Good day, ladies and gentlemen. Welcome to the Norsk Hydro Q2 2018 presentation. For information, today's call is being recorded. At this time, we turn the call over to your host today, Mr. Stian Hasle. Please go ahead, sir.
Thank you. Good afternoon, and welcome to Hydro's second quarter 2018 conference call. As always, we will start with a short introduction by President and CEO, Svein Richard Brandtzæg, followed by a Q&A session, also joined by CFO Eivind Kallevik. With that, I leave the word to you, Svein Richard.
Thank you, Stian. Good afternoon, let me then start with a brief overview of the key developments in the second quarter. The underlying EBIT for the second quarter was NOK 2.7 billion, down from NOK 2.9 billion in the second quarter last year, down from NOK 3.9 billion in the first quarter this year. This quarter was negatively affected by Alunorte, Paragominas, and Albras producing at 50% capacity, resulting in reduced volumes as well as cost inefficiencies. The main factors affecting the results in second quarter this year compared to the second quarter 2017 is significantly increased raw material cost, as well as somewhat increased fixed costs, being mostly offset by higher realized oil and aluminum and alumina prices.
Resales from Extruded Solutions and Oil Products increased in the second quarter this year compared to previous year, mainly on increased margins and volumes. In addition, Energy delivered a strong result. Improvement from same quarter last year is mainly driven by prices and volume. We're obviously maintaining strong focus on the BETTER program and across the business areas we have good progress, and we'll do our utmost to reach the 2019 target. However, due to the situation in Brazil, we do not expect to meet the half a billion 2018 target. Towards the end of January, we started production at our world-class technology pilot at Karmøy, and at the end of June, we had successfully ramped up all the 60 cells. An impressive achievement. Now we will focus on delivering the technology performance as we have planned and promised.
Finally, when it comes to the market side, we see the global aluminum market is in a deficit situation in 2018, but with an continued and increasing uncertainty following the U.S. trade tariffs and wholesale sanctions together with the situation in Brazil. We reiterate that we expect global primary demand to grow by some 4%-5% in 2018. Let me end my introductory comments with a few words on the situation in Brazil. As you know, we are currently running Alunorte, Paragominas, and Albras at 50% capacity as a result of the embargo on Alunorte. The process to resolve the situation in Brazil is highly complex and demanding and is taking longer than expected.
We are in a continued dialogue with the government of Pará and SEMAS, as well as Ministério Público, and we have implemented measures that will enable Alunorte to continue to operate safe and sound also going forward, and are eager and ready to resume full production any time. We do not know exactly what it will take for the authorities to lift the embargo, and the timing to get back to 100% is therefore still uncertain.
Thank you, Svein Richard. Operator, we are now ready for questions.
Thank you much, sir. Ladies and gentlemen, if you'd like to ask an audio questions, please press star one on your telephone keypad. A voice prompt will indicate your line is open. Please state your name before asking your question. We'll move to our first question now.
Hi, Svein Richard, it's Jason Fairclough calling from Bank of America Merrill Lynch. I just wanted to start with the obvious question here, which is Alunorte. I mean, you've said that there's not really much change. What's the problem? It would be great to have a little bit more color as to, you know, where we're stuck. Are we stuck with the local government? Are we stuck with the state government? Are we stuck with the federal government? Are we still back at Ministério Público? You know, you guys, I believe, had initiated a court action. Where are we with that? It just seems to be, you know, we're just dead here. I mean, in a way, I wonder if I should just take out 50% of Alunorte forever.
Is that, overstating things?
Thank you, Jason. No, I think, yeah, that is really overstating. Since we met last time, there has been made progress, of course, and it's moving forward in the right direction. As I said, it has taken longer time than what we expected, and that's why we're also now evaluating to curtail three lines out of the seven production lines in Alunorte. We are now negotiating or discussing with the government of Pará, SEMAS, the state environmental agency, and we also have had several meetings with the Ministério Público. The embargo to lift the embargo, we have to have clearance from government of Pará, from SEMAS, and also IBAMA, that initiated the embargo on the DRS2 and the press filter.
Of course, we also need the court ruling to formally lift the embargo. What we are now working with is the Term of Adjusted Conduct, which has moved forward, I would say, constructively, and we are very close there. It's a TC, it is the social part of the agreement that we are now discussing with the authorities. Also there we are moving forward. As I said, we don't know exactly what it will take for the authorities to lift the embargo, and that's why we, of course, a bit disappointed to observe that it has taken longer time than what we expected.
We are not in a situation where we really think we are not going to find a solution now. It's just a matter of time when the solution will be found and agreed with. All in all, I would say there is definitely progress, but yeah, I'm uncertain about the speed to reach the final target.
Richard, I acknowledge that you guys are working very hard on this, and it must be very, very frustrating. I'm just gonna push a little bit here, if that's okay. If we actually walk through these different bodies, has anybody given you any kind of sign-off, you know, whether verbal or written? It just feels like it's a chess game, but nobody wants to go first. Is that what we're dealing with? Or is there one particular group that's not allowing this to happen? Or is it all of them together don't feel particularly motivated?
