Good day, ladies and gentlemen, and welcome to the Norsk Hydro Q3 2012 Conference Call. At this time, I would like to turn the conference over to your host today, Mr. Rikard Lindqvist. Please go ahead, sir.
Welcome to Hydro's third quarter results conference call. To present the results is President and CEO Svein Richard Brandtzæg, and Executive Vice President and CFO Jørgen Rostrup. After the presentation, there will be an opportunity to ask questions. I would first like to draw your attention to the cautionary note in relation to forward-looking statements. With that, I leave the word to Svein Richard.
Thank you, Rikard, and I would like to start this presentation with a brief recap of the deal we announced last week. We are creating a world-leading extrusion company together with Orkla. We will have 50/50 ownership in the joint venture. The new company will be called Sapa and will have number one position in Europe, North America, and strong foothold in emerging markets. This will be a company with strong management and leading technology, leading competence, and good organizational capabilities. The synergy potential is estimated to be NOK 1 billion per year. It will be a company with a revenue of about NOK 47 billion and 25,000 employees.
For Hydro, this is value creating from day one, and I'm very happy with the attractive valuation for Hydro's assets. Hydro is through this deal again taking leadership in the industry and building a better industry structure. Let us turn over to the highlights from the third quarter, where we had the underlying EBIT of NOK 8 million, a weak result, very much influenced on the decline in alumina and aluminum prices. The alumina prices went down to about 10% in the quarter, and aluminum prices down 7% in the quarter. We had the record high bauxite production in Paragominas. The downstream were very much influenced by a weaker market especially in Europe, but partly offset by lower operating costs.
In energy, we had lower prices and also lower production. If you take a closer look at the Extruded Products business, we saw a decline in all different areas. Extrusion Eurasia, -9%. Building Systems, -13% in the quarter. And Extrusion Americas and Precision Tubing, -7% on volumes. If you compare the quarter this year with the third quarter last year, we can see a steep decline in Extrusion Eurasia and Building Systems, while Extrusion Americas and Precision Tubing was quite stable. The Extrusion Eurasia and the Building Systems business is, of course, reflecting the very weak situation in Southern Europe and very much influenced by the sovereign debt crisis.
All in all, 9% down in Extrusion, quarter by quarter, and also this quarter compared to the third quarter last year, -9%. Rolled Products sales were more stable. Some improvements in litho and foil, but also significantly weaker in the building and packaging. Can, beverage, auto, heat exchanger, general engineering is stable. We had similar volumes this quarter as the previous quarter, and also similar volumes this quarter as we had in the third quarter last year. It is still a challenging market with 0% growth. However, it's more positive in Rolled Products than the more challenging Extruded Products market. In the Primary Aluminum, the third quarter demand was reflecting normal seasonality, meaning a bit lower than the second quarter, which is a stronger one.
The aluminum production was quite stable due to curtailments or also restart of disrupted capacity. The announced curtailments of 1.2 million tons will not be in full effect this year. About 700,000 tons will be the total effect for 2012. With regard to the disrupted capacity, about 400,000 tons has been out of production in total as we estimate for 2012. We maintain 2% growth in aluminum demand outside China, and we expect a more balanced market in 2012. Looking at the inventories, there's been some changes between reported inventories and unreported inventories, but all in all, quite stable levels. However, with regard to ingot premiums, we see that this metal is not easily available in the market.
There's very high ingot premiums between $230-$280 per ton in different regions. That means that for us to do remelting of standard ingots and producing, for example, primary foundry alloys, this is no longer attractive. We have reduced the production of primary foundry alloys this quarter due to the high premiums of standard ingots. There's been volatile aluminum prices in the quarter. Realized price was $2,022 coming down from $2,167 per ton in the previous quarter. It's volatile on low levels, and it's reflecting the uncertainty and the weak macroeconomic outlook.
This is a good opportunity for me now to give some comments on the situation in Brazil. We acquired the bauxite and alumina assets in February last year. First of all, we can confirm the strategic rationale for the deal. There is a fight for raw materials, and we are also seeing a change in pricing of bauxite and alumina markets. We have also seen that there is a higher cost to build new capacity. In Paragominas, we increased the production since we closed the deal with 42%. I'm happy to see what we said, that the volumes is now confirmed, that we were focusing very much on volumes and we have delivered accordingly.
