
combination of the following:
A. A one-offup-front nominal fee: this would give Alcoa the right to operate within thestipulations of the contract;
B. A moderate fixed price per MWh, which would guarantee a meaningful income;C. An escalation fee proportional to the price of aluminium once it exceeds a defined
threshold, with a built-in accelerator if the individual projects return exceeds a defined
amount; to compensate for this premium, the GHR can offer long term ownership of the
energy resource;
D. A minor interest in the project in the form of shares.
Ownership options for GHR
GHR SmelterParticipation
GHR
Hydropowerparticipation
WATERRIGHTS
SOLE
POWERSUPPLIER
JV POWER
SUPPLIER
JV PARTNERIN
INTEGRATEDPROJECT
No active participation in project
X % participation in hydropower
100 % control of hydropower
Y % participation in smelter,Y % participation in hydropower
WATER RIGHTS
JV POWER SUPPLIER
SOLE POWER
SUPPLIER
JV PARTNER IN
INTEGRATED PROJECT
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Probably the best example of such a scheme being used are Alcans smelters in Canada, such
as Grande Baie, Beauharnois and Laterriere. All three are powered by self-generated
hydroelectric power from rivers in Quebec, where Alcan holds the water rights in perpetuity
(with the exception of Peribonka river, where the contract runs out in 2058). Alcan pay an
annual charge to the Quebec provincial government based on total energy generation in the
province, escalating at the same rate as the Consumer Price Index in Canada. The rights for
these rivers were contracted before 1970, hence the advantageous terms for Alcan. Already in
1984, when the contract for Peribonka river was negotiated, Alcan was tied to an annual
payment based on sales realisations of aluminium ingot, ensuring that the Quebec provincial
government participate in any upside generated by strong aluminium prices. The reason this
example is relevant is that at the time the initial contracts were signed, Quebec was more or less
in the same position as Greenland is now: the Canadian government in the 1940s wanted
economic activity in the sparse North-West, while Alcan wanted a location for smelters that had
both ocean access and, crucially, cheap energy. Nevertheless, the competitive nature of todays
global market, as well as the strong demand for aluminium should enable the GHR to push for a
more favourable agreement.
The North Atlantic:
cheap energy, small economic density
Alcan 1943-68
Quebec rivers
water rights inperpetuity
annual tax per
energy produced
escalator based
on CPI
1984, Peribonka
water rights till2058
annual tax persales of Al ingot
Alcoa, 2008
Greenland
? long-term waterrights (2038)
? up-front payment
? annual tax perenergy produced
? escalator basedon Al price
? potentialaccelerator once
the projects
returns exceed athreshold
? shares in project
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1.2.Jo in t Venture par tner in pow er supp ly Depending on the available financing, the GHR could opt to become a minority or majority
partner in a Joint Venture with Alcoa that only covers the energy side of the project.
The GHR would have to contribute to the cost of construction, but would incur smalloperating costs. Therefore the Greenland government would need initial access to cheap
capital, for instance infrastructure subsidies from the Danish government.
Alcoas smelter would not run on self-generated energy, but would in effect purchase theenergy from the Joint Venture company. Two basic types of tariff arrangement exist at
present:
A. Power price-relatedUnder this arrangement, the smelter would purchase power from the Joint Venture based on
a fixed base price to which an escalator is applied. The aim of the GHR would be to secure a
profit proportional to the global increase in energy prices, which can be achieved in twoways that are not necessarily mutually exclusive. Firstly, the escalator would have to be an
index reflecting price changes (similar to the Alcan example, where it was the Consumer
Price Index).
Secondly, the Greenland government, as owners of the power source, can attempt to
lock the position of the power provided to the Alcoa smelter on the global smelting power
price curve. With hydropower operating costs remaining low regardless of the global energy
context, such a measure introduced in the contract with Alcoa would guarantee that
whenever energy prices increase, the profit margin increases proportionally. Furthermore,
this is an attractive option for the smelter, as it guarantees that it remains competitive in
terms of power costs.
