THE MOTHER OF INNOVATION
A pending trade war, high energy costs and an unreliable NEM – a trifecta of potential issues for Australia’s largest aluminium smelter at Tomago. But buoyed by strong prices, Tomago Aluminium’s strong innovation culture is driving immediate benefits and future-proofing the business.
STRONG pricing for aluminium in 2017 was propelled by demand from Australia’s largest consumer market China (32mtpa), which grew by 5.2 per cent year-on-year.
In December, the Office of The Chief Economist forecast a 19 per cent increase in the value of Australia’s aluminium exports to $3.8 billion for 2017-2018.
Australia’s fifth largest export commodity remained steady in the New Year, with prices continuing to rally into February to reach their highest level since 2012.
Then there was a pullback on the London Metals Exchange (LME) in March as the US Government escalated it’s ‘who blinks first’ approach to international trade, putting world markets in a tailspin.
It may be pre-emptive to panic at the prospect of US tariffs on Australian steel and aluminium – and the fallout of a full-blown trade war with China – but at the time of writing the Trump administration had downgraded Australia’s previously unqualified tariff exemption to a ‘pause’ status.
To be fair, Malcolm Turnbull and Donald Trump had both ‘confirmed’ Australia’s exemption via social media, but as AI Group chief Innes Willox put it “this on-again, off-again and on-again stuff is no way to treat a serious trading partner”.
The Tomago Aluminium (TAC) joint venture between Pacific Aluminium, Gove Aluminium Finance (CSR and AMP) and Hydro Aluminium has been a Hunter region mainstay for 35 years, operating 24 hours a day since 1983.
As chief executive of TAC, Matt Howell has said he was less alarmed by the potential fallout from tariffs, telling the Financial Review in March that “we’ve got good strong contracts in place”.
A more pressing concern for TAC and other Australian smelters is escalating electricity costs over the long term and – more immediately – reliability of supply.
Aluminium smelting is an energy-intensive business. TAC is Australia’s largest aluminium smelter and NSW’s largest energy user, accounting for between 10 per cent and 12 per cent of total State power demand to produce about 585,000 tonnes of aluminium every year.
From a pricing perspective, TAC is currently about four months into an 11-year hedge contract with energy provider AGL.
According to a May 2017 release from TAC JV partner CSR, based on this contract power costs would increase by about $250 per tonne of production. Mr Howell estimated the extra cost at $100m per year.
Smelting is also fragile business. Reliable electricity supply is critical, and interruptions to a smelter’s supply could cause a catastrophic potline freeze in a matter of hours.
This happened in December 2016 at the Alcoa Portland smelter in Victoria, which lost about 70 per cent of cells due to a potline freeze during an extended power outage.
Portland’s future was only secured when State and Federal Governments committed to a $240 million rescue package in January 2017.
On 10 February last year, TAC was forced to conduct a managed shutdown to cut production by 30 per cent – saving 300 megawatts (MW) – to avoid blackouts in NSW, after a number of generators failed and reduced low priced supply in NSW by 1200MW.
It took about a week for the smelter to return to normal operations.
In a July 2017 submission to the ACCC Inquiry on Retail Electricity Supply and Pricing, TAC claimed that 5500MW of NSW coal or gas-fired generation had exited the market in the last five years, challenging the underlying volume, and reliability, of electricity supply in the NEM.
Looking forward, TAC and other vested interests are concerned that the 2022 closure of AGL’s aging Liddell Power Station in the Hunter Valley would remove 1800MW of reliable baseload power from the grid.
TAC’s current 11-year hedge contract with AGL is independent of what happens to Liddell.
However, AGL — prior to its acquisition of the Macquarie Generation ( MacGen) assets in 2014 – worked from “conservative modelling assumptions” that major customer TAC would close in 2017, which would mean Liddell was no longer required after that period.
It was an odd assumption to make, but this also helped drive the bargain $1.505 billion price tag for MacGen; a purchase price which valued Liddell at $0.
