Why+the+Alcan+deal+does+not+compute,+Mathabo+Le+Roux,+Weekender

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=Why the Alcan deal does not compute=


 * Mathabo Le Roux, Business Day Weekender, 9 February 2008**

In November 2006, the government proclaimed its largest single greenfields investment — worth R21bn — from a foreign investor when agreement was finally reached with aluminium giant Alcan to build a smelter at the Coega industrial development zone outside Port Elizabeth.

With foreign direct investment proving disappointingly elusive despite the favourable economic environment established since the ANC came to power in 1994, the smelter deal was seen as a psychological victory. It had broken down a barrier which would see other major foreign investors realise SA’s potential as an investment destination and follow Alcan’s footsteps to bring much-desired investment to our shores.

But that rosy prognosis is increasingly coming under attack, with the economics of the project now in question.

The clincher for Alcan was SA’s promise of cheap power. But the problem with aluminium smelting is that the process is so power- intensive, it is sometimes called the beneficiation of electricity.

SA’s electricity has for years been the cheapest in the world. But the power situation has changed fundamentally.

As Eskom embarks on the most costly building programme the country has seen, the price of its power is expected to more than double over the next five years.

But Eskom is locked into an agreement — reached at the end of 2006, when the power utility was already well aware of its generating shortcomings — whereby it would provide Alcan (now Alcan Rio Tinto) with power over a 25-year period at a special rate.

The rate at which Alcan will get power is confidential, but an industry insider estimates it at about $0,02/kWh, or about R0,14/kWh — well below the rates of R0,18 and R0,45 that other industrial users and households pay for power respectively.

While Eskom is cagey about what it costs the power utility to generate power, in a capital expansion revision compiled in the first quarter of last year, the power utility says that, in terms of global benchmarks, it will cost 25c/kWh for an efficient base load coal plant to generate power.

Eskom CE Jacob Maroga has pointed out that the rates the utility charges for electricity cover only half the replacement value of its assets. It is clear then that long-suffering South Africans will be subsidising cheap electricity to bring the investment to Coega.

The extraordinary extent of the subsidisation becomes apparent when one considers the gas turbines independent power producer Ipsa will build at Coega. The gas turbines have been mooted as a possible source of power in the interim until Eskom brings additional generating capacity on stream, to ensure the smelter project is not delayed. In terms of an agreement, Eskom will buy the power at no loss to Ipsa, regardless of the cost of generation.

The gas turbines will run on diesel until liquefied natural gas supplies are ensured — which could take several years.

At present diesel prices, it would cost up to R1,50/kWh to generate power from the turbines, an analyst confirmed.

Admittedly, the gas turbines are likely to provide the smelter with power only during peak times, but if Eskom buys power from Ipsa at R1,50/kWh plus a margin, and sells it on to Alcan at 14c/kWh, Eskom will pay Alcan several times over for the electricity Alcan uses to run the smelter.

An industry source who asked not to be named shrugs at the cost: “The government would be prepared to pay 10 times that, because there is no price for no electricity. If the power is out, the mines shut down, industry shuts down and there are tremendous costs to the economy.”

But if the smelter is provided with power at the expense of established industries, the situation would be less palatable.

Two weeks ago, when Eskom declared the instability of its systems, cutting power supply to industrial users to 80% of normal consumption, SA’s mining industry ground to a halt at a cost of R1,3bn a day.

However, for the duration of the power cuts, BHP Billiton’s Bayside, Hillside and Mozal smelters received their full electricity complement — a formidable 2500MW.

SA’s mining industry employs about 400000 people compared with the fewer than 5000 working at BHP Billiton’s smelters, and several mining companies have already indicated that job cuts are on the cards because of the damage done by prolonged power interruptions.

That brings into sharp relief the economics of the smelting project. The subsidisation of large industrial projects would make sense if it were offset by the benefits to the economy.

But the gains for the South African economy from the smelting project, in exchange for SA sacrificing its very scarce electricity, are rather modest.

Alcan’s smelter will permanently employ just more than 800 people. Moreover, the bauxite needed as input in the smelting process is not mined in SA and will be imported — hence no additional jobs would be created at mining level. But even more extraordinary, in agreement with the state, Alcan will be required to supply only 5,5% of total production into the local market. The rest would be exported.

The government’s stated aims with industrial development — under which it lured the Alcan project to SA — are to create jobs and advance downstream beneficiation. The Coega smelter would achieve neither of these goals.


 * From: http://www.businessday.co.za/Articles/TarkArticle.aspx?ID=3140123**

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