Locking in the profit: establishing a fixed position on
the tariff curve
tariff
production
2007 prices
2012 prices
2017 prices
2007 position onthe curve is fixed
minimum tariff
threshold
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B. Metal-relatedThis arrangement basically ties the power tariff to the price of Aluminium, so that the owner
of the power plant, in this case the Joint Venture, can take advantage of the profitable
commodities market. The formula for the calculation of the tariff can be proportional to the
aluminium price as traded on a major exchange such as the LME, or it can include
thresholds, where the proportion between power tariff and the price of aluminium is
variable according to certain aluminium price brackets stipulated in the contract. The
percentage of the aluminium price that will determine the power tariff can also be
renegotiated periodically. Below is an example:
1.3. Sole suppl ier o f e lect r ic i ty
This is the most expensive option available to the GHR, involving the building and fullcontrol of the hydropower plants. For this option to be feasible, a very sizeable capital fundwould have to be available to the GHR at relatively low interest.
The building of the power plants would have to begin between 15-30 months prior to thestart-up of construction for the smelter, as construction time is longer.
The Greenland government would set up a company independent of the smelter project tocommission the building of the dams and power plants.
The Alcoa smelter would then purchase the electricity from the GHR. The same types oftariff as above would apply.
This type of fully split ownership between the power source and the smelter is very common
throughout the world. The difference is that most often the smelter is the priority customer for
Venalum
State-owned Edelca increases the power tariff,but there are no thresholds
0%
5%
10%
15%
20%
1997 2001 2006
Power tariff
proportional to
LME aluminium
price
Example
If LME price = $1500/t
Power consumption = 14.8 MWh/t
Tariff = 16% = $16.2/MWh
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the power, but not the only available customer. The implications of this distinction will be
examined further in the next section.
Smelters that secured long-term energy contracts before 1980 generally still benefit from
simple, inflation-escalated contracts. By contrast, contracts concluded after 1990 are almost all
short- or medium term, metal-linked, and contain some provisions regarding escalation based on
the increase in the global or regional price of energy. These are more advantageous for the
hydropower owner and allow for more flexibility and renegotiation.
1.4. Jo in t Venture par tner in an in tegra ted projec t The GHR would commit to part of the investment in an integrated project that includes both
the hydropower stations and the smelter.
The share of participation would depend on the availability of viable capital. Alcoa would no longer purchase the energy, which would in effect be self-generated. The Greenland government would gain profits only from the difference between the price of
aluminium and that of alumina.
Given the strong interdependence between hydropower and smelter, this option appearslogical.
Joint Venture enterprises in primary aluminium production are a fairly recent trend, most
apparent in the projects set up in the Middle East and Asia. The giant EMAL smelter due to be
built in Abu Dhabi for a capacity of 1.4 mtpy will source power from a dedicated 2000 MW gas
power plant. The project is a 50-50 Joint Venture between Dubal and Mubadala and will
become the biggest single smelter in the world. A similar deal was struck between Qatar
Petroleum and Hydro for the building of Qatalum smelter and its dedicated 1350 MW gas-fired
Comparable smelters, vividly different deals
Mosjen, Norway (189,000 tpy), 100% hydropower
Power purchased mostly on the basis of 1950s and 1960s contracts.
Fixed long-term contracts.
Only escalation mechanism is local inflation.
Good deal for the smelter, BUT the contracts run out in 2007
THE FUTURE ?
Sundsval, Sweden (103,000 tpy), 100% hydropower
Power purchased on medium-term contracts (4-5 years).
Terms related to the aluminium price.
Escalation is based on prevailing forward power market prices,with a defined floor and a ceiling: HIGHER TARIFFS
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power plant. The Russian state has stated it is prepared to finance a third of the Boguchansky
smelter project, including a dedicated hydropower plant expected to cost $1.3 bn on its own.
Of the existing smelters, the most relevant is Asahan smelter in Indonesia, owned jointly by
the Indonesian state (41%) and Nippon Asahan Consortium (59%). The smelter is powered by a
dedicated hydroelectric plant on Lake Toba in Sumatra.
