Aluminum smelters and national economic prosperity Although current power prices in Trinidad are by far the lowest in the region, it is understood that a 50% reduction is necessary in order to make an aluminum plant viable in today's market conditions
Industry
By Gregory McGuire
Stabroek News
March 20, 2007
The following is a revised version of a paper presented to the Aluminum Symposium at Paria Suites Hotel, Trinidad on December 5, 2006
(reprinted from the Trinidad and Tobago Review January 1, 2007)
When public outcry forces the government into taking positive action we know that our democracy is working. It is therefore necessary to compliment the anti-smelter activists for pressing the govern-ment into agreeing to hold a national symposium on a matter of significant public interest which, whether directly or indirectly, had led to a major change of course. Regardless of the government's motivation, the Aluminum Symposium was, to my knowledge, the first such open discussion on the natural gas-based industrialization since the inaugural conference on "Best Uses of our Natural Gas Resources" was held in 1974. Much of the debate thus far has focused on the environmental issues. However, I will focus primarily on the question of How Can Aluminum smelter(s) enhance national economic prosperity and sustainability? This is not a feasibility study on smelters because I am not privy to relevant numbers. I propose instead to provide a framework for analyzing economic value created by major energy sector projects of which smelters are a subset.
History of T&T and smelters
The desire to have an aluminium industry in T&T is not new. The 1974 national consultation on the best use of our natural resources identified aluminum as one of the best options for the utilization of Trinidad's natural gas reserves. An aluminum smelter was considered to have greater potential for employment creation and local value-added than, say, LNG. The smelter was viewed as an excellent example of Caribbean economic integration, combining bauxite of Suriname, Guyana and Jamaica with T &T's natural gas resources.
The Alucam smelter (owned by Canadian based Alcan and the Government of Cameroon)
Successive Budget speeches over the period 1977 to 1980 provided updates on the proposed smelter project. In the 1980 White Paper on Natural Gas, a smelter was forecast to be up and running by 1985. In his final Budget speech, (December 1980) Dr. Eric Williams, mandated the National Energy Corporation (NEC), then headed by Professor Kenneth Julien, to complete "the remaining work" so that a final decision on the smelter could be taken by March 1981. The remaining work included drafting marketing agreements, partnership agreements and company structure, firming up the supply of alumina with regional partners, and perhaps most importantly - the finalization of specific proposals for downstream industries. The latter was imposed by Cabinet as a precondition for the consideration of any smelter. With the onset of the economic recession in 1983, government was forced to shelve the aluminum smelter project and, indeed, all other planned energy sector investments not already committed.
There was renewed interest in the establishment of an aluminum smelter from the mid-1990s. The primary stimulants were a growing global market for the metal, combined with the discovery of additional gas reserves, the breakthrough with LNG, and a new wave of foreign investor interest in T &T's gas sector. Several companies were engaged in discussions with the government and the National Gas Company. These included Southwire Corporation, Norsk Hydro and later Noranda. One gets the impression that the Norsk Hydro project came closest to closure. In November 1999, the government hosted a lavish ceremony to mark the signing of a Memorandum of Understanding with Norsk Hydro for the establishment of an aluminum smelter at Point Lisas. Then Prime Minister Basdeo Panday boasted at that time that his government had accomplished in three years what the PNM could not do after 35 years in office. But alas, Norsk Hydro pulled out and opted to expand its facilities in Norway instead.
Why T&T?
What makes T&T such an attractive prospect for the establishment of aluminum smelters? The answer is pretty obvious: competitive energy costs - meaning essentially cheap gas and electricity. Electric power is the single most important cost factor in the production of aluminum, representing some 35-40 per cent of operating costs. Primary aluminum production facilities are located in areas where there are abundant supplies of inexpensive energy, such as hydro-electric power (55%) and cheap coal (30%). Only 15% of the world's aluminum production capacity is fired by natural gas-based power plants. In most cases, the gas used is gas that would have been flared or in very large supply. Such countries include Qatar and Venezuela which are among the top ten in global gas reserves. Although current power prices in Trinidad are by far the lowest in the region, it is understood that a 50% reduction is necessary in order to make an aluminum plant viable in today's market conditions. Current costs for industrial power are reported to be of the order of US$0.04 per KWh, but investors were said, at one time, to be asking for power at a cost of US $0.015 per Kwh (Norsk Hydro Project). These numbers are only indicative. The salient point is that the current commercial electricity prices are too high to attract a smelter. It follows therefore that if we do have MOUs agreed for smelter or smelters, it means that there has been an agreement on a competitive price of gas and hence lower cost of power. We should also note however, that the use of combined cycle gas turbine technology can lower the cost of generation.