The macroeconomic situation and raw material pressure is continue to be a challenge. LME is lagging the raw material cost inflation, and that means that margins in this business is also under pressure. Looking at the prices of alumina, we see that it has been quite stable during the last year, while the LME has been quite volatile. We have seen that the contracts now is based on index pricing. Index pricing, as we see today, is the new development that we are welcoming. Alumina is priced on its own merits and not linked to LME.
We expect that the long-term contracts will both be more likely to be index linked now than the LME linked reference, as we have seen previously. If you take a look at the Chinese import and export balance, we saw a quite high demand for bauxite in the beginning of the year. Import of bauxite from, especially from Indonesia, some bauxite also from Western Australia, but a strong increase in import of bauxite. From May, when Indonesia introduced the ban on bauxite export, they gave licenses to certain players. However, with 20% export tax this year, which is planned to be increased 50% in 2013, and a ban on export from 2014.
It seems that this change has been extremely effective. We see from June a significant decline in import of bauxite to China. China is now looking for alternatives in even the Atlantic area. We have sold also cargos now to China, showing the strong appetite for bauxite and also the challenging situation that the Chinese aluminum industry is in today. If you look at alumina imports, there has been 200% growth in 2012 year to date compared to 2011. With regard to primary aluminum, we see they are broadly balanced this year in China. With regard to semis and fabricated products, the export, as it is today, is similar to the levels in 2011.
As I mentioned, there is a raw material cost challenge. If you compare the LME, for example, with the situations in the first quarter 2010, it has been a reduction of 10%. While when we compare the cost index of today compared with the first quarter 2010, there is a 119% increase. Coal price increased in this period with 36%, and there's also been an increase in fuel oil price. We had ICMS tax in Brazil added to the fuel cost in second and third quarters this year, which would add another 30 percentage points in these two quarters. We have, from the fourth quarter, been released from this tax in Brazil.
If you compare our position in bauxite alumina with our peers, first half 2011, second half 2011, and first half 2012, we have the highest EBITDA margin in dollars per ton compared to our peers. Meaning that we keep leadership in this business. This is also confirming what we said during the presentation of the acquisition, that we believe that the cost position of Paragominas and Alunorte was good. This can be confirmed also through this slide. This doesn't mean that we feel that this is good enough because there is a weak results from this business. That's why we are continuing our efforts in improving the bauxite alumina business.
We continue the NOK 1 billion improvement program that is going to be delivered next 2-3 years. This is, of course, essential to keep our competitive position. It will be an improvement of productivity, maintenance, operational performance. It will be optimizing and right sizing of the activities. Also a part of this program is to continue to commercialize bauxite and alumina, and get the effect of the new pricing of these materials. If you then move to primary metal, we see that the cash cost has been reduced to $200 per ton from 2011. This is due to probably 1/3 of the effect is due to the introduction of Qatalum. This is included now.
It's effect of reduced alumina cost, that is, 1/3 of the effect, and remain is related to the overall improvement and also some help from currency and raw material. The $300 program continues and is on track. One comment there is that the costs and margins are challenging due to the high standard ingot premiums. However, we are outperforming these targets. We will discuss more on the $300 programs at the Capital Markets Day later this year. In Qatalum, we continue the strong production. We have a stable production and are producing above nameplate capacity. The seawater cooling tower is now under progress to be reconstructed. It is already in operation, parts of it.
That means that we can now operate all turbines in Qatalum, where we have four gas turbines and two steam turbines. All turbines are now operating. The next step for us is to continue to optimize the operations and make sure that we reach the cash cost levels we are aiming for, and there are still some potential. Thank you, and then I leave the word to the CFO, Jørgen Rostrup.
Thank you, Svein Brandtzæg. Let me walk you through some financial numbers. We start with a slide showing the development in underlying EBIT over time. You will see the change from Q2 this year to Q3 of more than NOK 500 million down to a zero result or close to zero result for the quarter. This is significantly impacted by lower prices, the effect of LME on our earnings, as well as reduced volumes above seasonality, lower energy result, and somewhat offset then by reduced costs. Just one reference to Svein 's comment around the planned joint venture within Extrusion with Sapa.