I think it has been a maturing process during the last months. Because if you think about the statements given in newspapers and media in Brazil, after having rain-heavy rainfall in February, it was a quite strong messages that was also supported by some politicians that concluded based on pictures and based on articles. It's quite a long way to go to really turn their mind positively after what was said in media.
When we are now getting more external support for what we have said all the time, and what also was the result out of the internal and external review, that is also published the ninth of April, where we concluded that there has been no harmful pollution or no pollution after the heavy rainfall from Alunorte and no overflow from the red mud deposits that was really in focus here. We have now got also the clear conclusion from SEMAS, the local environmental agency, the state environmental agency, that there has been no overflow from the red mud deposits. IBAMA, the federal environmental authorities, also confirming the same.
When we look at now the recent media situation, it has changed quite a lot. There was quite a good article in the newspaper in São Paulo last week that they are addressing the problems for the population now is, as we have also said, related to lack of infrastructure. When it's 90 cm of rain coming within a few days, then there is a overflow of sewage and into the wells. It's a landfill that is close by that is not protected. There are a lot of other things that really they have to look into there. I think it has taken some time to mature.
When we now see and listen to the authorities, I would say that it's a constructive dialogue, but we are still not able to really conclude on what time it will take, Jason. There's still uncertainty with the timing, but we are going to solve this issue.
Just one last one for me. Are the courts an avenue for you here? I mean, I believe there was a court action. When do you go to the courts?
Well, we see now that we will find a solution now with authorities first, and then we will go to the court with agreement, and then that will be the step that is necessary to lift the embargo.
Okay, I guess the point is if we get to, let's say we get to November or December and nothing's happened still, can you actually go to the courts to try to force some sort of re-resolution of the issue? Are you basically at their pleasure?
This is not an avenue that we're pursuing, Jason. We would much rather like to find a constructive agreement with the government, avoiding the sort of legal court discussion.
Okay. Okay, thanks very much, both. Appreciate it.
Thank you, sir. Ladies and gentlemen, once again, if you wish to ask any questions, please press star one on your telephone keypad. We'll take our next question. Caller, please introduce yourself once you hear the prompt saying your line is open. One moment, please.
Hi, this is Dan Major from UBS. A few questions. Firstly, not to labor the point, but just on Alunorte, more of a follow-up from Jason. Am I correct in saying, so you've got a clear conclusion from SEMAS and IBAMA on you not causing environmental damage? Do you have a similar agreement from Ministério Público? Is that, yeah, and is that still a contentious point in the negotiations?
Well, I wouldn't say that this is, this is the main point here. What we are discussing here is, I think is the main point for, for the fact that we have not, contributed with any pollution. That is, of course, very important that these authorities are stating that, not only, the internal and external report, but also the environmental authorities, they are doing the same. This is, this is of course, very important. With Ministério Público, it's, more discussions about the social, the social plan, how we can support our neighborhood, and that is, that is ongoing.
Ministério Público has agreed with the conclusion of SEMAS and IBAMA and yourselves that you didn't cause any environmental damage, and the focus is really on the Term of Adjusted Conduct from their perspective. Is that correct?
That it, they are not going into the press and giving statements about this. This is a ongoing discussion that we have. The Term of Adjusted Conduct is key. The TAC is the technical part, which I think we can say we are very close to agree on. The other one is the TC, the terms of conduct for the social agreement, where I think the views from Ministério Público will has to be taken into account.
Okay. Thanks. That's clear. Second question. You mentioned on the call earlier that you have your alumina requirements covered for the rest of the year, you are obviously still in the market, it looks like, in terms of your sourced alumina, purchasing more alumina than is implied by the contract from Yarwun, and you're still supplying externally. Can you give us a sense of how much alumina you're still buying in the spot market, what conditions are like at the moment, and what do you see as being driving the recent tightness in the market that's being reflected in the uptick in the alumina price?
Yeah. With regard to, as I said, we are mostly covered, for our smelting capacity for the rest of the year. We have been working in the, in the third-party market there. Maybe Eivind you can talk more on that.
Yeah. When it comes to pricing, Dan, these contracts are related to the FOBs index, as most if not all contracts are in the marketplace today.
Sorry, just to follow up on that. Am I right in saying you, if you take the annual number that you buy from Rio Tinto on an aluminium price linkage, it's about 225,000 tons a quarter, and you bought 985. You're buying the rest just simply in the spot market. Is that the right assumption?
That's the right assumption, Dan.
Okay. Perfect. Thank you.
Does that answer your question to some nature?
I'll let someone else go and follow up as it's been already answered.
Thank you much, sir. Ladies and gentlemen, once again, as a reminder, please press star one on your telephone keypad. If you have any follow-up questions, please do signal again by pressing star one. Caller, please, I'm just gonna open the next line. Please, again, introduce yourself before asking a question. Phone, please.
Hi, it's Jason Fairclough again. It sounds like there's only me and Dan on the line, or we're the only ones asking questions. Look, a little bit more techie. Karmøy, I see it's up and running at full capacity now. In terms of the cost performance, do you feel like that is now at a steady state cost performance? How long before we think about taking the benefits from Karmøy and the learnings from Karmøy and transferring those to some of the other smelters?
