development dialogue 22 july 2014 options for managing...

Development Dialogue 22 July 2014

Options for Managing Electricity Supply to Aluminium plants

Presentation on CBA Modelling

Contents

1. Background – Overview – Why did Eskom Enter into the Contracts with BHP? – Problem statement

2. Objectives of the Social CBA 3. Data Sources and Missing Data 4. Overview of the South African Aluminium Industry 5. Overview of the Electricity Contracts for the Aluminium Industry 6. Cost Benefit Analysis

– Modelling – Results

7. Conclusions 8. Policy Implications of a CBA 9. Discussion

Background: Overview The Long and the Short of it: - Eskom entered into the S/NPAs with BHP in the 1990s. - The contracts resulted in low-priced (below production cost) electricity to

BHP. - They were negotiated on a Risk-sharing basis, which was important to

ensure financial viability over the long-term. - Since the recession, commodity prices have gone down, which means the

prices BHP pays have dropped as well (The electricity price BHP pays in SA is directly linked to the Aluminium price).

- BHP uses about 6% of Eskom’s electricity supply. - At the time of the contracts, Eskom had excess capacity. This has

decreased in recent years with a resultant shortage of electricity with associated price increases for electricity.

- The length of the contract(s) has been somewhat controversial. - Eskom estimates the liability of the contracts to be R11.5bn (for 2013).

Where the liability can be taken as the opportunity cost of supplying BHP on the special price vs. supplying at Megaflex rates i.e. the PV of what Eskom projects BHP would pay for electricity against projections around what similar electricity users would pay.

Background: Why did Eskom enter into the contracts with BHP?

• After taking a feasibility study Eskom agreed to supply Alusaf (predecessor to BHP) electricity at a rate that was in line with world energy prices (at the time).

• Projections around the following economic variables seemed conducive (in favour of Eskom) in 1992 – 2020 period.

- Aluminium price - Exchange rates (R/US$), or foreign production price indices. - Interest rates

• Eskom had excess electricity capacity, and it is expensive to

store excess electricity. • Cost of power generation was much cheaper in the past.

Background: Problem Statement

Problem statement:

- Is there a negative impact arising from the Eskom electricity supply agreement with BHP Billiton; and

- if the electricity contract were broken, what would the penalties be, and

- if the electricity price rises to the smelters, what would be the cost in terms of production and employment; and

- how would that compare to the impact of greater electricity availability in the economy?

Objectives of the Social CBA

Aim of the Study:

• To compare social costs and benefits of smelters with and without electricity subsidy in order to address the problem statement:

- Scenario 1: Have subsidy (BHP continues paying contractual tariffs)

- Scenario 2: No subsidy (BHP pays Megaflex tariffs, for similar industry user)

• Governments use Economic Impact Analysis (EIA) (type of CBA) more than any other method to assess the broader policy implications.

• EIA generally produces a quantitative measure of the economic effect of an intervention.

• In practice, through income-expenditure analysis or input-output analysis, EIA inevitably involves the use of multipliers — hence the overall impact is a multiple of the initial impact.

Data Sources and Missing data

• Data Sources

– Company-specific annual reports of firms in the aluminium industry (and downstream sectors);

– The inter-relationships between inputs and outputs

– Quantec data.

• Missing data – Aluminium sector-specific data e.g. input costs, details of employees,

skill levels and associated salaries and wages.

– Quantec captures industry trends in the aluminium sector through the more aggregated ‘Basic Non-ferrous metals’ category using the Standardised Industry Classification (SIC 352). This category includes metals with no iron such as aluminium, nickel and zinc.

– No information was obtained by TIPS from BHP

Figure 1: Production in the Aluminium industry (1000 tons)

0

100

200

300

400

500

600

700

800

900

1000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

0

100

200

300

400

500

600

700

800

2005 2006 2007 2008 2009 2010 2011 2012 2013

Hillside Bayside Mozal

Figure 2: BHP smelters (production 000’s kt pa)

Overview of the South African Aluminium Industry

Aluminium production decreased since 2006, but is higher than the 2002 rates of production

Hillside is the largest producer and Bayside the lowest. About 50% of the Bayside operation was moth-balled in 2008 due to the energy crisis.