We have this quarter reported Extruded Products, as we normally do, meaning that we have not reported it as discontinued business or business for sale. The reason for this is that the decision to combine our extrusion activity with Sapa was made in Hydro in the fourth quarter, and no conclusion or decision was made at the closing of the account at the 13th of September. We will only next quarter most likely report it as business for sale or discontinued business. We expect that closing of this transaction could result in a gain to be recognized in our books in the magnitude of NOK 500,000 . I will get back to the business areas later on.
Just say that the other and elimination reporting area has a similar charge of common services and other businesses as normal. The lower charge this quarter compared to last quarter is due to elimination of internal gains and losses on inventories. This is the number that fluctuates up and down every quarter according to the margins in the internal sales that is stored in inventories. The charge in itself is at the same level. If we look at kind of a high-level waterfall analysis of the NOK 0.5 billion in change quarter-on-quarter, you will see that we allocate NOK 0.6 billion, so more than the change itself, NOK 0.6 billion to the effect of changing LME.
Either changing LME directly on our metal sales or the consequence for our alumina contracts, our legacy alumina contracts. The 0.6 is more or less evenly distributed on both our alumina business area and the primary metal business area. There are two minor changes. One is the energy earnings, and the other is a net number including the volumes. The volumes are a little bit down, as Svein Richard Brandtzæg said, partly because of seasonality and partly because of continued weakness in the European markets. Counteracting this is improved costs, lower costs in the quarter. This is partly variable costs, but also several cost elements, fixed cost elements, both in upstream and in downstream business. Some of them are one-offs.
The third quarter normally, particularly in the upstream business, has lower costs than the other quarters, so we should expect some rebound of a little bit of this part in the next quarter. Looking at key financials, you will see that revenue is down with some 12%, NOK 2.5 billion. This is due to the same factors as we talked about, the combination of lower prices and lower volumes. We have the eight million, excuse me, in underlying EBIT and minus four hundred and fourteen in reported EBIT, which means that we are excluding from the underlying EBIT negative effects of four hundred and twenty-two million in the quarter.
Hundreds of this is related to derivative effects on LME and power, associated with an increasing LME over the quarter. As you know, these derivative effects we always put in items excluded every quarter. The remainder of this part is the impairment and rationalization charges related to our restructuring program in the various business areas. Most of this is non-cash. We have positive NOK 245 million in financial items, mainly related to net currency gains of NOK 283 in the quarter, which is influenced by the appreciating Norwegian krone over the dollar. This is the impact on dollar debt of the change, of the strengthening of the Norwegian krone. This gives us income before tax of NOK -169 million.
A small tax expense due to payable power surtax in the Norwegian hydropower system that we have, which again then gives a net reported loss of NOK 231 and underlying net loss of NOK -70. If we turn to the different business areas and starting with bauxite and alumina, you will remember that we guided cautiously on this in the second quarter. We have a significant weakening in this quarter in bauxite and alumina. It's NOK 200 million down to NOK -386 and only marginally positive EBITDA in the quarter. Prices were significantly down in the quarter in the range of 9% from $300 down to $270.
You will see from the slides that Svein previously showed you that the index prices are around $320. The mix of contracts and sale that we have in our portfolio is then sold at $50 below the index prices in the market. We have somewhere between 10% and 20% of our portfolio sold on index prices, which means that still a majority sold on contracts linked to LME, so-called legacy contracts in this context. We expect the share sold on index prices to gradually increase. After 2015, 2016, a large part of our contract portfolio can be renewed with different pricing structures.
As Svein was alluding to, we are very pleased to have a record high production in the Paragominas mine this quarter. We are up 15% quarter-on-quarter, and we are at an annual rate for the quarter at 9.7 million tons. For a month in the quarter, we were on nameplate capacity of 9.9 million tons annual rate. We have succeeded in bringing up the mine and stabilizing it at good production levels. The Alunorte refinery production was a little bit more disappointing. It's a slight decrease from last quarter. We have experienced some issues in the calciners last part of the production process in the refinery.
