Life without the smelter? It's a big change

A ship docked at Tiwai Point Aluminium smelter on a cold foggy morning in Bluff. Photograph / Dean Purcell

It is a bit soon for consumers to start relishing the prospect of lower power bills because the future of the Tiwai Pt aluminium smelter is shaky. A deal may yet be done.

Pacific Aluminium, the Rio Tinto subsidiary which owns 80 per cent of the smelter, says a commercial arrangement can still be reached.

Meridian Energy says it wants one too, even if it has told the market, in the interests of continuous disclosure, that it is "unlikely".

The central question is how the power price Pacific Aluminium needs to keep the smelter commercially viable compares with the price below which Meridian would be better off making the power it generates at Manapouri available to the rest of the country instead.

"Commercially viable" does not mean that the smelter never runs at a loss. It means the smelter is worth more to its owners alive than dead when they discount back to present value all their projections of the likely future path for metal prices, power prices and all the other relevant costs.

At least, that is the central question in the negotiations between Pacific Aluminium and Meridian.

But what is in Meridian's interests as a company may not be the same as what is in the interests of its shareholder, the Government.

It has other power company assets and is committed to partially privatising them.

This is to say nothing of the effect of closure on the Southland economy and the trade accounts, which were $1 billion in the red over the past year.

It has been obvious, since it said last July that it wanted to renegotiate the contract, that Pacific Aluminium would ram as big a lever as it could into that gap between Meridian's interests and those of the Government.

Rio, as Meridian chief executive Mark Binns likes to point out, is about 18 times larger than New Zealand's largest listed company, Fletcher Building.

"We are not dealing with grandma," he said on Thursday. "And it did not get to be that big by being nice to little old power companies."

It has wrung concessions from the Tasmanian Government over the Bell Bay smelter, and from the Northern Territory and Australian Governments over the Gove alumina refinery.

No surprise, then, that the New Zealand negotiations are moving to the level of the owners.

State-owned Enterprises Minister Tony Ryall said the Government had been in contact with Rio Tinto this week to "discuss helping to bridge the gap in their positions over the short to medium term".

One way or another that bridge will be built of public money.

Binns would not put a figure on how far apart the parties were. "But it's a lot of money," he said.

Meridian said it had offered significant concessions and changes to the contract, but the gap between the parties on several issues was so wide that it was unlikely a new agreement could be reached.

Pacific Aluminium chief executive, Sandeep Biswas, said the negotiations had progressed more in the past two weeks than in the previous nine months, and a commercial agreement could still be reached.

Suppose, however, that the incentives - commercial and political - are insufficient to get an agreement, the contract is terminated and the smelter set on a path to closure.

What would that mean for the electricity market and the consumer?

Meridian's chairman, Chris Moller, told MPs on the commerce select committee on Thursday: "If they were to leave, and we are working to make sure that doesn't happen, it will certainly result in lower electricity prices for all consumers in New Zealand."

Though the terms of the contract are shrouded in secrecy, it appears that if the smelter gave notice of closure, production would gradually reduce.

Binns told the MPs: "If [the company] left in accordance with the notice provisions, we think the market would have time to largely adjust.

"What I mean by that is that if you have 5000 gigawatt hours of power which Manapouri produces brought on to the market ... those people in the market who have higher-cost thermal plants are going to find it very uncomfortable. It is the market working.

"On our estimates, it is likely that some of our competitors might close some of their plants. Therefore you will have an adjustment in supply."

As it is, generating capacity has been growing faster than demand.

The smelter represents about 14 per cent of national electricity consumption so if it disappearsfrom the demand side of the market, prices in a competitive market should fall.

If they did not fall, Labour leader David Shearer said, consumers would be entitled to ask why not.

But the question is by how much, and that is where the calculations get tricky.

It is not average costs but marginal costs which set prices on the wholesale electricity market.

It is the cost of the most expensive generation which has to run in any half-hour to meet demand that sets the spot price all the generators dispatched get, and all the electricity retailers pay.

That would still be a fuel-burning power station a lot of the time, and particularly when demand is heavy.

Calculations on the effect on prices of the smelter's closure would also have to consider commercial responses from other generators.

It would appear rational, as Binns said, for the owners of some thermal generating plants to shut them down and contract with Meridian instead. But will they? And which ones?

Genesis Energy's coal-fired units at Huntly are obvious candidates. "Some gas-fired plant might also be marginalised," Binns said.

The big power companies are on both sides of the wholesale market, as generators and retailers.

Their exposure to wholesale prices depends on the extent to which they are net buyers or net sellers, and that varies from year to year with flows into the hydro lakes.

The effect on any company will depend on the extent to which it can and will hedge its position.

Clearly, there are a lot of moving parts when trying to figure out the effects, if the smelter closes, on wholesale and retail prices, and on the profitability and the value of the power companies. A wide range of outcomes is possible.

For fiscal conservatives such as Finance Minister Bill English, that is all the more reason to get such risk off the Crown's books.

But it enables Labour and the Greens to label the Mighty River float a fire sale because investors would demand a risk premium.

And if a deal is struck between the Government and Rio, they can say it will mean power prices higher than they would otherwise be, without a comprehensive analysis of whether that is the best outcome in the national interest.