Figure 3: Trade position of Aluminium and articles thereof

0

2,000,000,000

4,000,000,000

6,000,000,000

8,000,000,000

10,000,000,000

12,000,000,000

14,000,000,000

16,000,000,000

18,000,000,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Ra

nd

s

Exports: Aluminium and articles thereof Imports: Aluminium and articles thereof Balance of payments

Overview of the South African Aluminium Industry (cont.)

Exports have increased since 2002, peaking in 2007-08 and 2011. Imports have increased significantly, peaking in 2012. In recent years, the BOP has started to reflect the increase in aluminium imports.


Electricity usage • Hillside 1& 2 Potlines: 850

MW • Hillside 3 Potline: 225 MW • Bayside: 350 MW • Mozal: 900 MW Total: ~ 2300 MW Eskom operates 27 power stations with a total nominal capacity of 41 919 MW Smelters use around 5.5% of Eskom’s nominal capacity


Direct

employment

Primary

Hillside and Bayside3000 (including

contractors)

Mozal 98

Secondary and recyclers/merchants

Zimalco 150

Others 150

Aluminium scrap industry 8800

TOTAL UPSTREAM 12,198

Upstream

Aluminium industry employment, ~ 15,000 (direct), 29,000 (direct, indirect and induced)

Direct

employment

Fabricators and semi fabricators

Hulamin 2100

Wispeco 1000

Others Unknown

TOTAL DOWNSTREAM ~ 4,800

Aluminium foundry industry 1700

Intermediate/midstream

Econometrix report (2012): • Bayside and Hillside smelters jointly created 7 000 jobs (direct and indirect) in KwaZulu-Natal (KZN),

primarily in the Richards Bay area; impacting on the livelihood of more than 33 000 people in northern KZN

• Using a dependency ratio of 4.0, it is estimated that the livelihood of approximately 28 000 people could be dependent on the operations

Pricing clauses: Hillside Potlines 1 & 2 Energy Change: The charge for electrical energy supplied in each month shall be calculated as follows:

ES x 6.54 x AL x R/$= Rands

Demand Charge: The charge for electrical power supplied in each month shall be calculated as follows:

MD x 3.237 x AL x R/$= Rands where, ES = the total number of GW.h of energy supplied in the month; MD = the maximum demand in GVA (Gigavolt amperes) supplied during peak hours [as defined in the Eskom Schedule of Standard Prices for Tariff (E)] in the month; AL = is the three-month London Metal Exchange (LME) sellers’ price for 99.7% high grade aluminium ingot expressed in US Dollars per ton; R/$ = the Rand/US Dollar exchange rate

Overview of the Electricity Contracts for the Aluminium Industry

Pricing clauses: Hillside Potline 3 • A basic charge of R174.80 (+VAT= R199.27) per month for each point of delivery, which

charge shall be payable every month whether any electricity is used or not • A DEMAND CHARGE for each kilovolt-ampere of the maximum demand supplied during

peak hours in the month at the rate of R40.23 (+VAT= R45.86) • An ENERGY CHARGE at the rate of 7.26 cents (+VAT= 8.28c) per kilowatt-hour (kWh) of

electrical energy supplied in the month. • These charges are subject to floor and ceiling provisions, discounts and transmission

surcharges • On 1 January each year, since 2002, Eskom escalates the prices annually such that the

pricing in year n+1 is equal to the price in year n multiplied by the ratio between the South African Producer Price Index, PPI (November in year n)/ PPI (November in year n-1)

• Unlike the contracts for Potlines 1 and 2, there are provisions for escalation of costs by using the PPI

Overview of the Electricity Contracts for the Aluminium Industry (cont.)