The promise of aluminum
As any other mega gas-based investment, aluminum promises to increase investment, output, government revenue, employment and export earnings. The development of an Aluminum industry is simply an extension of the Point Lisas model of resourced-based industrialization which we have pursued since 1974. The major difference in the last ten years has been the resurgence of foreign capital. What we can glean from the scant information in the public domain is that its attractiveness is based primarily on potential contribution to two important national development objectives. Firstly it represents a diversification of the gas portfolio - that is the mix of gas-based industries. Trinidad and Tobago already has the distinction of being among the countries with the most diverse portfolio of gas-based industries which includes steel, cement, ammonia, methanol, LNG, CNG, gas processing, power generation and a range of light industrial and commercial applications Secondly, aluminum holds great potential for deepening the country's industrial base. Aluminum products feature prominently in the aerospace, automotive, packaging, building and construction, commercial transportation, power distribution and industrial markets. Myriad opportunities for downstream expansion will arise.
From the above discussion, it is evident that vastly different factors influence the investment interests of the state and companies. In these circumstances, there must be a significant trade-off if any investment is to take place. In short, T&T must provide competitively priced natural gas if it wishes to win aluminum investment(s) and fulfill the downstream expansion promise. The essential economic question then becomes does the stream of economic benefits compensate T&T adequately for the revenue foregone in lower gas / electricity costs?
Gas Master Plan consultants Gaffney Cline estimated that government would have had to forego revenue of US$500 million over the life of the project to secure the Norsk Hydro investment. Given govern-ment's insistence on two projects my own rough estimate suggests well head revenue foregone of US$ 800 to $1000 million over the life of the projects. In addition to this, the state also bears the cost of infrastructure - estate and marine facilities. Given the burden of the trade-off that seems necessary to "win" an Aluminum project, careful consideration needs to be given to its potential benefits. Simply put, growth in output, exports and employment is necessary but far from sufficient. In deciding on the attractiveness or appropriateness of an aluminium smelter for T&T, we need to determine what makes an investment sustainable from an economic development standpoint?
After 30 years of resource-based industrialization, this question seems trite. The harsh truth however, is that as a society we have failed to take note. As a result we seem to be starting in the same place at each juncture, not having assimilated and distributed the lessons of experience. The first criterion is that we must seek to quantify net value added. It is insufficient to speak only about growth in output. Real sustainability is a positive function of increased value added. A crude rule of thumb is that an industry increases its net value added as it grows from primary to tertiary or finished goods production. After thirty years, Point Lisas is only now beginning to move towards downstream processing. LNG is no more than a primary processing plant, exhibiting all the features of the plantation in an industrial age. In the specific case of aluminum- it is imperative that the country seeks to maximize linkages with the national economy. It is here that the onshore economy can meet the offshore. This means that the tremendous downstream potential of aluminum must be captured. The onshore economy must be stimulated so that domestic entrepreneurs either by themselves or in conjunction with foreign partners can seize the opportunity to become involved in what is still a growing business. But the downstream promise does not happen by chance. Much the same was promised by the investment in ISCOTT in 1979. To date, the downstream steel industry has not grown as expected. It would be naive for us to expect a different result if our approach to aluminum is the same. Conscious, well-planned and deliberate action is required.
