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ALUMINIUM IS SOLID ELECTRICITY, BUT WHERE DOES THE PROFIT GO FROM TURNING ONE INTO THE OTHER?

zeus_deripaska

By John Helmer, Moscow

The ancients were pretty sure that when Zeus tossed his lightning and thunder bolts, he wasn’t well-intentioned, let alone fair-minded. It’s that way too in Russia when electricity gets distributed between the big shots and ordinary folk. The ancients were also sure Zeus could be bought off, but obviously not by those who couldn’t afford the temple offerings.

Last month, when Prime Minister Dmitry Medvedev, followed by President Vladimir Putin, and then Economy Minister Alexei Ulyukayev announced that they are going to freeze Russian power tariffs for next year, in effect distributing electricity at a discount to big shots, but keeping in place the 12% increase in the tariff for ordinary citizens, implemented on July 1, they were rewarding those in a position to pay off.

If aluminium is electrolyzed alumina powder – think of this as electricity in a solid form – then the payoff for this particular lightning bolt is likely to be a bigger boon for the state aluminium producing monopoly, United Company Rusal, than for almost anyone else. But exactly what Rusal pays for electricity, compared to everyone else, is one of the company’s most tightly held secrets. For public consumption the company’s reports indicate that its cost of energy currently takes almost 30% of its total costs of sales. However, because more than half of its smelter production is fired by power plants in which Oleg Deripaska (image), chief executive of Rusal, has a related shareholding stake, and almost 60% of Rusal’s total energy needs come from these related companies, it’s difficult to tell where along the production chain between water, coal, electricity, alumina, and aluminium, he is taking his biggest profits, and leaving on his balance-sheet his biggest losses.

Moscow’s investment analysts specialize in either Rusal or in electricity utilities; it’s unheard of for the same analyst to follow both Rusal and its electricity suppliers, including Deripaska’s own EN+, Eurosibenergo, and Irkutskenergo asset combinations. For background on these units, read this [1]. There is a rough consensus among the experts, though. According to Ilya Kupreyev of Aton in Moscow, if the price of electricity grows then this is lossmaking on Rusal’s balance-sheet and profit-making for EN+, Eurosibenergo, and Irkutskenergo. Kupreyev concedes, though, it’s very difficult to follow the pricing of electricity through the aluminium production chain because “there are no [published] prices. At one time [the company presented] a price formula. But to be frank, even with the help of these formulae, it was not very clear at what price they sell.”

Kupreyev is referring to the formula, several of them, which Rusal published in its initial public offering (IPO) on the Hong Kong Stock Exchange in January 2010. Click here [2] to see the electricity price formulae disclosed at the time. Click here [3] for a more recent Rusal presentation of the price formulae for the four smelters producing about 58% of Rusal’s aluminium – Krasnoyarsk, Bratsk, Irkutsk, and Taishet. The electricity supplying companies which have contracted with the smelters — Krasnoyarsk HPS and Irkutskenergo — are part of Deripaska’s EN+ holding.

It is unclear from the Rusal documents what the supply sources and pricing arrangements are for three other Siberian smelters – Sayansk, Novokuznetsk, and Khakas. They produce another 27% of the company’s total metal. It is believed they too benefit from related-party contract formulae. So that makes 85% of Rusal metal production whose pricing and costing are regulated, not by the retail electricity market nor by the Federal Tariff Service, but by the formulae.
 

TARIFF FORMULA FOR KRASNOYARSK ALUMINIUM PLANT LONG-TERM CONTRACT
formula

  • Tb = initial (base) price (11 kopecks / kWh)
  • Tfr = average weighted fixed-ratio price for electricity at the market (it is capped at 1.66c/ kWh)
  • Pa = average LME price for aluminium in the preceding quarter
  • Pb = basic aluminium price (US$1,800 / t)
  • V = aluminium production volume
  • E = electricity consumption

But how to interpret Zeus’s mathematics? The variables indicate a link to the price of aluminium traded on the London Metal Exchange – if this price goes up, so should the electricity supply price. But there is no telling what the “base price” stands for, what the cost of generation is, nor who decides these values. If the volume of aluminium produced goes up faster than the volume of electricity consumed to create it, the formula should result in a reduction of the electricity price, and thus add cash on Rusal’s profit line. At the same time, the formula is capped – a floor and a ceiling price are fixed at numbers whose profitability to Rusal and the electricity companies isn’t revealed.