0.00

0.20

0.40

0.60

0.80

1.00

1.20

Jan

-02

Ma

y-0

2

Se

p-0

2

Jan

-03

Ma

y-0

3

Se

p-0

3

Jan

-04

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y-0

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Se

p-0

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Jan

-05

Ma

y-0

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Se

p-0

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Jan

-06

Ma

y-0

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Se

p-0

6

Jan

-07

Ma

y-0

7

Se

p-0

7

Jan

-08

Ma

y-0

8

Se

p-0

8

Jan

-09

Ma

y-0

9

Se

p-0

9

Jan

-10

Ma

y-1

0

Se

p-1

0

Jan

-11

Ma

y-1

1

Se

p-1

1

Jan

-12

Ma

y-1

2

Se

p-1

2

Jan

-13

Ma

y-1

3

R/kW

h

Average Megaflex Hillside Potline 3 Hillside Potline 1&2

Figure 4: Difference between BHP prices and comparable average Megaflex tariff Year

Megaflex tariff

over Hillside 1 & 2,

% difference

2002 -10%

2003 15%

2004 -12%

2005 -3%

2006 -31%

2007 -32%

2008 -26%

Average 2002-2008 -14%

2009 80%

2010 115%

2011 146%

2012 210%

2013 (till June) 166%

Average 2009 till

June 2013 143%


Year

Average

Megaflex

(R/kWh)

Hillside

Potlines

1&2

(R/kWh)

Hillside

Potline 3

(R/kWh)

Eskom’s

costs:

Annual

Reports

(R/kWh)

Hillside

Potlines 1 &

2,

% difference

over costs

Hillside

Potline 3,

% difference

over costs

Average

Megaflex,

%

difference

over costs

2002 0.14 0.16 0.14 0.13 28% 12% 15%

2003 0.14 0.12 0.16 0.14 -11% 18% 2%

2004 0.11 0.12 0.16 -

2005 0.13 0.14 0.16 0.11 18% 40% 14%

2006 0.14 0.20 0.17 0.14 37% 19% -5%

2007 0.14 0.21 0.19 0.16 30% 18% -11%

2008 0.18 0.24 0.20 0.19 25% 6% -7%

2009 0.28 0.16 0.23 0.26 -39% -11% 9%

2010 0.38 0.18 0.23 0.28 -36% -18% 35%

2011 0.48 0.20 0.24 0.33 -41% -27% 46%

2012 0.57 0.19 0.26 -

2013 (till

June) 0.52 0.20 0.28 -

Table: Difference between the smelter prices and Eskom’s operating costs

Special pricing agreements, history and pricing clauses

• The different BHP contracts

– Hillside Potlines 1 & 2

– Hillside Potline 3

– Mozal

– Bayside

• Interruptibility provision- max of 2hr/week at BHP’s cost; Eskom can impose when grid is under immense pressure

Not in the public domain, Mozal contract re-negotiated in 2010 and no longer linked to LME and exchange rate

LME and exchange rate

2001 Nightsave escalated by change in PPI


Impact of these contracts on Eskom’s financials- embedded derivatives • NPAs, where the revenue is linked to commodity prices and foreign currency rates (mainly dollar)

or foreign production price indices, give rise to embedded derivatives • An embedded derivative is a provision in a contract that modifies the cash flow of a contract by

making it dependent on some underlying measurement • Combining derivatives with traditional contracts (embedding derivative), changes the way risk is

distributed among the parties to the contracts

• Eskom’s contract with BHP accounted for 95% of the utility's embedded derivative liabilities • BHP has had a dispute with Eskom regarding: - the length of the contracts. Eskom referred the matter to NERSA which is investigating. - BHP accuses Eskom of having profited from the contracts between 1995 – 2008 when the

aluminium price was high, but now after the recession when the price fell Eskom does not want to honour the downside of the contract.

• Mozal renegotiated in 2010, Skorpion Zinc also in 2010 • Dispute on duration of contracts - big effect on embedded derivatives • Impact on Eskom? Lowers credit rating, increases cost of borrowing


Rmill 2006 2007 2008 2009 2010 2011

Reviewed

September

2011

Reviewed 30

September

2012

Audited 31

March 2012

Income statement 1318 4305 -1680 -9514 2284 -1261 334 698 236


Implications of increased electricity prices to BHP Billiton on each level of the aluminium value chain • Impact on BHP

- Smelter financials not in public domain. - Bayside and Hillside, despite the preferential electricity rates, have allegedly shown

successive losses in the last few years. - Dominant, significant market power – may cut back production, or pass on costs

depending on import price ceiling; unlikely to pass on costs to export markets.