By October 2014 – post acquisition – former AGL chairman Jerry Maycock correctly predicted that TAC probably would not close in 2017 as assumed.
“If the Tomago smelter remains open, then Liddell will continue to operate and will provide incremental profits to AGL over and above that assumed in our base case valuation for Macquarie Generation,” Mr Maycock said.
Soon after, AGL began aiming for a 2022 closure at Liddell. AGL proposed to replace Liddell capacity with new wind farms and gas plants, battery storage, and an upgrade to its Bayswater coal generator, which – by its own calculations – would cost 20 per cent less to produce than if Liddell’s life was extended for five years.
The Federal Government has voiced its concerns about the impacts of removing more baseload supply from the NEM.
In March this year, Federal Energy minister Josh Frydenberg said while AGL are willing to undertake all three stages of their replacement plan, the 100MW Bayswater upgrade is, according to AEMO, the “only committed resource at this point in accordance with criteria AEMO applies for determining new supply”.
“Without the implementation of AGL’s full plan or equivalent investment by others, AEMO has concluded there will be an 850MW shortfall in dispatchable power and in their words “a high risk of load-shedding” following the closure of Liddell,” Mr Frydenberg said.
“The existence of a major shortfall in dispatchable power following Liddell’s closure would clearly present an unacceptable situation undermining the stability of the system.”
AGL stated that decisions for the investments were staged to enable flexibility to respond to the changing needs of the market and improvements in technology over the next five years.
A Culture of Innovation
Despite these potential headwinds, TAC is still a strong, profitable business buoyed by LME pricing for aluminium which – while volatile – remains about $US150 higher than the same period last year.
According to key performance indicators, TAC had also decreased the amount of power needed to produce aluminium over the course of 2017, while metal purity was on the increase.
The smelter is constantly searching for means to increase volumes, reduce costs and avoid loss and waste.
To facilitate this, TAC has built and maintained a strong culture of innovation that incentivises both employees and suppliers; an approach that can pay huge dividends over the long term.
For example – a number of significant projects are helping to combat escalating power costs.
One of the largest and most important of these projects is the Pacific Aluminium Low Energy Pot (PA-LE) pot, designed by the Pacific Technology Centre (PTC), which
could deliver savings of up to $10 million each year.
TAC has recognised that the key to a successful business is a strong supply chain, and works with suppliers to find better ways to deliver results through continuous improvement and innovation.
For the past 13 years the company has rewarded these partnerships – which include more than 500 businesses from the Hunter region alone – at its annual Supplier Event Awards.
For its 950-strong workforce, the Tomago Innovation Awards are one way TAC rewards those employees who contribute to this innovation drive. And there are many; the company’s Wins of the Week newsletter is replete with a number of very impressive employee-driven innovations.
The Overall Excellence in Innovation winner for 2017 was potline operator Nathan Bevear, who designed a lightweight, unhinged, removable aluminium door to replace the heavy hinged tapping doors on the 860 pots.
They were so successful the company has ordered at least 150 of them.
Mr Howell told the Newcastle Herald that Mr Bevear’s innovation increased safety for employees, reduced emissions, cut down on maintenance costs and showed Mr Bevear as “an extremely competent designer and engineer”.
“As well as the safety and health benefits that are an obvious part of the design, Nathan’s re-done doors are cheaper to manufacture than the previous doors and require less maintenance,” Mr Howell said.
Mr Howell said this innovation was a perfect example of challenging the accepted way of doing things.
“Innovation is the lifeblood of success and I’m proud to say, we have some of the best innovators in the business,” he said.
Then there was a pullback on the London Metals Exchange (LME) in March but pricing for aluminium remains strong.
AGL’s aging 1800MW Liddell Power Station in the Hunter Valley is due for closure in 2022. “The existence of a major shortfall in dispatchable power following Liddell’s closure would clearly present an unacceptable situation undermining the stability of the system.”