Brian Fallow: Comalco's tax status not cut and dried

As we digest news of a $9.4 billion gap between what New Zealand spends internationally and what it earns, it is reassuring that we are not in any imminent danger of losing a billion-dollar exporter, Comalco's aluminium smelter, because of the coming carbon tax.

Comments by the company last week might have given that impression.

CEO Tom Campbell said: "The carbon tax, completely unmitigated by any sort of agreement, could cost us $50 million to $60 million a year. That would be enough to put us out of business."

This is a little like saying that if the smelter were hit by a meteorite it could put it out of business.

The chances that Comalco will not be able to conclude a negotiated greenhouse agreement with the Government, exempting it from the carbon tax, are almost as remote.

It would not be eligible for such a deal unless its international competitiveness would be at risk if subject to the tax.

That is the first hurdle companies seeking an agreement have to clear.

So saying the tax could put it out of business should not be construed as a threat to quit New Zealand so much as an assertion of what is common ground between the company and the Government.

Comalco is in the throes of negotiating a greenhouse agreement.

Such an agreement exempts a major emitter from the tax in return for a binding commitment to move to world's best practice for greenhouse gas emissions among comparable enterprises.

The discussions, we are told, are amicable and reasonably well advanced. Bloodymindedness is nowhere to be seen.

But the issues are complex, in particular those relating to the impact of the tax on wholesale electricity prices.

About a third of the smelter's potential exposure to the tax comes from the carbon anodes consumed in the smelting process itself. The rest relates to the effect of the tax on wholesale electricity prices.

Even though physically most of the power the smelter consumes flows from Meridian Energy's Manapouri hydro station and involves no greenhouse gas emissions, the price it pays under its take-or-pay contract with Meridian is linked to the average price on the spot electricity market over the previous year.

The spot price in any half-hour period is set by the most expensive power needed to satisfy demand in that period. That is increasingly likely to be a gas-fired or coal-fired power station and, from April 2007, the costs of that generation will include the carbon tax.

This is an issue not only for Comalco but for most of the other companies seeking a negotiated greenhouse agreement.

Another problem they have is that the Government is not prepared to conclude any greenhouse deals that extend beyond 2012.

The Government says it cannot commit to anything beyond that date - the end of the Kyoto Protocol's first commitment period - because it does not know what the country's international climate change obligations will be.

But Campbell says the smelter has had to cut back capital spending sharply because a business case cannot be made for projects with a payback period stretching beyond 2012. They're just not bankable.

"For capital-intensive enterprises like ours, the 2012 horizon is too short to justify significant investment," he said.

"In any assessment we make of an investment, the only thing a bank would allow us to do is assume that post-2012 we are exposed to it [a carbon tax]."

Comalco traditionally did $25 million to $30 million of capital expenditure a year. But, for the past two years, it had been about $10 million a year and the company was forecasting the same for the next two years.

The minister responsible for climate change policy, Pete Hodgson, says international negotiations about what will happen beyond 2012 have not started yet. "It would be bizarre to offer a negotiated greenhouse agreement for a commitment period, negotiations for which had yet to begin."

NGAs would remain a good idea as long as only some countries had signed up to Kyoto, he said.

The idea behind NGAs is the risk of "leakage". If the smelter were to close, demand for the metal it produces would be met from some other source such as China, more than likely using electricity from coal-burning power stations. New Zealand would lose jobs, tax and export dollars, and the atmosphere would be worse off.

It would be a lose-lose outcome. That is still liable to be a problem post-2012.

"So long as carbon leakage can occur I would imagine governments would be attracted to an NGA-type solution," Hodgson said.

"Unlike earlier agreements, they are legally binding; we find them rather attractive. But I can't bind future governments."

He accepts that might not be enough comfort for Comalco's bankers.

Some other caveats need to be attached to Campbell's comments.

They are predicated on a carbon tax of $25 a tonne, which is the level the Government has capped it at.

But the actual level, which will not be struck until Budget time in May, is supposed to be based on international prices for "carbon" - tradeable rights to emit greenhouse gases. Lately they lave been closer to $15 a tonne.

Precisely how the impact on wholesale power prices will be calculated remains to be seen and that is the larger part of Comalco's potential exposure.

The reference to the banks may be a bit of a red herring. With commodity prices at high levels, including aluminium, the smelter's owners could probably fund the normal capital expenditure levels he indicates from cash.

If uncertainty about the position post-2012 is having a chilling effect on investment at the smelter, only some of that can be put down to the carbon tax issue.

The power supply contract with Meridian runs out that year. Negotiations on a new one have begun and Comalco has been talking to Solid Energy about the feasibility of building a dedicated power station in Southland burning local lignite.

Comalco is not averse to firing warning shots about closure.

Campbell's predecessor, Barbara Elliston, last year put one across the bows of Contact Energy and Genesis Energy.

Their proposal to import liquefied natural gas as a fuel for power stations would be likely to require wholesale electricity prices which would be too rich for the smelter's blood, she said, in which case there would be a big hole in the demand side of the generators' calculations.

The smelter consumes about a seventh of the country's electricity.

But it would be too easy to put the company's comments down to gamesmanship. Electricity represents about half its operating costs and it is already in the top quartile of smelters worldwide in terms of what it pays for it.

Nearly 1000 jobs are at stake, to say nothing of the knock-on effects.

A country which does such a poor job of paying its way in the world as we do - as yesterday's current account figures attest - needs to think twice about endangering an enterprise of the smelter's size.