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><a target="_blank">Electricity Sector</a></h2>
Calling RIO’s Bluff
We are calling Rio Tinto’s (RIO) bluff that closure of its NZAS aluminium smelter at Tiwai Point near Bluff is imminent without more favourable terms. Fundamentally its actions make little sense in the context of climate change and minimising carbon emissions. This paper reviews NZAS economics, looks at its position within RIO’s portfolio and within global aluminium smelters, and considers the four possible outcomes from RIO’s strategic review. We retain our view that NZAS will remain open, although whether RIO remains a 79% owner is another question.
Long-term future secure if a global price is placed on carbon
NZAS’s long-term future should be&nbsp;secure. We estimate that a global carbon price of ~US$16/tonne is enough to shift NZAS into the lower half of the aluminium cost curve. This is because coal-fired power stations emit significant quantities of carbon. The current carbon price in New Zealand is ~US$19/tonne and in Europe it’s higher still. With 61% of the world’s aluminium production coal-backed, NZAS is in a strong position long-term. If RIO were to close NZAS, it would lose the option value associated with NZAS remaining open.
A sale is far more likely than closure
We believe a sale is far more likely than closure as fundamentally we do not believe there are no buyers. In the past three years RIO has sold (or almost sold) its European smelters, so deals are being done. Arguably, RIO paying a third party NZ$200m to take NZAS off its hands is a better outcome than closure. In addition, a sale fits the facts better than closure.
High on the cost curve due to the electricity contract, but NZAS doesn’t fit the profile of recently closed assets
We estimate that NZAS is at the 93rd&nbsp;percentile on the cost curve. Whilst that is not great, we still believe NZAS is profitable based on ~75% of its production being “value-added” product and RIO’s disclosed 2019 product premium vs. the LME aluminium price being +19%. In addition, all smelters that have closed in recent years (that we could find) are significantly smaller than NZAS and most use fossil-fuel electricity. NZAS does not fit the profile of recently closed aluminium assets.
No change to underlying views — closure is highly unlikely
There is no change in our underlying view that NZAS will remain open. Whether it’s RIO owning it or someone else, we are less certain. Our current electricity generator/retailer valuations assume (conservatively) a 20% chance of closure, with the value impacts less than 5% (on a weighted basis). We do assume Meridian Energy (MEL) lowers its electricity price -$13m and Contact Energy (CEN) -$5m.
RIO’s strategic review is expected to be completed by the end of March 2020, assuming it sticks to its timetable.
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Investment View
We have a positive long-term view on the electricity sector. In our view the closure risk of NZAS is small and even if it were to close, the impacts on the electricity sector (in the long-term) should not be material. Our preferred stocks are CEN and Genesis Energy (GNE), which have OUTPERFORM ratings. We are NEUTRAL on MEL, Mercury (MCY) and Trustpower (TPW).<a target="_blank">&nbsp;</a>
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Andrew Harvey-Green andrew.harvey-green@forsythbarr.co.nz +64 4 495 8185&nbsp;
Scott Anderson scott.anderson@forsythbarr.co.nz +64 4 914 2219

Electricity Sector
Calling RIO’s Bluff
We are calling Rio Tinto’s (RIO) bluff that closure of its NZAS aluminium smelter at Tiwai Point near Bluff is imminent without more favourable terms. Fundamentally its actions make little sense in the context of climate change and minimising carbon emissions. This paper reviews NZAS economics, looks at its position within RIO’s portfolio and within global aluminium smelters, and considers the four possible outcomes from RIO’s strategic review. We retain our view that NZAS will remain open, although whether RIO remains a 79% owner is another question.
Long-term future secure if a global price is placed on carbon
NZAS’s long-term future should be&nbsp;secure. We estimate that a global carbon price of ~US$16/tonne is enough to shift NZAS into the lower half of the aluminium cost curve. This is because coal-fired power stations emit significant quantities of carbon. The current carbon price in New Zealand is ~US$19/tonne and in Europe it’s higher still. With 61% of the world’s aluminium production coal-backed, NZAS is in a strong position long-term. If RIO were to close NZAS, it would lose the option value associated with NZAS remaining open.
A sale is far more likely than closure
We believe a sale is far more likely than closure as fundamentally we do not believe there are no buyers. In the past three years RIO has sold (or almost sold) its European smelters, so deals are being done. Arguably, RIO paying a third party NZ$200m to take NZAS off its hands is a better outcome than closure. In addition, a sale fits the facts better than closure.
High on the cost curve due to the electricity contract, but NZAS doesn’t fit the profile of recently closed assets
We estimate that NZAS is at the 93rd&nbsp;percentile on the cost curve. Whilst that is not great, we still believe NZAS is profitable based on ~75% of its production being “value-added” product and RIO’s disclosed 2019 product premium vs. the LME aluminium price being +19%. In addition, all smelters that have closed in recent years (that we could find) are significantly smaller than NZAS and most use fossil-fuel electricity. NZAS does not fit the profile of recently closed aluminium assets.
No change to underlying views — closure is highly unlikely
There is no change in our underlying view that NZAS will remain open. Whether it’s RIO owning it or someone else, we are less certain. Our current electricity generator/retailer valuations assume (conservatively) a 20% chance of closure, with the value impacts less than 5% (on a weighted basis). We do assume Meridian Energy (MEL) lowers its electricity price -$13m and Contact Energy (CEN) -$5m.
RIO’s strategic review is expected to be completed by the end of March 2020, assuming it sticks to its timetable.

Investment View
We have a positive long-term view on the electricity sector. In our view the closure risk of NZAS is small and even if it were to close, the impacts on the electricity sector (in the long-term) should not be material. Our preferred stocks are CEN and Genesis Energy (GNE), which have OUTPERFORM ratings. We are NEUTRAL on MEL, Mercury (MCY) and Trustpower (TPW).&nbsp;

Andrew Harvey-Green andrew.harvey-green@forsythbarr.co.nz +64 4 495 8185&nbsp;
Scott Anderson scott.anderson@forsythbarr.co.nz +64 4 914 2219

Electricity Sector: Calling RIO’s Bluff

Rio Tinto Ltd

Electricity Sector: Calling RIO’s Bluff