This has led to roughly 150,000 tons of hydrate being stored and being ready for the final conversion to alumina in the last part of the processing in the refinery. Which means that we should clearly see a significant increase in production in Alunorte next quarter. Looking forward besides production, realized prices will mainly follow the LME with a one month lag. So that means that within the current pricing environment, it should represent an upside in fourth quarter compared to third quarter. We also expect cash costs to come further somewhat down in Q4, mainly due to the exemption of the ICMS tax.
You might recall that we discussed this in previous last quarter, and a decision has been made by the state of Pará in Brazil, which will again exempt Alunorte from ICMS tax on fuel oil. It's effective, I believe, from October first. We expect maybe only some minor inventory effects on the Q4 results. In other words, most of the NOK 150 million charge due to ICMS taxes in Q2 and Q3 will not be included in the fourth quarter and onwards. We obviously will focus, as Svein said, on continuing to stabilize, improve production, and bring cost further down. Moving to primary metal, NOK -10 million versus positive NOK 240 million in EBIT.
A change of NOK 250 million in underlying EBIT for the quarter. Before depreciation, the number is close to 500 positive in Q3. Significantly lower realized prices this quarter going down to $2,022, so it's $150 down compared to last quarter. Price, besides some sales volume effects reduced the result by some NOK 300 million. Offsetting the price effect, somewhat was reduced the raw material cost, improving results by NOK 100 million. This obviously includes alumina, which is then price linked to the LME, but also some energy and pet coke prices came slightly down. We also saw, as I said, a decline in fixed costs contributing positively.
As I said, both here and in particular in the Qatalum unit, these are one-off items predominantly and will change again slightly in fourth quarter. Our cost focus is maintained, and we don't see any negative development. It's just that the one-off items helped us a lot this quarter and will be of smaller effect in next quarter. I will get back to Qatalum on next slide. Obviously, the result is included in these numbers, but I will take that separately. For the outlook, we have sold 80% of our production excluding Qatalum at $1,925, somewhat down from this quarter.
We are expecting somewhat lower production and sales volumes for two reasons. Both the Kurri Kurri plant in Australia has been completely shut down now, including the cast house. There is no remelting taking place. As of now, it's completely stopped. We also see a general reduction in remelt volumes in our global portfolio, also due to the high ingot margins, which makes the remelt of cold metal unprofitable. Somewhat higher fixed cost, as I said. We also would like to say that the President Dilma of Brazil has expressed her intent to reduce the power cost in Brazil, aiming at increasing the competitiveness of the domestic industry. Obviously, we acknowledge the importance of the issue for the industry, and we very much appreciate the initiative.
We believe it will have an effect both for our refinery and our smelter. We will have to return with more information when the process is mature and when we have full insight into the concrete effects on our operations. Looking at Qatalum. First of all, it's very good to see that we continue with a higher and stable production in Qatalum. We are producing 2%-3% above nameplate design capacity and at very stable rates. That is good running only less than a year in full production. Underlying net income, which we include in our EBIT line for the group, was down by NOK 144 million from Q2.
This is very much equal to the positive effect in Q2 from insurance settlement of the power outage incident of NOK 140, wh ich means that the effect of lower LME in Q3 has been offset by reduced cost level. We believe that this is partly due again to non-recurring items, and that the cost level in Q3 is not necessarily representative for the cost level going forward. This is a plant running at somewhat higher than $1,500 a ton cash cost. We are working on trimming that cost level further down. This quarter came out maybe a little bit on the good side when it comes to costs.
The underlying EBITDA in the quarter is on our share 50%, NOK 179 million. Obviously, the underlying net number of -129 is including financial costs and also depreciation on the newly invested asset. Metal Markets, just two comments to that. Performance-wise, we are almost at the same level as last quarter, NOK 104 million versus NOK 117 million last quarter. That is when we keep out of the equation currency and inventory valuation effects. If you include those, including quite high effects on inventory valuation effects, negative effects, the underlying EBIT is NOK 7 million.
Obviously, this inventory valuation effect is due to the increasing aluminum in the quarter, loss on the hedge of this inventory, which we have to take to our books immediately, while we can't write up the physical inventory due to the LME increase. We will only take that when we release this quarter. We expect somewhat reduced volumes for fourth quarter as partly a seasonal effect and partly due to the higher ingot premiums for our remelters, melting cold metal. Rolled Products, a good result from Rolled Products. We are quite pleased with that. It's NOK 90 million above third quarter last year. It's somewhat higher than second quarter this year.