Major Joint Venture integrated smelters and projects
EMAL
(1.4 mtpy)
Dubal &
Mubadala
2000 MW (gas)
QATALUM
(585,000 tpy)
Qatar
Petroleum &Hydro
1350 MW (gas)
BOGUCHANSKY (600,000 tpy)
RusAl & Unified Energy Services
1500 MW (hydro)
ASAHAN
(255,000 tpy)
State & NipponAsahan
Consortium
447 MW (hydro)
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2. Econom ic Risk fac torsThe success of the Greenland smelter project from the perspective of the GHR depends on the
successful management of two key risk factors. The first is the potential cost of building the
hydropower network relative to the likely profits that ownership of all or part of that network
would bring. This is a risk that would primarily result in a heavy loss of invested capital,
although it does have some implications for profit opportunities. The second fundamental risk
relates to the parallel evolution of alumina and primary aluminium prices, which determines the
economic success of the smelter. This risk is more closely linked to profit lost or realised,although an abrupt change in the proportion between the two price structures could lead to real
loss of investment.
This section analyses each of the options outlined previously from the point of view of these
two main risk factors. For each option, the risks are identified and quantified according to
probability and likely impact, and potential management solutions are outlined.
Risk factors: possible scenarios
Power network building costs
Smelter project abandoned orsize reduced: stranded asset
Costs escalate beyond viabilitylimits during construction phase
Spread between alumina andaluminium prices
Alumina price increases at ahigher rate than aluminium price;if alumina supply is constrained,more value will be retained by the
alumina producers
LOSS of PROFIT
LOSS of INVESTMENT
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2.1. Water r ight sSince this option involves no upfront direct investment on behalf of the GHR, the risks only
relate to the loss of potential profit. The financial burden of constructing and running the
smelter and hydropower station would belong exclusively to Alcoa.
The limited risks associated with this option depend upon the system of payment. Ideally, the
water rights agreement would incorporate elements of all four types of tariff presented above: an
upfront payment, a yearly fixed charge, an adequate escalator that varies according to the
change in the price of aluminium, and a very small equity participation in the project. The best
ways to ensure that the GHR maximises its returns from the project are shown below.
RISK: Returns to GHR not maximised
Probability: Dependent on negotiations. However, we feel that the GHR would
be in a good position to negotiate a profitable tariff. Impact: Small. Some opportunities for profit may be lost in the negotiation, butthe GHR still stands to make substantial gains.
A fixed charge of $3/MWh for a usage of 600 MW would yield over$15,000,000 per year!
Small up-front fee: FIXED, one payment
Small equity participation: FIXED, shares
Charge per MWh: FIXED (annual tax) or VARIABLE(% of Al price with or without thresholds)
Accelerator based on project return: VARIABLE
NEGOTIATION TERMS: the tariff
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2.2. Jo in t Venture par tner in pow er supp lyAs mentioned above, this is a suitable option as long as the GHR has access to low-interest
capital, such as infrastructure subsidies or other forms of credit from the Danish government.
This would relieve some of the financing pressure off Alcoa. In return, Alcoa would have to
purchase the energy from the Joint Venture company, at a higher tariff than if they were paying
for water rights alone. An initial investment would therefore be compensated by higher later
returns.
Power purchase tariffs would necessarily be higherthan water rights tax
OPTION 1.1. WATER RIGHTS
GHR investment = 0
GHR revenue = water tariff
OPTION 1.2. JV partner
GHR investment = % CAPEX + % OPEX
GHR revenue = investment + profit margin
GHR PROFIT = WATER TARIFF
GHR PROFIT =
PROFIT MARGIN
POWER TARIFF > WATER TARIFF + INVESTMENT PAYBACK
Solutions for maximising the GHRs returns
Give them part of what they want: grant Alcoa long-term rights to the water (atleast 30 years)
Only charge what they can afford to pay: the escalator would only apply whenthe price of aluminium exceeds a threshold or when the project makes substantialreturns
Ask for shares in the project: this is less of a direct cost to Alcoa and means
some profit in the early phases of the project.
Prepare for negotiations Good understanding of capital andoperating cost structure of the futurepower network
Good knowledge of Alcoasalternative options
PLANTCAPEX
+OPEX
ALT.OPTIONTARIFF
GHR marginfor negotiation
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Whether the GHR holds a majority or minority stake in the Joint Venture company is
immaterial: Alcoa would have to purchase the energy regardless, and the hydropower network
owners, whoever they be, have no other option but to sell it to the smelter. The only real
variable is in the degree of exposure to risks, not in the nature of those risks.