• Impact on secondary smelters - No direct impact, use scrap mainly (small amounts of virgin aluminium). - Indirect impact – less virgin material, increases demand for scrap (particularly high

grade) which increases the price of scrap. *Note that scrap cannot fully replace the use of virgin material - Main concern: Municipality electricity mark-ups and scrap pricing, availability and

quality - policy directive that scrap merchants offer preferential prices to local users of scrap

and first offer product to these local users is not yet in full effect - Limited ability to pass on cost increases

Quantitative Analysis with Direct and Indirect Costs and Benefits Calculated: • Assess the impact of two scenarios, projected until 2020

– Scenario 1: Maintain the status quo; – Scenario 2: Increase the tariffs to Megaflex levels (i.e. no subsidy)

• Assess the direct impact on the firm (smelters) • Assess the indirect, second round, impacts on the downstream industries and

certain economy wide factors

Approach: • Calculate Net Present Value (NPV) of each scenario to compare overall

outcomes. • Future profit values are discounted at the prime lending rate of 8.5%. • Data accuracy is a concern and the CBA should not to be looked at in

isolation. • Impending litigation means that BHP will not release information easily • CBA must be looked at in conjunction with legal and firm level analysis

Cost Benefit Analysis – Modelling

Modelling Dynamics • The model is driven by production (as a result of limited information available)

obtained from BHP on a quarterly and semi-annual basis. • Output levels for BHP are fairly stable, except for 2008 and 2012. Thus there is

certainty regarding impacts on revenues, exports, imports and employment. • In MA we use 3,2,1,0 weighting for the different years for Hillside so that a

smaller weight is assigned to 2012 production. • Weighted Moving Average was used to project production from 2013-2020 for

Hillside.

Modelling Assumptions • Subsidy for Mozal is the same for Hillside 3 and the subsidy for Bayside is same

for Hillside 1 and 2. • 50% decline in production after Megaflex electricity price increase. • Consumption multiplier = 2.89 • Employment multiplier (mining) = 0.5 • Export multiplier (mining) = 1.07 • Government fiscal multiplier = 1.6

Cost Benefit Analysis – Modelling (cont.)

Direct Effects (on the BHP Smelters and employees) – NPV calculated for: • Revenue and sales

from output and production

• Exports • Cost of production

including: – raw material

input (imports and locally sourced)

– salaries, wages, and benefits

– electricity cost – Profitability

and – Taxation

Cost Benefit Analysis – Modelling (cont.) Indirect Effects (economy-wide second round effects) – NPV calculated for: • Consumption effects on growth from: Employees’ salaries and

wages to the economic nodal area where the smelters are located; Remittances repatriated out of South Africa and into South Africa; Profits and resultant dividends and retained earnings.

• Tax effects on growth from: Companies Tax; Income tax of employees; VAT effects from consumption of employees.

• Subsidy effects on growth from: Unemployment Insurance; Electricity effect on smelters and the rest of the economy;

• Impact on Downstream industries, including: Hulamin; Wispeco; Zimalco etc.

• Environmental effect on the carbon footprint • BHP Corporate Social Investment (CSI) effect on growth:

CSI programmes; Infrastructure upliftment/investment. • Balance of payments: Imports of raw aluminium; Imports of

processed aluminium products; Remittances from foreign employees working in South Africa; Exports of aluminium ingots; Exports of processed aluminium products (downstream role players); Remittances from South Africans working abroad at Mozal.

Cost Benefit Analysis – Results (cont.)

Year

Revenue Costs of Production Profits from Operations Taxation Net Profits

Scenario 1 Scenario 2 Scenario 1 Scenario 2 Scenario 1 Scenario 2 Scenario 1 Scenario 2 Scenario 1 Scenario 2

