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Opinion: Aluminium and electricity export might not what should matter for Iceland

Alcoa smelter in Reyðarfjörður, East Iceland (source: Krator/ commons wikimedia)
Alexander Richter 28 Jul 2015

A recent study by Icelandic Arion Bank on how the energy resources of Iceland should be used is topic of an opinion piece in the Icelandic media, discussing that heavy industry, a submarine cable might not be the solution.

In a recent opinion article in Icelandic news site Kjarninn, the author looks into how profitable the development of power generation projects has been for the country. The article bases a lot of its point on a recently published Market Research Note by Icelandic Arion Bank.  The following notes are partly translated and partly commentary.

While in many countries, the development of power projects simply fuelled growing electricity demand, Iceland developed its electricity projects to attract energy-intensive industries to Iceland, namely those of aluminium smelters.

Today, no country in the world produces as much electricity per capita than Iceland. The proportion of renewable energy as source for electricity generation is also seldom higher anywhere else, at almost one hundred percent. Nevertheless the straight dividends from electricity generation have been deteriorating on a constant basis. This is highlighted by the fact that the largest power generating company, the National Power Company (Landsvirkjun) has for the past 50 years only paid ISK 15 billion in dividends at present value. This is around $111 million.

This is the outcome of research done by Icelandic bank, Arion Banki and published recently in a Market Research Note, which asked the question on how Iceland should utilise its energy resources. “There is now the opportunity to reverse the situation so that the owners of the resources benefit directly from the proceeds of electricity sales. Demand for “greener” Icelandic electricity has probably never been greater and continues to grow, so the piece by Arion. “The energy projects currently in the utilisation category of the General Master Plan on Natural Resources in Iceland could produce about 9 TWh of electricity annually, which would increase electricity production by 50%. But before starting development one should ask the question of how would it be most efficient to sell all this electricity”, so the report.

Electricity prices must pass yield test

The article then goes into several of the project development options presented and clearly say something to the Icelandic readers, but are also of interest in the international context. Among them are the comments on the Theistareykir geothermal project currently being built.

In its analysis, Arion Bank looks at the Theistareykir project, which constitutes the cheapest power option in the utilisation category of the General Master Plan. With a levelised cost of electricity (LCOE) of $35 per MWh. Under current price levels, the plant would not provide any yield. Therefore funding would be better spent on anything else than a project that sells electricity below cost. If the price is lower than the LCOE then essentially it would represent a subsidised source of power.

No prerequisite for new aluminium smelters

If current power prices achieved, the question is if there would be other ways to sell electricity, e.g. through a submarine cable. At today’s exchange rates, Landsvirkjun and other electricity producers could achieve a profit of ISK 30 billion ($220m), this if a power price of $80 per MWh can be achieved and about 5TWh of exported electricity/ year. This refers to a recent analysis by Arion Bank on the pros and cons of the submarine electricity cable connecting Iceland with the United Kingdom. (report here)

“The aluminium industry is the largest customer of the Icelandic energy companies and represents a large part of the country’s export earnings. Despite this it seems there is no prerequisite for the construction of new smelters in the country, based on the example given above, this in terms of the discounted cost of power which is far above the current price paid by the smelters today.

If one takes the current average price of power paid to Landsvirkjun, this by the aluminium smelters in Iceland, the power purchase by big industry and the world market price of aluminium (London Metal Exchange) in June of this year, the cost of power represents about 25% of their revenues. If there price of power would raise up to $43/ MWh, the electricity cost would represent about 42% of the companies’ revenues. Therefore one can assume that aluminium prices would have to rise considerably should the investment into new smelters pay off, so the research by Arion Banki on the economics of the construction of a new aluminium smelter in Iceland.

Maybe something else matters more

In the final chapter of Arion Banki’s analysis, the question is raised that maybe something else might provide more opportunities for the Icelandic nation than heavy industries or a submarine power cable. “It is possible that neither a submarine cable nor an aluminium smelter provide the nation the best returns from utilising our nation’s energy resources. The main point might also not be the demand on yield, but also maybe the profitability to the owners of the Icelandic energy company – the (Icelandic) nation. The overall interest in the country’s energy resources has grown in parallel to strong tourist streams that make the untouched nature undoubtedly even more valuable than before. A fact that needs to be taken into consideration as well.

Before untapped energy resources in the Terrawatts will be set into contracts on new aluminium smelters,  heavy industry or other submarine cable it would be wise to fully explore also other alternatives that can yield the greatest overall benefit to the economy. How we then distribute the benefits between the state, landowners, local authorities and other stakeholders is a topic for another discussion.”

Comment: This has been a hot topic in Iceland not just with the privatisation of Hitaveita Sudurnesja (now HS Orka and HS Veita), but also with the development of a large hydro power project of 690 MW in the early 2000s and a new smelter in the East of Iceland.

Here another article of today that looks in the average power price of contracts with Landsvirkjun, the chart is courtesy of Askja Energy Partners.

ElectricityPrices_Iceland_2005-2014
Electricity Tariffs to Aluminium smelters in Iceland 2005-2014 (Source: Askja Energy Partners 2015)

Source: “Beinn arður af raforku er rýr – Skilar stóriðja, sæstrengur eða eitthvað allt annað mestu?” from Kjarninn, and “Hvernig á að nýta orkuauðlindir Íslands?” a Market Research Note by Arion Banki (all in Icelandic) – For the article on the electricity tariffs to Aluminium companies in Iceland, see Askja Energy Blog. (in Icelandic)