The higher the participation of the GHR in the hydropower plant project, the greater the
exposure to this risk will become. There is no readily available solution, beyond leaving plenty
of contingency capital for the possibility that costs will escalate. This does not solve the
problem of losses suffered if capex grows to the extent that power costs are higher than the
tariff.
Furthermore, under this option, Alcoa has considerable degree of flexibility in how it can
react to an increase in construction costs. Given the lag time between the start of construction
for the power network and the start of construction for the smelter, Alcoa has up to two and a
half years to reconsider its position regarding the smelter and the size of its own investment in
the power plant network.
We do not believe this risk to be acceptable from the GHRs perspective. The only way to
manage it would be to negotiate a tariff that leaves room for potential cost increases by
increasing the profit margin. This is unlikely to be acceptable to Alcoa, as it would negate the
smelters competitive advantage on the cost curve.
RISK 1: Costs balloon during construction phase
Probability: Medium.
3 plants connected to smelter inunforgiving environment high quality
reinforced transmission lines required.
Tight construction market and global
financial uncertainty could run up the cost
considerably.
Impact: High.
If cost exceeds available budget, then
smelter project may need to be scaleddown or even abandoned strandedasset would have to be sold elsewhereat much reduced price.
Rising CAPEX can force losses ifpower cost becomes higher than thetariff agreed upon in the off-takecontract.
EXPECTED
CAPEX
PAYBACK
OPEX
PAYBACK
MARGIN
OPEX
PAYBACK
CONTRACTED
TARIFF
ACTUAL
CAPEXPAYBACK
ACTUAL
COST
LOSS
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This second risk is more easily manageable. While metal-related tariffs have recently
become the norm, it is still possible to ensure against price drops in aluminium. Over the short
and medium term this can be done through hedging, but a better long-term solution is locking
the tariffs position on the price curve as shown above, or providing for safe thresholds below
which the tariff remains constant. The former solution is more creative and provides more room
for profit made on the back of energy price surges, while at the same time reassuring Alcoa asthe consumer of energy that it faces no risk of tariffs rising abruptly with energy market
fluctuations. The latter solution is simpler and more frequently used in contracts worldwide. Its
appeal lies in the certainty of a fixed range of possible results, which is comforting both to the
supplier and the consumer of energy.
2.3. Sole suppl ier o f e lect r ic i t yAs mentioned above, the degree of commitment on behalf of the GHR does not change the
nature of the risks, only the level of risk. This option carries with it the same risks as above, but
the potential impact is much more devastating, particularly in the case of the risk 1.
If the hydropower network construction costs rise above initial estimates, the GHR is now
alone facing the consequences. Should the project be abandoned, the GHR is faced with
gigantic losses and a stranded asset with much less potential for revenue. This is of course the
worst of all potential outcomes, and its likelihood is low. Nevertheless, a substantial increase in
capex would lead to a shrinking of the profit margin on the contracted tariff, to the point where
the GHRs initial investment is no longer justified.
Given that the construction of the power network is likely to cost in excess of $1 billion,
which would have to be sourced entirely by the GHR, the risk degree is entirely unacceptable.Even if this amount were available at low interest, the particular mutual dependence between
the smelter and power network and the lag time between their respective construction times
RISK 2: Smelter profits hit by high alumina price andlow primary aluminium demand
Probability: Medium to low.
Strong demand growth forecast for primary aluminium and no imminentshortage of alumina.
Impact: Low.
Plant is likely to remain competitive in terms of power costs, although theGHR would lose profit from the metal-related segment of the tariff.
Solutions:
Long-term off-take contract that specifies the minimum energy to bebought by Alcoa from the power network: buy-or-pay agreement
Flexibly constructed tariff system: lock in the hydropower networksposition on the tariff curve as shown previously or fix thresholds in theformulae for calculating tariff on the basis of aluminium price
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makes separate ownership a risky proposition. Aluminium market fluctuations can be managed
for. However, this risk is about loss of sizeable hard capital, and under exclusive ownership,
there are no measures that can mitigate it. We therefore propose that this option be excluded
from further consideration.