2005 R 11,401 R 11,401 R 7,605 R 7,467 R 3,795 R 3,934 R 1,101 R 1,140 R 2,693 R 2,793

2006 R 16,959 R 16,959 R 11,117 R 10,390 R 5,842 R 6,568 R 1,678 R 1,881 R 4,163 R 4,687

2007 R 18,158 R 18,158 R 11,027 R 10,096 R 7,130 R 8,061 R 2,041 R 2,302 R 5,088 R 5,758

2008 R 20,233 R 20,233 R 11,950 R 11,305 R 8,282 R 8,927 R 2,364 R 2,544 R 5,918 R 6,382

2009 R 13,139 R 13,139 R 8,160 R 9,535 R 4,979 R 3,604 R 1,442 R 1,057 R 3,536 R 2,546

2010 R 14,021 R 7,010 R 8,767 R 5,595 R 5,254 R 1,415 R 1,522 R 422 R 3,732 R 993

2011 R 15,261 R 7,612 R 9,526 R 6,500 R 5,735 R 1,111 R 1,661 R 338 R 4,074 R 772

2012 R 12,136 R 7,364 R 9,167 R 7,891 R 2,969 -R 527 R 880 -R 118 R 2,089 -R 409

2013 R 18,315 R 9,441 R 14,205 R 10,097 R 4,110 -R 655 R 1,212 -R 151 R 2,897 -R 503

2014 R 20,645 R 10,690 R 16,086 R 11,577 R 4,558 -R 887 R 1,342 -R 214 R 3,216 -R 672

2015 R 22,520 R 5,823 R 17,518 R 6,501 R 5,001 -R 678 R 1,471 -R 171 R 3,530 -R 507

2016 R 22,276 R 5,748 R 17,377 R 6,954 R 4,898 -R 1,206 R 1,448 -R 318 R 3,450 -R 888

2017 R 21,450 R 0 R 16,883 R 0 R 4,567 R0 R 1,361 R 0 R 3,206 R 0

2018 R 21,282 R 0 R 16,833 R 0 R 4,448 R 0 R 1,333 R 0 R 3,114 R 0

2019 R 20,214 R 0 R 16,132 R 0 R 4,081 R 0 R 1,237 R 0 R 2,844 R 0

2020 R 20,084 R 0 R 16,111 R 0 R 3,973 R 0 R 1,214 R 0 R 2,758 R 0

Total R 288,102 R 133,583 R 208,470 R 103,914 R 79,632 R 29,668 R 23,314 R 8,714 R 56,317 R 20,954

Direct Effects: R000s: NPV for Scen 1 is R34,2 billion; NPV for Scen 2 is R18,6 billion

Cost Benefit Analysis – Results (cont.) Figure 5: Costs of Production - R000s

R 7

60

5 9

59

R 1

1 1

17

59

9

R 1

1 0

27

08

6

R 1

1 9

50

42

4

R 8

16

0 3

33

R 8

76

7 0

45

R 9

52

6 2

58

R 9

16

7 2

32

R 1

4 2

05

86

3

R 1

6 0

86

55

8

R 1

7 5

18

47

0

R 1

7 3

77

45

5

R 1

6 8

83

19

9

R 1

6 8

33

62

1

R 1

6 1

32

26

9

R 1

6 1

11

07

5

R 7

46

7 5

56

R 1

0 3

90

73

8

R 1

0 0

96

79

0

R 1

1 3

05

51

5

R 9

53

5 3

55

R 5

59

5 0

99

R 6

50

0 3

76

R 7

89

1 9

10

R 1

0 0

97

40

7

R 1

1 5

77

38

7

R 6

50

1 9

70

R 6

95

4 8

38

R 0

R 0

R 0

R 0

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

Costs of Production - Scen 1 Costs of Production - Scen 2 -R 2 000 000

-R 1 000 000

R 0

R 1 000 000

R 2 000 000

R 3 000 000

R 4 000 000

R 5 000 000

R 6 000 000

R 7 000 000

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

Net Profits - Scen 1 Net Profits - Scen 2

Figure 6: Net Profits

Cost Benefit Analysis – Results (cont.) Figure 7: Indirect Effects as a Percentage of the Cumulative Indirect Effect: Scenario 1

Figure 8: Indirect Effects as a Percentage of the Cumulative Indirect Effect: Scenario 2

Consumption, Profits and Dividends

4%

Taxation Effects

2%

Upstream and Downstream

sectors 21%

Electricity Capacity effects -65%

BOP effects 8%

CSI effects 0%

Scenario 1: Status Quo - Indirect Effects

Consumption, Profits and Dividends

4%

Taxation Effects 3%

Upstream and Downstream

sectors 33%

Electricity Capacity effects

54%

BOP effects 6%

CSI effects 0%

Scenario 2: No Subsidy - Indirect Effects

Cost Benefit Analysis – Results (cont.) Indirect Effects – R000s: NPV for Scen 1 is –R135,6 billion; NPV for Scen 2 is R339,8 billion

