Alcoa Corporation (NYSE:AA) Goldman Sachs Global Metals & Mining Conference November 16, 2022 9:40 AM ET
Company Participants
William Oplinger – Chief Financial Officer
Conference Call Participants
Emily Chieng – Goldman Sachs
Operator
Good morning, everyone, and welcome back to our second fireside discussion of the day. I’m joined now by Bill Oplinger, Chief Financial Officer of Alcoa Corp. Bill, thanks so much for joining us today.
William Oplinger
Thanks for having us.
Emily Chieng
Before we get into Q&A though, I might get you to start off with some opening remarks of the scene. What’s aluminum and what’s Alcoa looking like these days?
William Oplinger
Sure. So thanks again for inviting us to the conference. It’s good to see everybody. I was reflecting this morning that six years ago we were at this conference and it was right when we had started the company and we had spun out of Alcoa Inc. and reflecting over the past six years, it’s amazing what has changed.
And I’m sure many of you who have been following us over the years recognize the fact that six years ago we had close to $4 billion of proportional net debt, they were down to around $1.2 billion, $1.3 billion. The balance sheet has been significantly improved. We’re now an investment grade companies. So before when we launched we’re DD-. We’ve done a lot of work around the portfolio and have curtailed and in fact in some places restarted some low cost capacity and just done a lot of work over the last six years, so the company is in significantly better place. It’s fun to look back at six years ago being in this conference and we were probably within thirty days of separating out. So it’s been a great time.
As far as today goes, really — I’ll really just jump forward to what’s going on today. Interesting times in the industry. Metal prices and alumina prices have come down sharply since their highs in the first half of the year, but at the same time raw material costs have stayed stubbornly high. And you saw some margin — significant margin compression in the third quarter. We had record first and second quarter results and then had a third quarter where margins had been severely compressed.
We provided some guidance going into the fourth quarter and let’s just take that off the table because a lot of times people are looking for me to give guidance again in the middle of the quarter. And I would tell you, related to EBITDA, our guidance is the same. So we’re not changing our guidance. At the time, we were saying that the bauxite business would be up $5 million, the aluminum business would be up $20 million, the aluminum business would be flattish and these are irrespective of metal prices or excluding, I should say, metal prices and alumina prices. So you’ve got to update your model for the most recent, not on alumina prices, but holding to the guidance that we’ve provided at the beginning of the fourth quarter.
Question-and-Answer Session
Q – Emily Chieng
Fantastic. So we’ll definitely jump back into the cost side of the equation, but wanted to start really big picture. It’s been clearly a very volatile space for aluminum over the last several years. But things appear to have maybe structurally changed for the better half for aluminum, at least as it relates to longer term demand. Maybe talk about what you are seeing on the structural demand growth side for the aluminum as it relates to its role in renewable energies, EVs, packaging. anything that you’ve seen change among your customer base over the last 12 months that might suggest that those longer term growth rates that we were thinking about accelerating or decelerating?
William Oplinger
So the long term growth of aluminum is a really good picture. Aluminum is a metal that’s used in the energy transition. So significant usage, about 100 kilograms per car difference between an electric vehicle and an ice vehicle, significant usage for solar expansions and for the grid. So when we look out the growth levels of aluminum, usage are strong. So overall, we think they’re probably at around a 3% rate over the next decade.
In our industry, if you’ve been following it long enough, it’s never really been an issue around demand growth. It’s been an issue around supply growth. And one of the reasons why, about a year ago we came out and provided a stronger for longer viewpoint on aluminum is because we do think there are some trends in the industry that will constrain supply growth. First and foremost, the Chinese have put a cap on their primary supply growth to 45 million metric tons. Today, we think they’re probably running around 40.5 million metric tons on a run rate basis. And we think they will get to around a 42 million to 43 million metric ton operating production over the next couple of years and then probably stop growth on primary aluminum.
We’ve seen them stick to that over the last couple of years. New operating capacity has needed capacity permits from existing operating capacity. So we’ve seen them stick to that. And we believe with the focus around the environmental side and the focus around decarbonization, they will stick to that. The rest of the industry with a focus around decarbonization of the process of aluminum, we believe will constrain capacity. And then on top of that, we’ve announced the Elisys project, which is a joint venture between us and Rio Tinto with some ownership from the Quebec government and the Canadian government that is a process that completely eliminates carbon from the smelting process. And that’ll be ready. Our projection is, that’ll be ready by 2024 [isn’t] (ph) in a commercial package and we believe that a lot of customers, a lot of competitors around the world are looking at that and trying to determine whether that will succeed or not.