2.4 Jo in t Venture par tner in an in tegra ted projec tAn integrated project would mean that the smelters power is self-generated. For the GHR, this
means that since power is no longer purchased, all revenue will be made on the back of the
strength of the aluminium market. From the projects point of view, this would reduce the
power costs to operating costs, with no tariffs to pay to the state. This arrangement essentially
means that the GHR and Alcoa share the exposure to the same two fundamental risks presented
above.
The risk of capex rising above expectations has the same probability as before, but a slightly
different impact on the GHR. The main problem in this case is not the imbalance between
construction costs and tariffs, but the change in the smelters position on the cost curve. This
shift upwards will most probably mean loss of potential profit. Given that no tariffs are paid and
operating costs are so low, it is unlikely that the total power costs could push the smelters costs
above the equilibrium price and lead to loss of investment.
RISK 1: Costs balloon during construction phase
ALCOA
GHR
ALCOA
GHRESTIMATED
CAPEX
ACTUALCAPEX
COST
QUANTITY
expected positionactual position
Impact: Medium
Fall of profits for GHR, if the smelter is still competitive relative to demand.
Loss of investment, if production costs exceed equilibrium price unlikely,given the low OPEX
DEMAND
equilibrium price
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As with separate ownership, this is a more easily manageable risk, for slightly different
reasons. The lack of a power tariff gives the smelter project a slight advantage in terms of its
position on the cost curve, meaning that the project is more likely to be able to afford temporary
drops in primary aluminium demand.
Participation in a Joint Venture integrated smelter project would therefore expose the GHR
to some degree of risk, but the potential impact of these risks is lower and they are easier to
mitigate. As long as there is readily available capital at low interest at the GHRs disposal, this
option is worth further consideration.
2.5 ConclusionsOf the two risks that we have considered the available options against, the construction-related
one appears to be decisive. The potential impact of the risk and the level of uncertainty that is
inevitably associated with a construction project of such complex nature in a punishing
environment leaves very little room for reliable, watertight solutions. We believe that the levelof risk is unacceptable, and therefore that any option involving split ownership of the
hydropower network and the smelter should be discarded from consideration.
Probability: Medium to low.
Strong demand growth for primary aluminium and no imminent shortage ofalumina
Project has a more advantageous position on the cost curve due to no powertariffs.
Impact: Medium to low.
Loss of profit more manageable, better position on the cost curve meansproject can afford lower premiums.
Solution:
Hedging for up to 5 years
RISK 2: Smelter profits hit by high alumina price andlow primary aluminium demand
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The option of participating in an integrated Joint Venture can be explored further, as the
risks in this case target the profit levels of the project rather than the investment itself. While the
GHR and Alcoa alike are exposed to the risk, the issue is likely to be how successful the project
is, not whether it will make any profit. This option also makes sense from the point of view of
the mutual dependence between the aluminium mill and the power source.
An investment of DKK 2.5 billion would secure a participation of up to 15-20% in an
integrated Joint Venture. If the GHR is confident that such a sizeable amount of capital can be
secured easily, it would be necessary to examine in detail the returns that participation in an
integrated Joint Venture would most likely yield, and compare them with the gains to be made
from selling the water rights.
At this point, given the respective risks associated with the two options, we believe that the
latter is the ownership solution that best suits the GHR. in view of the risk of spiralling capital
expenditure for the building of the power plant network. Water rights for the three rivers should
be sold to Alcoa for a minimum of 30 years, subject to the payment of an up-front fee, and then
an annual tax which is varied in accordance with inflation, the performance of the aluminium
market in general. Such an arrangement would not require any sizeable investment and would
provide a reliable annual income, which would enable the GHR to benefit from the projects
overall success freely, at no substantial risk. As long as the tariff is negotiated well, the GHR
will stand to gain substantial yearly revenue at virtually no cost.
The options and degrees of risk
PROBABILITY
IMPACT
WATERRIGHTS
JV POWER SUPPLIER
SOLE POWERSUPPLIER
JV PARTNER ININTEGRATED
PROJECT
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The options compared: water rights vs. Joint Venture
Returns
Market risk
Construction
risk
Investment
??