Year

Consumption, Profits

and Dividends Effects

on the Economy

Taxation Effects on the

Economy

Upstream and

Downstream Sector Effects

on the Economy

Electricity Capacity on the

Economy

BOP effects on the

Economy

Scenario 1 Scenario 2 Scenario 1 Scenario 2 Scenario 1 Scenario 2 Scenario 1 Scenario 2 Scenario 1 Scenario 2

2005 R 2,606,792 R 4,395,561 R 1,765,373 R 1,882,661 R 15,493,680 R 15,493,680 R 0 R 0 R 165,049 R 171,154

2006 R 3,701,883 R 4,395,561 R 2,687,746 R 3,071,612 R 23,046,475 R 23,046,475 R 0 R 0 R 255,110 R 287,174

2007 R 4,422,189 R 5,203,057 R 3,271,905 R 3,751,027 R 18,948,777 R 18,948,777 R 0 R 0 R 311,791 R 352,829

2008 R 5,073,824 R 5,661,814 R 3,975,071 R 4,331,087 R 21,114,343 R 21,114,343 -R 17,980,775 -R 10,597,681 R 362,620 R 391,068

2009 R 3,490,021 R 3,150,120 R 2,369,238 R 1,828,477 R 13,712,184 R 13,712,184 -R 28,864,488 -R 16,444,627 R 216,686 R 156,029

2010 R 3,711,226 R 1,423,181 R 2,444,622 R 1,658,930 R 14,632,626 R 11,445,485 -R 39,173,233 R 0 R 228,675 R 60,891

2011 R 4,087,226 R 1,331,133 R 2,661,736 R 586,691 R 15,926,612 R 12,426,830 -R 49,621,365 R 69,693 R 249,636 R 47,355

2012 R 2,546,658 R 592,641 R 1,800,242 -R 141,225 R 14,910,575 R 13,384,412 -R 46,842,359 -R 5,875,985 R 127,996 -R 25,094

2013 R 3,458,300 R 602,672 R 1,944,393 -R 191,385 R 24,889,555 R 18,391,470 -R 65,894,802 -R 1,174,216 R 177,527 -R 30,864

2014 R 3,842,509 R 563,760 R 2,163,229 -R 287,525 R 28,054,577 R 20,823,231 -R 76,671,367 -R 1,570,987 R 197,045 -R 41,223

2015 R 4,248,253 R 205,948 R 2,359,758 R 426,664 R 30,602,809 R 11,342,585 -R 89,802,389 R 24,927,525 R 216,295 -R 31,070

2016 R 4,349,881 -R 13,472 R 2,322,323 -R 477,057 R 30,271,241 R 11,197,179 -R 105,237,552 R 29,270,450 R 211,420 -R 54,424

2017 R 4,319,575 R 0 R 2,184,742 R 775,248 R 29,149,719 R 11,197,179 -R 122,997,695 R 70,702,171 R 196,470 R 0

2018 R 4,425,248 R 0 R 2,140,353 R 0 R 28,920,732 R 11,197,179 -R 143,857,460 R 82,690,984 R 190,849 R 0

2019 R 4,381,264 R 0 R 1,987,029 R 0 R 27,469,104 R 11,197,179 -R 168,215,778 R 96,692,690 R 174,264 R 0

2020 R 4,508,834 R 0 R 1,949,960 R 0 R 27,292,565 R 11,197,179 -R 196,697,090 R 113,064,550 R 169,037 R 0

Total R 63,173,681 R 27,511,977 R 38,027,722 R 17,215,206 R 364,435,575 R 236,115,369 -R1,151,856,352 R 381,754,567 R 3,450,470 R 1,283,827

Figure 9: NPV od Direct and Indirect Effects from 2005-2020: R000s

Cost Benefit Analysis – Results (cont.) Figure 9: NPV of Direct and Indirect Effects from 2005-2020: R000s