Emily Chieng
And then bringing back maybe more nearer term in nature, there’s been a lot of moving pieces around the world in the last couple of weeks, we’ve seen potential of that. We could see China reopening next year. But on the other side, European demand has been quite weak. What exactly are you seeing around demand into the remainder of the year? And any early insights on to how 2023 might be shaping up?
William Oplinger
So if I go around the world to some of the key markets, I’ll start in China. Clearly, Chinese demand this year has been weaker due to the COVID lockdown. It’s been weaker due to some of the issues around building and construction. However, their supply at least recently hasn’t been constrained also. They’ve had to take a couple of million metric tons of capacity offline due to energy situation in southern China. So while the demand has been weak, the supply growth has not been huge. And what that means is that, it gets reflected in the Japanese premium. Japanese premiums have been down a little bit.
We then go to Europe. It’s probably the area of weakest demand around the world for obvious reasons. We are seeing our customers shorten up their order books. So instead of a 90 day order period, we’re seeing our customers asking for about 30 days. They simply don’t have the visibility into the strength of their end markets at this point to be ordering on a 90 day basis. That’s largely in the building and construction business. So we sell billet that end up in building construction and for obvious reasons because of the war in Europe, we’re seeing that weaker demand. However, at the same time, we’ve seen about 1 million metric tons of supply come offline. We still think that there’s maybe another one million metric tons of supply that is under pressure with the high energy prices and high raw material costs. So we’ll see over the next six months whether that supply comes offline.
Then I come over to North America. North America is the area that we’ve seen pretty steady order volumes. Our value add product premiums have been strong. Going into 2023, we think they’ll continue to be pretty strong. Many of our customers have self-sanctioned off of aluminum — off of Russian metal. And therefore, our order book has been pretty steady in 2022. Going into 2023 we’ll see, we’re in the contracting season at this point.
Emily Chieng
Fantastic. Maybe shifting gears. I know you touched a little bit about European supply coming offline, but it does look like the number of curtailments installed. Maybe what are you seeing globally around potential for further smelter curtailments? I know a lot of smelters are under pressure. You’ve got maybe some high energy cost in China or lack of power there. Is there more potential for more capacity to come offline in the near term?
William Oplinger
I think there is. I mean, obviously, each of our competitors makes their own decision. They’re looking at their own cost structure. But when we look at the industry in aggregate, as of September I believe the numbers were our Western world capacity — the industry Western world capacity, we believe that around 50% of that was cash negative and something like a quarter of the Chinese capacity was cash negative. And that’s on the smelting side.
On refining, in China, we thought around a third of the Chinese refineries are cash negative. And my recollection is around 20% — 15% to 20% of the Western world capacity on refining was cash negative. What’s causing that? Aluminum prices dipped to $2,200 a ton. They’ve recovered now up to about $2,400 a ton, but coke and pitch prices have stayed high, energy costs have stayed high. And so that’s the smelting situation. In the case, in refining, alumina prices have come down to [$311 million] (ph), and yet caustic prices, which are largely disconnected from the alumina process. Caustic prices have been very high.
Now your next question should be, are we starting to see some relief on that? We are starting to see some small amount of relief on calcined coke. Coal tar pitch has stayed significantly high and we’re starting now to see a little bit of a reduction in caustic pricing. However, as — if you follow our company, that will take time to flow through the income statement. Caustic takes typically around six months, coke and pitch takes roughly a quarter to flow through to the income statement. So, lower caustic prices that we’re seeing today will be reflected in our income statement toward the end of second quarter of next year, early third quarter.
Emily Chieng
Maybe switching gears and talking about the portfolio. You’ve done a lot of work over the last six years into taking higher cost assets down, closing what doesn’t make sense, curtailing there, but you’ve also brought back some capacity as well. So perhaps thinking about the world that we live in today, it doesn’t make sense to have brought back Alumar and Portland, the small pieces of capacity there. And then maybe the second question is how are you thinking about greenfield growth?
William Oplinger
So in the case of the plants that we brought back online, I think we’ll be very pleased over time. And just to give you a little bit of perspective on each of those. Portland is in Victoria Australia. We had incremental pots that were at the facility that we just needed to electrify to gain additional capacity. And I think over time, we’ll be pleased with that. In the case of San Luis, there’s many factors that led us to restart that capacity that are still in place today. So for instance, we’ve got 100% renewable energy contract that kicks in 2024 that is a competitive renewable energy contract that is the kind of the basis for that restart. In addition to that, it’s co located with the refineries, so you don’t have transportation costs for alumina. We’ve got a great workforce that is in place there. We’ve got a strong U.S. dollar in comparison to the real. If you look historically very strong U.S. dollar that helps us with our cost structure in Brazil.