LOWVERY LOW
MEDIUMNONE
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3. Soc ial and Polit ica l Considerat ions
Having discarded the options based on separate ownership, we will now examine the non-
economic factors we believe the GHR needs to be aware of in determining whether to opt for
the concession of water rights or for junior participation in a Joint Venture integrated project.
One important note is that the social and political risks for any smelting project are only as
significant as the social and political problems in the area where the project will be located. For
instance, in a country or region of consensus government, where both the incumbent
government and the opposition are in agreement over industrial development and energy policy,
a smelting project can expect to meet with much fewer problems in the preliminary negotiation
phases than in areas where there are considerable differences of perspective. As an example
below shows, Alcoa has first-hand experience of the effect of political factors on the success of
its projects. Similarly, if a region has a serious unemployment problem, the aluminium company
can expect to be tied into more cumbersome negotiations regarding employment development
and knock-on effects on secondary and auxiliary industries that the state or region in question
expects the project to achieve.
In these respects, a project in Greenland is far less complicated both in political and in social
terms for Alcoa than an alternative in either more congested areas of the developed world (like
the US or Norway) or in socially struggling environments in the developing world (Trinidad,
Jamaica or Brazil, all potential Alcoa targets). For any aluminium company, it is important that
negotiations can proceed smoothly and as quickly as possible. Any deal will be made or broken
by the energy cost, but bureaucratic efficiency and the extent of likely social and economic
obligations that the smelter project will likely be burdened with are considerations that can
make one option safer and more attractive to the aluminium company than others.
GREENLAND
Population density:
negligible
GDP per capita:
$20,000/capita
Unemployment: 8.6%= 5,000 unemployed
Nearby smelterpower tariff: $21/MWh
(Nordural, Iceland)
JAMAICA
Population density:
250/sq. km
GDP per capita:
$4,000/capita
Unemployment: 11%
= 275,000 unemployed
Nearby smelterpower tariff: $25/MWh
(Venalum, Venezuela)
Different challenges, different deals, one goal for
ALCOA: Low energy costs
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An example of this is Alcoas negotiations with the Icelandic government in the run-up to
the opening of Fjardaal smelter in June 2007. Negotiations for the smelter began in 2003, with
the Icelandic government committed to securing a deal that created over 1,000 jobs for the
economically depressed Eastern coast. Environmental concerns were raised as the smelter
location overlapped with plans for a national park, but overall Alcoa was satisfied that the
government was open, forthcoming and committed to a swift resolution. There is no reason whythe same could not apply in Alcoas negotiations with the GHR.
A lesson learnt : Baie Com eau
In terms of deciding between ownership options, Alcoas planned modernisation and expansion
at Baie Comeau, Quebec offers a few useful insights into the political and social risks associated
with the negotiation process, as well as a useful comparison tool between these and Alcoas cost
considerations. The smelter is one of the largest in the Western Hemisphere, but its technology
is outdated and likely to be rendered obsolete within 10 years.
In 2002, Alcoa and the Quebec government, then ruled by the Parti Quebecois, signed a
Memorandum of Understanding for modernisation and expansion by 2010. Alcoa committed to
replacing its Soderberg technology with pre-bake utilities through investments worth C$ 1
billion. In return, the government agreed to renew the water rights for the McCormick dam for
25 years beginning in 2011 and to sell Alcoa 175 MW of the remaining necessary energy at
industrial rate. However, the Liberal government that replaced the Parti Quebecois in power in
2003 reneged on the non-binding terms of the MOU and called for a renegotiation of those
terms.
The new terms proposed by the government included the creation of 500 jobs in secondary
manufacturing in addition to the 1500 already pledged in the aluminium processing industry by
Alcoa. However, the most significant issue was over energy tariffs. The Quebecois government
(HQ) argued that the region was facing shortages before Hydro-Quebecs capacity expansion
was finalized, and that therefore the initial industrial rate was not satisfactory. Instead, it offered
to provide low-cost electricity for 50 years, with annual rate hikes no higher than inflation. The
deal tied the tariff to the energy price, which Alcoa stated as an unacceptable risk. Negotiations
fell apart and the project was called off in 2006, as Alcoa stated that it cannot commit over C$ 1
billion for a project where there is the risk that energy costs would escalate over the life of the
project.
