Is Rio Tinto’s ISAL smelter a bargain or a smart investment?

Is Rio Tinto’s ISAL smelter a bargain or a smart investment?
ISAL smelter Flickr

At least three companies (including Swiss commodity trader Glencore and German Trimet Aluminium) have expressed interest in buying Rio Tinto’s aluminium assets in Iceland, Sweden and the Netherlands, priced at up to US$ 350 million, news agencies reported earlier this month. A source cited by Reuters mentioned that Liberty House is also interested in these assets. Other than the ISAL aluminium smelter in Iceland, Rio has put on sale a 53% stake in a Dutch anode facility and 50% of the shares in a Swedish aluminium fluoride plant, both of which are key materials used in aluminium smelting process.

Rio Tinto restarted the sale process for the assets in early July, after Norwegian aluminium company Norsk Hydro pulled out of buying them in September last year, blaming the delay on getting European Commission approval. Given that Hydro is already a major player in the European aluminium industry, the European Commission may have had competition concerns, sources said.

But why is Rio Tinto selling these assets in the first place? Any trader worth their salt knows that you sell high and buy low – in this case based on LME prices – which is quite the opposite of what Rio Tinto and Alcoa have been doing recently. Indeed, Rio Tinto sold last year the Dunkerque smelter, the largest aluminium smelter in Europe, located in northern France. The deal was agreed with Liberty House, and was worth US$ 500 million. Just before that, in December 2016, Rio Tinto’s smaller Scottish Lochaber smelter was snapped up by  – again – Liberty House. At the same time, Alcoa has been trying to sell its smelters in Spain.

But what’s even more interesting is that Rio Tinto bough Alcan in 2007 for US$ 38 billion, when aluminium was trending at 20-year highs. By contrast, the LME is now trending at low historical prices.

Rio Tinto’s chief executive Jean-Sébastien Jacques, who took charge in July 2016, has embarked on a strategy of selling all but the company’s best-performing units. He defended the sale of smelters, while also pledging to continue selling non-core assets, by saying: “what is important for us is not to be the largest company, it is to be the most profitable company.”

Rio Tinto has been considering for the last several years the sale of non-hydroelectric-powered aluminium assets, in Australia and Europe, while the core Canadian assets, whose electricity costs are in the first quartile (or even decile) of the global smelters cost curve, will be bolstered.

Glencore always on the scene

It is interesting that Glencore is usually among the first companies to show interest whenever there is a bargain sale (or at least what looks like one), despite the fact it doesn’t directly own aluminium assets. The Swiss trader relies on offtake agreements with other producers, including US Century Aluminum, in which it has a more than 40 % stake, and Russia’s Rusal (8.75%). Century Aluminium operates one smelter at Iceland.

Glencore’s agreements to buy aluminium from smelters around the world are estimated at a total of about 3 million tonnes or some 10 % of ex-China supply. Glencore also showed initial interest in taking over Aluminij Mostar earlier this month. Aluminij is a long term business partner with Glencore, but talks with the Bosnian Federal government collapsed on Monday over high electricity costs. As Aluminij Mostar’s electricity contract lapsed, supplies were terminated in the first minutes of July 10 and the smelter had to stop production.

The situation in Iceland in decidedly better: despite the fact that ISAL pays the highest electricity price among Iceland’s aluminium smelters, it is still among the lowest in Europe. Iceland generates all its electricity from hydropower and geothermal energy, consistent with Rio’s “green aluminium” hopes. But given that electricity prices are much higher than Rio’s smelters in Canada – with expectations of further hikes in 2024 – the company’s decision to offload the asset is coherent with the overall strategy of lowering overheads and maximizing profits.

Investments in ISAL

Even if ISAL started production in 1969, Rio Tinto has invested massively between 2010-2014 in the facility, buying new equipment and upgrading the existing one, increasing production capacity, and altering the production process in the smelter’s casthouse from rolling slabs to extrusion billet to meet products demand. This latter transformation required modifying the casting equipment and installing three new continuous homogenizing furnaces. Rio also completed the installation of new gas treatment centres and increased operational reliability by updating the electrical equipment and installing new rectifiers.

The plant’s production was increased with a raised amperage and bath recycling plant, rodding shop, two new additional Gas Treatment Centres (GTC’s), alumina handling and a general upgrade of plant infrastructure. After the finishing the project, smelter capacity was increased to 230,000 t/y, while total investments costs were estimated at US$ 500 million. What’s more, ISAL smelter has its own port which enables lower shipping costs. HRV Engineering, in cooperation with Hatch, managed the investment upgrade at ISAL.

Electricity costs rising

In 2010 the Icelandic national power company Landsvirkjun and Rio Tinto signed a power contract, for power delivery extending to 2036 (some additions and corrections were made in 2014). The electricity price for the ISAL smelter initially was just below US$ 30 / MWh. According to a special price equilibrium mechanism prescribed in the contract, the power tariff shall be revised once during the contract period (in 2024). To fulfill the contract, Landsvirkjun built the Budarhals hydro power project.

Unlike the two other smelters supplied with electricity by Landsvirkjun, who have electricity costs linked to the LME aluminium price, the price for ISAL is linked to the US consumer price index (CPI). This is the reason why ISAL has to pay the highest electricity price of all three smelters in Iceland.

The lowest electricity price in recent years among Iceland’s three smelters was paid by Century Aluminum (Norðurál), with Alcoa (Fjarðaál) coming in second place. The most recent electricity price for ISAL was US$ 35/MWh and has kept rising steadily since the contract signed in 2010, tracking rising CPI index. It is currently twice as high as the old, pre-2010 contract

Final remarks

The ISAL aluminium smelter is an attractive plant for interested investors, especially in this low-price market environment. It is up to the potential buyers (or investors) to decide if US$ 350 million is worth paying for the three production sites. ISAL is an excellent smelter, has a long term electricity supply contract at still-favourable prices, and has new and upgraded production facilities,  which are all preconditions for a bright future.

In business as in life, it is worth remembering that good chances and opportunities needed to be grabbed at the right time. Once the window of opportunity closes, it’s hard to predict whether optimal conditions will appear again, if ever.

A cautionary tale is Aluminij Mostar: back in 2007, the plant was among the best smelters in Europe and was on track to be sold to Vedanta for €640 million (88% stake). Unfortunately, the acquisition was derailed by unknown, mostly bureaucratic reasons, and the company was never able to recover and be profitable, closing down this week.

The takeaway? Investors need to take their chances while they can.