-R 101 143 694

R 358 352 003

-R 459 495 696

Scenario 1 - Status Quo: NPV

Scenario 2 - No Subsidy: NPV

Variance

-R 6 742 913

R 23 890 134

-R 30 633 046

Scenario 1 - Status Quo: Annual Average

Scenario 2 - No Subsidy: Annual Average

Variance

Figure 10: NPV Annual Average from 2005-2020: R000s

Cost Benefit Analysis – Results (cont.) Figure 11: Electricity Costs of Production: Variance between Current Preferential Rates and Megaflex Rates - R000s

-R 1

01

14

3 6

94

-R 1

94

25

7 0

17

-R 3

99

22

6 2

45

R 3

58

35

2 0

03

R 7

42

58

5 6

10

R 5

15

41

5 7

85

NPV TOTAL: 2005 Base year (2005-2020)



Scenario 1: Status Quo Scenario 2: No Subsidy

The CBA shows that Scenario 1 (the status quo) results in a loss of NPV of in the region of R101billion per annum. This suggests that increasing prices to Megaflex rates implies that the smelters would find it financially unviable to continue operations and thus shut down. This has a positive impact on the economy as there is extra electricity capacity which can filter through to the rest of the economy will less adverse effects on the rest of the economy. However, any conclusion based on these figures alone would be partial. This CBA has not taken into account how this compares to the loss to the economy as a result of the carbon footprint.

Conclusions • The impact of BHP on secondary aluminium level and foundries was limited (second level

of the value chain). Concerns were raised by these sectors around scrap pricing, quality and availability as well as municipality tariffs.

• The impact on Wispeco in the next level of the value chain, the semi fabrication level, is also minimal given small volumes of ingots it buys from BHP and its ability to import this at more or less the same price that BHP sells locally. This is because BHP prices its local sales of re-melt ingots at levels at or close to import parity prices (IPP).

• The impact on Hulamin, a large semi fabricator, is significant due to high cost of importing billets as an alternative to BHP’s locally produced billets at Bayside. The cost of importing value-added billet or slab is much higher than the price at which BHP sells locally. The effect on Hulamin needs to be taken into account as Hulamin is a significant employer (around 2000 employees) and is a large exporter, therefore contributing positively to the Balance of Payments.

• A key conclusion and policy recommendation is that any decision taken to increase BHP’s electricity tariff to Megaflex levels should be combined with efforts to strengthen the secondary aluminium value-chain through addressing municipality electricity pricing and scrap issues (particularly the progress of the ITAC scrap policy directive), and local content procurement (for the automotive sector) to cushion any negative impact the reduced/no output from BHP smelters of primary aluminium would have on the value chain.

Conclusions (cont.) • The second leg of economic research involved a Cost Benefit Analysis of amending

electricity prices to the BHP smelters to Megaflex rates which general industry pays. Given the lack of data from BHP and Eskom (due to upcoming litigation) the CBA results be used in conjunction with the qualitative assessment.

• Due to time constraints, it was not possible to compare the costs to the economy of load-shedding and the environmental impact.

• According to the CBA: – Direct effects: NPV of Scenario 1 – Status Quo is estimated to be R 34,2 billion. – Indirect effects: NPV for Scenario 1 is –R135,6 billion – Cumulative effects: Total NPV for Scenario 1 is –R101,1 billion. – Direct effects: NPV for Scenario 2 – No Subsidy is R18,6 billion. – Indirect effects: NPV for Scenario 2 is R339,8 billion. – Cumulative effects: Total NPV for Scenario 2 is R358 billion. – Scenario 1 is better for BHP and the smelters but detrimental to the rest of the economy in

terms of the second round effects stemming from the impact of electricity capacity on the rest of the economy. Scenario 2 has adverse direct effects on the smelter and its employees and their dependents, but has far-reaching second and indirect benefits to the rest of the economy due to the spare capacity of electricity.

– This has implications on BHP’s future investments decision.

• If the CBA results are to be considered and the increased capacity reduces load shedding then the application of the standard Megaflex rates should be phased. Although one manner, allowing for adjustments to more energy saving methods. Is Megaflex appropriate for such heavy users of energy?

• Any decision must be sensitive about message it sends to investors

Questions and Discussion

development dialogue 22 july 2014 options for managing...

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