New Zealand Professional Investment Services Firm

Forsyth Barr

We are proud to be a New Zealand owned firm, with 21 offices throughout the country and over 300 employees. We assist personal, institutional and corporate clients providing a full range of investment services.

Forsyth Barr is a foundation New Zealand Exchange firm (NZX) and accredited market participant. We have been confirmed by the Financial Markets Authority as a Qualifying Financial Entity (QFE).

Research is the cornerstone of our advice. We have one of New Zealand's leading teams of analysts. Our global affiliations ensure comprehensive research coverage of all major investment markets.

New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Electricity Sector<br>Aluminium Soars to New Levels</h2>
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<p>Aluminium prices have soared above NZ$4,000/tonne for the first time since 2008, rubbing further salt into Meridian Energy's (MEL) wounds around the electricity price it is currently receiving from NZAS. Since it agreed to the cut price contract in mid-January 2021, aluminium prices have risen +61% in USD terms and +50% in NZD terms. The main factor lifting the price has been China's decision to cap aluminium production for environmental reasons. This reinforces our view NZAS will remain open beyond 2024, also for environmental reasons. In our view, NZAS remaining open is a net positive for the sector and MEL in particular. Assuming NZAS does remain open, the contract price is material to MEL's value with every NZ$5/MWh worth NZ$25m of EBITDAF and 15cps of value.</p>
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<h3>Aluminium prices soar on Chinese production cut backs and Guinea bauxite concerns</h3>
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<p>Since their March 2020 low (below US$1,500/tonne), aluminium prices have doubled and risen at rate not seen since the commodity boom of the mid-2000s. Whilst much of the 2020 price uplift was due to an improving&nbsp;global economic outlook, lately the price increase has been more about Chinese policy. China is the largest aluminium producer in the world, producing more than 50% of global aluminium. In an effort to reduce pollution from coal-backed aluminium smelters, China has capped output in two provinces and banned the use of&nbsp;preferential electricity prices by local governments. The result, record aluminium prices as the market becomes concerned about a supply shortfall. In addition, political unrest in Guinea, the world's largest bauxite producer (the key starting raw material used to make aluminium) has caused a further price spurt. Whilst alumina prices have also increased +20% in the past two weeks due to the Guinea unrest, the aluminium/alumina spread has continued to expand.</p>
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<h3>We retain our view NZAS is likely to stay open, which is positive for electricity demand growth</h3>
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<p>We have long held the view NZAS will remain open as renewable electricity backed aluminium smelters will only increase in value over time. Current aluminium prices, China's policy moves and Rio Tinto's (RIO) plans to decarbonise its Tomago smelter in NSW Australia by supporting massive wind and solar developments all support our view. However, to stay open beyond 2024 RIO has to negotiate a new electricity contract with MEL, having given up its optionality in accepting the rock-bottom electricity price for four years. That said, if aluminium prices remain firm, it will not be difficult for RIO to outbid any hydrogen project (assuming hydrogen proves itself as a credible alternative).</p>
<p>In our view, NZAS staying open is a net positive as it will lead to further electricity demand growth with MEL and Contact Energy (CEN) busy finding replacement demand options. Even if MEL and CEN accept NZAS is likely to remain open, finding replacement demand is still important as it increases the price NZAS will have to pay. If MEL and CEN can commit electricity to other users NZAS will need new generation built to remain at full capacity, ergo it will have to pay a market price. Southland has plenty of good wind development sites which could be brought on stream. Mercury (MCY) owns one of the best wind development sites in Southland, the 240MW Kaiwera Downs. We currently assume NZAS remains open, paying NZ$55/MWh for its electricity. The contract price is material for MEL, with every NZ$5/MWh adding ~+NZ$25m of EBITDAF and ~+15cps of value.</p>
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<h3>NZAS has option to restart its 4th&nbsp;potline, with current contract lifting +50MW on&nbsp;&nbsp;</h3>
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<p>NZAS currently has an option to restart its 4th 50MW potline. If it does nothing the supplementary electricity supply contract will automatically increase on 1 November 2021, as the suspension of the existing contract ceases. Whilst there has been no communication from NZAS, it would be reasonable to assume the contract restarts, adding ~+1% to NZ's electricity demand. That said, given current wholesale electricity prices, MEL would prefer NZAS did not restart the potline as we estimate it would cost MEL ~NZ$2m/month to service the contract. As it stands the 4th potline contract ends on 31 December 2022.</p>
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Electricity Sector Aluminium Soars to New Levels