We have seen a stable sales volume in this business, so it's quite a different development than the extrusion business, partly due to the product mix, partly due to the fact that we have more global contracts in this business. The seasonal decline that we saw in some segment was offset by positive effects within the litho business and the restart of production in our Hamburg rolling mill again. We also benefited from a revenue from overseas in the quarter. Operating cost was down in the quarter, also affecting result positively. Into next quarter, we expect to see more and a normal seasonality, lower volumes. Q4 for our rolling business is also a high-maintenance season.
You should expect the result to be more in line with same quarter last year. If we then look to extrusion, which is obviously structurally our most troubled business and where we are hit by the European significant economic turbulence and the decline in Southern Europe in several markets, not least the building and construction markets. We have made an illustration here alluding to the point that our cost program and restructuring program has picked up in speed. We have indicated EUR 80 million over a two-year period from 2011 to 2013. Half of that should be delivered by 2012, so within this year. We are well on the way to achieve that target within new year.
As you can see, whether you look at the year to date or you look at Q3 2012 compared to Q3 2011, we are more or less now at the speed of improvement program where we are compensating the market shortfall with measures taken in our own portfolio. This is obviously cutting capacity, reducing manning, reorganizing our distribution systems and our sales outlets, working on logistical setup, and cutting fixed costs in general. At least we see great benefits from our own program. Obviously the very challenging fact is that the market keeps declining and we haven't seen the end to that yet, we believe.
If I look at extrusion, sales volume was down 9%, as I said, and underlying EBIT was half what it was in the second quarter. Hit by the difficult economic situation, particularly in Europe. We believe some continued weakness in fourth quarter, but we also expect a positive impact by the continued rationalization that we are carrying out. Energy, I think, the headline is high reservoirs and low prices.
As you know, there is a significant volatility in the earnings numbers from energy from quarter to quarter, both due to seasonal reasons and also due to the fact that this is heavily influenced by how much rain and snow is turned into water that we can produce, and to what prices can they be optimized and sold at in the market. Now we are in a situation with high reservoirs. Norwegian hydrological balance and water reservoirs are significantly above the normal 10-year average. That is also what the situation for Hydro as such. If you look into the quarter, power production was down quarter-on-quarter and also compared to last quarter.
Net spot sales the same and prices also lower for this reason of high reservoirs. We have also been in a situation where we have kept out one third of our production capacity in the second quarter, the Rjukan production system. We have had a significant upgrading, first part of our significant upgrading. I'm very pleased to see that that has gone well. We were prepared to spend 16 weeks on this, but we managed to take it down to 12.5 Weeks until we were able to move our production again. All in all, it went well, and we are ready for higher production, and also we will see higher prices in the fourth quarter.
There is no change in our energy setup. This is only the normal volatility in earnings that you are accustomed to. I will end my part of this pointing to our net cash, net debt situation. We started the quarter with a small net debt position of NOK 0.4 billion. We have generated a little bit more than NOK 1 billion from operations, divided on the three different elements that you see on the slide. We have spent NOK 1 billion in investment in the quarter. Capital Markets Day last year, we guided on NOK 4.5 billion-NOK 5 billion in annual CapEx, 2012.
I believe we are able now to see more the number around NOK 4 billion. We have taken down our investment estimates. Another token of the capital discipline that we are putting into the organization with these earning levels. You have some translation effects on the dollar debt depending on Norwegian krone value. Based on this, we are about zero net cash, net debt at the end of the quarter.
Okay. That concludes the presentation, and we open up for questions. Please, operator, go ahead.
Thank you. If you would like to ask a question at this time, please press the Star or Asterisk key, followed by the digit one on your telephone. Please ensure that the mute function on your telephone is switched off to allow your signal to reach our equipment. If you find that your question has already been answered, you may remove yourself from the queue by pressing star two. Again, please press star one to ask a question. We'll pause for just a moment to allow everyone to signal. We'll now take our next question from Ben Defay from J.P. Morgan.
