Aluminium smelters have yielded 'enormous' benefits, study shows

A previously confidential report, which has been released to Engineering News Online, offers an entirely different take on the value of BHP Billiton's aluminium smelters in Southern Africa, which critics largely blame for South Africa's prevailing power constraints.

The 176-page Econometrix study claims that the smelters have yielded “enormous” benefits to the region and defends the power supply contracts with Eskom, which opponents describe as iniquitous, as having been pursued correctly when South Africa had surplus electricity capacity.

Details of the report, which was commissioned in 2008 by BHP Billiton, arise as the matter has become the subject of a court case and a Parliamentary enquiry. They also follow on from an Eskom assertion that the commodity-linked deals are “unsustainable”. In fact, the utility attributed the bulk of its record near R10-billion loss of 2008/9 to its contracts with the smelters, which reportedly consume as much as 5% of the country's power.

The smelters became the focus of public outrage at the height of South Africa's 2008 load-shedding crisis, when then Standard Bank chairperson Derek Cooper controversially suggested that the system could be immediately stabilised if Eskom simply ended its generous supply arrangement with BHP Billiton.

The resources giant has three aluminium facilities in the region: Hillside (commissioned in 1996) and Bayside (commissioned in 1971, with an expansion in the early 1980s) are located in Richards Bay; and Mozal (built between 1998 and 2002) is in Maputo, Mozambique.

Under the terms of its contract with Eskom, BHP Billiton pays less for power when the aluminium price falls and more when it climbs. For Eskom, the economic crisis of 2007 and 2008, which led to precipitous declines in commodity prices, including the price of aluminium, blew in the perfect storm, with large chunks of power reportedly supplied to the smelters at below cost.

Eskom and government are currently trying to renegotiate these controversial contracts, but a veil of secrecy has been thrown over the details of these discussions.

Meanwhile, the Econometrix report, which was commissioned by BHP Billiton in 2008, when the aluminium price was high, and the rand relatively weak, paints a positive picture of the contribution of the smelters.

At the time of publication, authors Tony Twine and Robert Jeffrey wrote that the “benefits have had a very broad impact and reach, far beyond and more extensively than the relatively narrow reach of many labour-intensive local and regional development projects.”

The report concludes that the industry has played and continues to play an important role in the region and contributes substantially to the overall economic performance of South Africa.

The smelters employed more than 3 200 employees and 2 800 contractors when the report was written, contributing R1,3-billion in corporate tax to the South African and Mozambique governments. In total, it was estimated that about 100 000 South African citizens depended on the Bayside and Hillside smelters for their livelihoods.

Foreign currency earned from exports, meanwhile, was more than R21-billion. Therefore, even after imports of about R9-billion, the direct positive impact on the Southern African regional current account of the balance of payments in 2007 was estimated to be R12-billion, excluding the flow of dividends abroad.

In sum, the warning was that should the smelters be starved of power, the region would lose valuable export earnings, which would have a big impact on the country's balance of payments. Together, Econometrix estimated that the facilities comprised around 1% of gross regional product. “Mozal is Mozambique's largest foreign exchange earner, generating 53% of its earnings,” Twine and Jeffrey wrote.

However, the picture has altered substantially since 2008. The aluminium price collapsed from over $3 000/t in 2008 to some $1 300/t in March 2009, leading to the now notorious embedded derivative losses at Eskom. The price is currently around $2 200/t.

The much lower reserve margin led to the load shedding of 2008, as higher demand bumped into serious supply-side problems, precipitated by low coal stockpiles.

But Econometrix asserts that the tighter supply/demand balance was not due to excessive demand growth, or a sudden increase in demand caused by the smelters. “Rather, it is a supply problem, which should have been planned for and solved prior to 2004.”

Should BHP Billiton now be punished for government's failure to plan properly?

The report argues that the answer should be a resounding no. It even avers that the decision to proceed with the development of the aluminium industry was, “at that stage in the country's development, correct”.

"The government must minimise the damage to all goods-producing industry in the country and the aluminium smelting industry should not be prejudiced in any rationing process,” it said, referring to calls for the smelters to be shut.

"The benefits of the aluminium smelting industry are enormous, in terms of jobs created, taxes paid, foreign currency earned, community contributions and purchases from local suppliers.

"The industry is a sound and long-term contributor to the economy and adds considerable value to a resource, which South Africa has in plentiful supply, namely coal.“