Aluminium prices have soared above NZ$4,000/tonne for the first time since 2008, rubbing further salt into Meridian Energy's (MEL) wounds around the electricity price it is currently receiving from NZAS. Since it agreed to the cut price contract in mid-January 2021, aluminium prices have risen +61% in USD terms and +50% in NZD terms. The main factor lifting the price has been China's decision to cap aluminium production for environmental reasons. This reinforces our view NZAS will remain open beyond 2024, also for environmental reasons. In our view, NZAS remaining open is a net positive for the sector and MEL in particular. Assuming NZAS does remain open, the contract price is material to MEL's value with every NZ$5/MWh worth NZ$25m of EBITDAF and 15cps of value.


Aluminium prices soar on Chinese production cut backs and Guinea bauxite concerns


Since their March 2020 low (below US$1,500/tonne), aluminium prices have doubled and risen at rate not seen since the commodity boom of the mid-2000s. Whilst much of the 2020 price uplift was due to an improving&nbsp;global economic outlook, lately the price increase has been more about Chinese policy. China is the largest aluminium producer in the world, producing more than 50% of global aluminium. In an effort to reduce pollution from coal-backed aluminium smelters, China has capped output in two provinces and banned the use of&nbsp;preferential electricity prices by local governments. The result, record aluminium prices as the market becomes concerned about a supply shortfall. In addition, political unrest in Guinea, the world's largest bauxite producer (the key starting raw material used to make aluminium) has caused a further price spurt. Whilst alumina prices have also increased +20% in the past two weeks due to the Guinea unrest, the aluminium/alumina spread has continued to expand.


We retain our view NZAS is likely to stay open, which is positive for electricity demand growth


We have long held the view NZAS will remain open as renewable electricity backed aluminium smelters will only increase in value over time. Current aluminium prices, China's policy moves and Rio Tinto's (RIO) plans to decarbonise its Tomago smelter in NSW Australia by supporting massive wind and solar developments all support our view. However, to stay open beyond 2024 RIO has to negotiate a new electricity contract with MEL, having given up its optionality in accepting the rock-bottom electricity price for four years. That said, if aluminium prices remain firm, it will not be difficult for RIO to outbid any hydrogen project (assuming hydrogen proves itself as a credible alternative).
In our view, NZAS staying open is a net positive as it will lead to further electricity demand growth with MEL and Contact Energy (CEN) busy finding replacement demand options. Even if MEL and CEN accept NZAS is likely to remain open, finding replacement demand is still important as it increases the price NZAS will have to pay. If MEL and CEN can commit electricity to other users NZAS will need new generation built to remain at full capacity, ergo it will have to pay a market price. Southland has plenty of good wind development sites which could be brought on stream. Mercury (MCY) owns one of the best wind development sites in Southland, the 240MW Kaiwera Downs. We currently assume NZAS remains open, paying NZ$55/MWh for its electricity. The contract price is material for MEL, with every NZ$5/MWh adding ~+NZ$25m of EBITDAF and ~+15cps of value.


NZAS has option to restart its 4th&nbsp;potline, with current contract lifting +50MW on&nbsp;&nbsp;


NZAS currently has an option to restart its 4th 50MW potline. If it does nothing the supplementary electricity supply contract will automatically increase on 1 November 2021, as the suspension of the existing contract ceases. Whilst there has been no communication from NZAS, it would be reasonable to assume the contract restarts, adding ~+1% to NZ's electricity demand. That said, given current wholesale electricity prices, MEL would prefer NZAS did not restart the potline as we estimate it would cost MEL ~NZ$2m/month to service the contract. As it stands the 4th potline contract ends on 31 December 2022.


Electricity Sector: Aluminium Soars to New Levels