Increased local value added can also be captured from greater local equity ownership including participation in the local capital markets. For example, state ownership of one smelter project opens the opportunity for direct public participatison in wealth creation through the divestment of state equity at a later stage. Another opportunity for increased value capture is via equity ownership along the aluminium value chain. It is one of the critical mistakes made with LNG. Ten years after the formal signing of ALNG Train 1 agreement we are only now discussing investments in shipping and re-gas facilities. These ideas on increasing value added are not new or unique. They are very well articulated in the policy document on local content and public participation. The challenge is to move from talk to action.
The second criterion is the development of local technological capability. TNCs, particularly in the extractive industries, are notorious for providing the workforce with only operating and maintenance skills. In the classic TNC subsidiary operation, most if not all strategic decisions are made at the head office. The result is that locals never get to learn the tricks of the trade. In a recent study of energy sector based TNC in Trinidad, Lou Anne Barclay found that "the foreign investor has played virtually no role in enhancing the country's indigenous technological capability." Their contribution has been limited to training nationals in the operations and maintenance of process plants. It is imperative therefore that we move beyond the mere provision of "jobs". What is required is the opportunity to develop innovative and strategic skills - including product innovation, commercial, business development and leadership skills. What is important is that these firms are committed to developing or funding specialized training institutions so that locals are exposed to and or assist in the development of new process and product technologies. Our history with energy sector based TNCs suggests that the above ideals may not be possible without a share of ownership and decision-making power.
The third criterion is export earnings. The hydrocarbon sector is the primary source of foreign exchange earnings for T&T. While aluminum will add to that export base and increase its size there is no reduction in price volatility. Aluminum prices have fluctuated from US$1000/ tonne to US$ 2100 pr tonne over the ten year period 1990 to 2000. Of interest to citizens would be the prices used in making projections of plant revenue and foreign exchange earnings. A conservative approach is advised. Here again downstream investment is advisable as a hedge against primary commodity price vulnerability.
There are two important fallacies of energy sector investment that need to be clarified. The first is with respect to employment. Over US$10 billion has been invested in the energy sector over the last ten years. Yet the sector continues to employ under 4% of the labour force (less than 22,000 people). The fact is that energy sector expansion will not provide much needed jobs in the number necessary to create the type of society we want. The current low levels of unemployment could quickly disappear if government reduces its expenditure on welfare employment. The combined workforce of CEPEP and URP is estimated at over 120,000 persons. What is true for the national community is also true for the South West Peninsula. This region has one of the highest levels of unemployment in the country and energy sector growth is not the panacea that it is made out to be. In some ways, the protests about the smelter is partly due to the absence of other viable employment in the area and the fear that beyond construction, most of the jobs generated will go to "aliens". In both Point Lisas and ALNG, the majority of workers in the industry do not come from or reside in the community.
The second myth that seems to be pervading is what I call "the more the merrier" aluminum is a mature industry. Trinidad and Tobago's entry is based essentially on lower energy costs. This is not a sustainable position since there are many nations where gas is relatively cheaper than T&T. There are also many nations in which hydro power can erode competitive advantage based on cheap natural gas. Michael Porter speaks of the value of rivalry among firms in the local industry in aiding and abetting national competitiveness. The concept of rivalry among firms is irrelevant in the case of the T&T aluminum business. In this case, the establishment of two aluminum smelters, on the terms outlined above, means that the state is in fact setting up conditions for a foreign firm to compete against a national firm, in which state as representative of the people proposes to hold 60% of the equity.
Summary
From an economic standpoint the development of an aluminum industry in T&T has opportunity costs in the form of revenue foregone with respect to the pricing of power and natural gas. In this context, a smelter seems attractive and advisable to T&T only if it meets prescribed targets for increased value added, increased economic rents and improved technological capability. The sum of these benefits should outweigh the revenue forgone or the opportunity costs of alternative investments. On this basis, it seems that a credible case can be made for the Alutrint smelter. National ownership, smaller size and gas consumption, a programme of training and research in conjunction with UTT, and a business model that embraces downstream expansion are its main attributes. This, of course assumes that the environmental issues are carefully managed to mitigate negative consequences. A final decision either way rests on the quantification of the broader socio-economic costs and benefits, the results of which should be subjected to public scrutiny.