Look closely at Tfr, the supposed market price for electricity which ordinary folk are paying when they leave work at the smelter, go home, and turn the lights on. Not only is this number manipulated in the Rusal backroom by processes of averaging, weighting and fixed-ratioing, but it is also capped. The effect is to make the formula appear to be sensitive to market competition, but at the same time ensure there is as little outside competition as possible, since the values of the “market” price and the “base” price in the formula cannot grow too far apart.

“This formula is not very clear,” says Okritie Capital analyst Sergei Beiden. “In 2011 our regulator has forced [Rusal] to pay the difference between the [contract formula] price and the price of the market in the energy zone of Siberia. That is, in 2011 part of this formula has been eliminated in some sense. But the other part remained. So yes, there is a transfer pricing.”

According to Kupreyev, the long-term related-party contracts generate power for the Siberian smelters which is “40% to 50% below the market. The total [electricity] price for the plant can be significantly less than that of other industrial users and may be lower than for the population in the region. For many of Rusal’s plants located in Siberia I think their price is lower than that of the population in these regions. It may even be much lower.”

Vladimir Sklyar, the electricity analyst for Renaissance Capital, thinks the opposite: “tariffs for people are lower than for Rusal, as Russia is the only one country [in the world], where people pay for electricity less than industry.”

So, by how much does Rusal get its electricity cheaper (or more expensively) than the ordinary folk living in the smelter towns?

That’s a question which the government’s electricity price regulator, the Federal Tariff Service (FTS), could be expected to know, and has been promising to answer for a week now. The Head of the FTS press office, Oleg Popov, is an obliging fellow, but he’s being let down by his colleagues. No data are forthcoming either from the spokesman for the MRSK (“Russian Grids”) electricity distribution holding, Vadim Nadtochiev. When Pavel Shpilevoi, Director of the Department of State Regulation of Tariffs, Infrastructure and Energy Efficiency at the Ministry of Economic Development, is telephoned for an answer to the same question, noone picks up the receiver.

For Rusal electricity is the Zeus ex machina, conferring special favour on the company because of the amount of electricity-generating water there is in Siberia, thereby enabling Rusal to maintain “its position among the leading companies on the aluminium cost curve”, as the company’s last annual report [4] claims.

And there is more good news from Zeus, according to Rusal’s financial report [5] for the first half of 2013: “energy cost was almost flat during 2012 as compared to 2011, as the increase in sales volumes of aluminium was offset by the decrease in weighted-average electricity tariffs and the depreciation of the Russian Ruble against the US dollar.”

Naturally, such benefits as have befallen Rusal are at risk of transfer to other claimants, particularly if the profit from Siberian aluminium production is transferred offshore, avoiding the Rusal production plants in western Russia, where gas and coal-fired electricity is more expensive and smelter supply tariffs closer to market rates. Again according to Rusal, “the Group’s competitive position in the global aluminium industry is highly dependent on continued access to inexpensive and uninterrupted electricity supply, in particular, long-term contracts for such electricity. Increased electricity prices (particularly as a result of deregulation of electricity tariffs), as well as interruptions in the supply of electricity, could have a material adverse effect on the Group’s business, financial condition and results of operations.”

According to one calculation in the same report, “a 5% increase in the projected level of electricity and alumina costs in the aluminium production [for 2012] would have resulted in a 27% decrease in the recoverable amount and would lead to an impairment of USD245 million.”

That was a hypothetical. In practice, the increasing costs of electricity for this year are being borne by individual consumers.