Hi, good afternoon, everyone. Couple questions from my side. Firstly, you're guiding to our fixed cost in primary aluminum in fourth quarter. Is that primarily due to lower capacity utilization, or is there anything else in the division which will impact fixed cost? I know you did touch on that topic during the presentation, but I was wondering if you could expand a little bit. Secondly, what can you do as a company to benefit from and capture the rising premium? Thank you.
Well, Ben, maybe I should start, and I guess Svein will comment on the premium side. On the fixed cost side, Ben, first of all, the prime reason for our comment is that if you look into, in particular, primary metal and including Qatalum, fixed cost is down in such a way this quarter that we were afraid you would interpret that as being a new level going forward. We are not saying that we will have a situation where fixed cost is brought up over and above the level where we have been operating at lately.
We are just saying that there is, first of all, a seasonal effect due to holidays and other things that is influencing the fixed cost level in third quarter compared to fourth quarter. Second, that we have had some one-off items that you from time to time have, that has gone more or less in the same direction and bringing down the fixed cost levels. You will see it when you make your calculation on Qatalum. You can also see it when you look at the primary metal numbers. More important is the fact that we have brought down our business cash cost in primary metal in total down to NOK 1,800 in 2012 compared to the level that we saw in 2011.
For the reasons that Svein was mentioning, it's the Qatalum impact, it's obviously the alumina impact, and it is the $300 impact.
Thank you, Jørgen. With regard to the question about raising premiums, of course, we will benefit directly from this situation in the plants where we are producing standard ingots, which is done in some of our joint ventures. In the Metal Markets area, then we are talking about the production of sheet ingots, extrusion ingots, and primary foundry alloys. That is the main Metal Markets that we are producing. We are benefiting directly from higher ingot premium in connection with the production of sheet ingots to the rolling industry. Because sheet ingots is based on LME, plus the standard ingot premium, and plus the conversion premium for slabs to produce the sheet ingots. That means we are directly benefiting there.
With regard to extrusion ingots and primary foundry alloys, these products are priced on LME plus a premium for the total product. That is, it takes some time before we get the full benefit of the primary ingot premiums. The extrusion ingot premium and the primary foundry alloy premium is under pressure with regard to that. We see there is increase in premiums, but not sufficiently to cover for the high premium of the standard ingots. That is also why we have taken down the remelt of standard ingots to produce, for example, primary foundry alloys in our system. We have now reduced the primary foundry alloy production significantly during the quarter due to that effect.
Okay. Thank you.
We will now take our next question from Neil Sampat from Nomura. Please go ahead.
Good afternoon. On the call, I think you alluded to some potential interest you've got from the Chinese, for bauxite from Brazil. I know you are in a, I guess, a small net long position in bauxite. Could you explain to us roughly what the kind of upside there and the timescale if you're looking at selling bauxite to third parties, and on what kind of timeframe, what kind of upside that could mean for the bauxite and aluminum division, please?
Yeah. Neil, this is of course at the early stage, and we haven't sold huge volumes from Brazil to China yet. It's quite interesting to see that the Chinese now is looking into the Atlantic region to get hold of bauxite. This is of course due to the fact that there's been limitations on the export from Indonesia to China. The Chinese players are now eager to get access to new sources. Most of our bauxite production is of course linked to the alumina production and also then further linked to existing contracts that was entered by Vale. What we can sell now is excess bauxite from the increased production that we have achieved in Paragominas.
We are of course evaluating how to optimize this in the next quarters. It's fundamentally interesting to see that China now is in a situation where they have to go quite far to get a hold of bauxite for their own alumina production in China.
In terms of the economics of that, could you just explain a little bit, I guess, around shipping it from Brazil to China? Is that the kind of thing holding you back at the moment, do the economics work?
In fact, we are shipping to China with good margin. It's clear that Chinese players are willing to pay not only the cost of shipment, but also the price that is necessary for us to be active in this market.
Okay. Thank you.
As a reminder, ladies and gentlemen, to ask a question at this time, please press star one on your telephone keypad. We will pause just a moment to assemble the queue. There are no questions at this time.
Okay. Thank you. That concludes the conference call. Thank you.
That will conclude today's conference call.