Okay. I would say that from a cost perspective, we have a higher cost for the moment. There are a lot of work on stabilizing the electrolysis cells, which is quite normal procedure. And stabilizing the equipment, there are follow-up costs that follows there. The cost is higher than a normal operation, obviously. If you then think about the technology elements that we are going to transfer from the Karmøy technology pilot to the existing smelters, we say that it's one to two years time before most of the elements will be ready for transfer. It's many different elements related to the cathodes, to the anodes, to the computer control system, its heat balance, its interpolar distance.
Several factors that is affecting the output and the energy consumption. All in all, we, if you look at the ongoing plan we have for increasing current density in our existing cells, you will see from 2015 to 2025 an increase of 200,000 tons altogether as a result of these technology elements. On top of that, our intention is of course also not only to increase production, but also at the same time to reduce energy consumption. That is something we will come back to later.
Just to follow up, Svein Richard. There was a interesting announcement that came out from the Canadians and Alcoa and Alcan, talking about starting to implement an inert anode project. Is that something that you guys have looked at or are working on? Do you feel like you're falling behind now on technology?
That's a good question, Jason, because we have got the discussion from others. We did quite a lot of research work on this in the 1980s and 1990s. It is quite a well-known technology from a principle point of view. There are different approaches there, but it is based on still the same molten salt technology with cryolite as the basis and where you have to operate it at quite high temperature. If you then take away the carbon anode in this process, you increase energy consumption quite substantially. From that point of view, it doesn't make sense.
You can in theory get the carbon CO2 free process, but utilizing the carbon in a way that is done in our process is a very, very efficient way of utilizing carbon. From an energy point of view, it is in a way the best way so far. I can also say that we are also working on a carbon-free technology long-term. That is not something you should worry about short-term, but that is more for the future. That is a technology which is not only carbon-free, but which also reduces energy consumption.
If you think about the technology that as you are referring to, if the energy source is not based on renewable energy, it will increase the carbon emissions because you will have higher energy consumption, and hence, if you use fossil fuel, coal or gas, you will have even higher emissions with this technology. That's why that is not the first priority for us to approach this kind of technology, but we have some other long-term alternatives. In the meantime, we are quite convinced that the technology we are now developing, from a competitive point of view and also from a climate point of view is the, is the best available technology today.
I'm very happy that we have succeeded on the ramp up, and also now already now see that we are producing aluminum at Karmøy with the lowest energy consumption the world have ever seen.
Okay, thanks very much.
Thank you, sir. We'll now take the next question.
Hi, good afternoon. This is Sylvain Brunet with Exane BNP Paribas. Two questions on cost, please. The first one was on Slide 26 of your presentation, where you give us the breakdown between fixed and variable for both Alunorte and Paragominas. If you could also give us how much of that is labor or if we should assume that most of the Alunorte fixed costs are labor? And my second question is on pitch and pet coke, to get a sense of whether your procurement department expects some pickup in those costs in the later part of this year, as winter cuts would kick in again in China, if there is any expectation that supply tightness could again push these costs higher? Thank you.
When it comes to fixed cost, a large part of this is manning related either directly or indirectly through maintenance workers at the plant. In terms of pitch and coke, what we see for, at least for the third quarter is that we don't really expect any significant pickups in those costs as we get into the third quarter. Then we'll see what the winter cuts are and if they come. We don't expect the same significant change as we saw last year.
Okay. Thank you.
Thank you, Mr. Brunet. Ladies and gentlemen, once again, if you have any questions, please press star one. We'll to our next question.
Hi, it's Dan from UBS with a couple of follow-ups. on Alunorte, you obviously stated very clearly you can't give any guidance on timing of the restart. on your comments around closing the three production lines, is there a hard deadline when, you know, can you give us any more guidance exactly on when you will have to make that decision?
There's no hard deadline here. Of course, this has been an option that has been ready also previously. As the time has now gone and we see that it has taken longer time than what we expected, we are now more seriously evaluating this option. By doing this, we can save also cost $10-$15 per ton, which makes a lot of sense, and adapting the manning to the situation. It is quite demanding the way we are operating now at five lines, two in standby, five lines and operated with the low outputs each. It's not the optimal way of running the refinery.
We are seriously evaluating that now, but we haven't taken a firm decision, but also it's not a firm deadline either.
Okay, thanks. Maybe a couple of kind of modeling related to questions. Can you give us any guidance on the closing date for the ESA acquisition? Is it a early Q2 or Q3 or late Q3 when we should be thinking about that?
We've said, we put a little bit more round that we said during second half of 2018, and this is currently in process in the European Commission, and as such, it's very hard to pinpoint a more specific date.
Okay, cool. Thank you.
Thank you, Mr. Major. Ladies and gentlemen, as a final reminder, if you have any questions, please press star one at this time. We do not have any further questions at this time, let's recall back over to the organizers for any additional or closing remarks. Thank you.
Thank you. Thanks for joining us today. If you have any questions, please do not hesitate to contact us. Thank you. Have a nice evening.
Ladies and gentlemen, that will conclude this presentation. We thank you for your attendance. You may now disconnect. Thank you.