The contrast between the Baie Comeau and the Fjardaal developments is evident and a small
part of the reason Alcoa chose Greenland as a site for future development could be an
association with the image of the latter. However, what is also apparent is that the social,
environmental and political factors exist, but are superseded by cost considerations. In the case
of Fjardaal, Alcoa committed to the creation of jobs and infrastructure for the local
communities, as well as providing substantial environmental assurances, in exchange for a
quick negotiation process and cheap energy provisions.
In terms of lessons to learn, one important implication of the Baie Comeau developments isthat Alcoa is adverse to energy-tied accelerators. It is much more likely to adhere to a cost
structure similar to the one presented above, which varies according to aluminium market
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CRU STRATEGIES conf ident ia l
factors and to the success of the project, or one where the tariff for the water rights is locked on
the global power cost curve. It should be much easier for Alcoa to feel that their investment is
safe in Greenland, as unlike Baie Comeau, where 66% of power was purchased, Alcoa would
generate all of their own power.
Another consequence of the failures in Quebec and, later on, in Brazil could be a preference
on behalf of Alcoa for the Joint Venture model. Political factors play a part here, as by joining
the project, a government effectively shows its commitment to the project and makes it
substantially more difficult for a different future government to back out of the venture, once
the initial investment has been made. These considerations were part of the reason for the
Asahan Joint Venture in Indonesia, where politics is considerably more volatile.
2. Financing optionsIf the GHR decides to participate in a Joint Venture integrated project, it will do so as a junior
partner to Alcoa. If the Joint Venture is incorporated, then Alcoa will take the primary
responsibility for sourcing the funding. Even if the partners do decide to each source their own
capital to avoid taking on excess risk, it is a common practice for the junior partner to follow in
the senior partners footsteps and approach the same financing institutions.
Most integrated smelter projects are financed through debt or through a mixture of debt and
equity. The proportion between the two varies, depending on the existence of sponsors for the
equity package, the availability of creditors at a competitive interest rate, and the degrees of risk
associated with the project. Sohar smelter in Oman, a recent integrated project, established a
60:40 split between debt and equity.
Debt gives the GHR full control of the returns once the loan and interest have been paid
back. While the issue of bonds would be logistically challenging, there are other commercial
options that can assist the GHR in finding creditors. One option is through the EKF, Denmarks
Export Credit Agency, which, by underwriting all or part of the financing, can give the project
more credibility and encourage investors. The Qatalum smelter project in Qatar recently secured
$600 million export credit loans, in addition to $2,000 million in a classic commercial tranche.
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Issuing shares is a way to attract up-front capital, but it means forfeiting a proportion of the
returns and possibly allowing a third party to be involved in corporate decision-making. The
GHR or the Danish Government could sponsor all or part of the stock.
In order to attract some financing from parties directly interested in the success of the
project, the equity could be divided between A shares and non-voting equity. A shares would
be destined for economic entities that have a vested interest in the price and quantity of
aluminium produced, such as off-take partners for the smelter or equipment providers for either
the smelter or the power plants. A shareholders would have a say in the floor price for the
primary aluminium produced and for negotiating interest rates with banks financing the project.
Non-voting shareholders would not be involved in such decisions, but they would get returns
proportional to their participation.
A more detailed evaluation of the mechanics of obtaining the financing can be performed
once a definite decision is taken by the GHR concerning the type of ownership it will opt forand the definite amount of capital it is looking to secure.
DEBT OPTIONS
BONDS cheaper and more secure for investors Logistics are difficult: Danish government would have to issue the bonds,
potential legal issues if Joint Venture is incorporated
COMMERCIAL CREDIT more expensive, but more likely to attract takers
Classic international syndicated loans, which would have to be
senior -> priority payback
secured, but limited recourse -> built assets as collateral
typical interest rates around 1% above London Interbank OfferedRate (LIBOR), lower during construction, higher during production
typical duration 15-25 years
Export credits facilitated through Denmarks Eksport Kredit Fonden (EKF)