And then we’ve got some value add tax credits that we’re able to monetize that we’re sitting on the balance sheet that really were unutilized that now we can monetize over time. So the restart of Alumar, we’re pretty pleased with. What was the second part of your question?
Emily Chieng
On greenfield growth.
William Oplinger
Greenfield growth, sorry. Interesting situation for us on greenfield growth. We have said two things very clearly. First of all, we’re not going to invest in a new potline that is [indiscernible] technology, whether that’s a brownfield or a greenfield, we will creep our existing facilities. So we’re not saying we’re going to under invest in our existing [Halaro] (ph) facilities. Where we have opportunities for creep will do so, but we’ve committed to not building a Halaro smelter. That means that our future is Elisys.
And as I said, Elisys commercial package, our expectation should be done by the end of 2024. That means between us or Rio, we should have first hot metal out of an expansion either a brownfield or retrofit in 2026. So really towards the second half of this decade, we’ll be looking at opportunities for either brownfields or retrofits or potentially greenfields on Elisys.
Emily Chieng
Maybe sticking with Elisys at this point, are there any sort of financial metrics or operating metrics you can disclose as to the progress you’ve made there?
William Oplinger
So the commitments that we have, the targets that we have in place for Elisys are a reduction of capital cost or capital intensity versus Halaro by 10%. A reduction of operating costs versus Halaro of 15% and a throughput improvement on a footprint basis of around 15% for Elisys versus Halaro. Clearly, these are targets, there’s R&D going, this is an R&D project. We’ve had a couple of smaller cells operating in Elisys that have operated effectively us in Rio through Elisys are now building the extension of the Alma facility that will be three Elisys pots that will occur in 2023. By the end of 2023 and these are going to be commercial sized spots of 450 KA sales. By the end of 2023, we will have much better indication of how effective that will be and whether we’ll be able to hit some of those cost targets that we have.
Emily Chieng
Shifting gear then looking at a segment that’s often overlooked, but very important to you guys as well still. It’s the alumina segment. You do have a net long exposure there. But looking ahead, what does the outlook of alumina look like? It’s a little different from the aluminum drivers that we’re seeing there?
William Oplinger
So the alumina outlook is different than aluminum. And I would tell you it’s probably different than what we’ve historically viewed it. And so, what has changed? First of all, let’s put in perspective what we have in alumina. We do have a net long position, we’ve got a joint venture between us and Alumina Limited, 60% owned by us, 40% owned by Alumina Limited, for the largely the bauxite and refining segments, bauxite and alumina segments. So we have capacity of about 12.5 million metric tons of alumina capacity across AWAC today, something close to 48 million metric tons of mining capacity across alumina.
First quartile position in mining, first quartile position — cost position in refining. Also, the world’s best carbon footprint for refining of any major refining system, we’re the only ones that offer a low carbon alumina product to our customers. So if smelter wants to lower their carbon footprint, they can buy eco sourced from us. So, a really, really strong upstream position. And I just want to make sure that that’s clear. As we look forward, we think that the alumina business maybe — the alumina industry may be a tougher industry than aluminum. That’s changed over time.
So what has changed? As we look forward in aluminum, again, our stronger for longer view means that the Chinese will cap at 45 million metric tons. The green dynamics of aluminum will be able to get a premium for aluminum. If we then go to alumina, as we look forward on alumina where the barriers to entry we believe are probably a little bit lower than what they used to be. The Chinese have a lot of capacity that they can add in the alumina space. And the green dynamics aren’t as strong in alumina as they are in aluminum, specifically the Chinese don’t have a cap on alumina capacity. And as we look forward, the next 10 projects around the world are going to be coal based refineries. And it’s hard to imagine that the world is going to build 10 coal based refineries, but those are the projects that are on the drawing board today. If we were ever to get a global carbon charge that was applied to the refineries that would then put those refineries in a worse cost position.
So as we look forward, we’re thinking that the economics are probably stronger in smelting than they are necessarily in the aluminum bauxite.
Emily Chieng
Maybe switching gears and talking about San Ciprian right now. So on the smelting side of the business, that asset has been curtailed at the start of this year and you’ve got a two year path for that to reopen. But maybe let’s focus on the refinery first, which is still open at this point. Can you talk to us a little bit about what are the energy cost pressures that you’re seeing there? What you’ve been doing and maybe what further can be done in this kind of an environment .
William Oplinger
It’s a very dynamic environment. And the energy given that we’re exposed to spot gas prices for around half of the existing capacity, operating capacity in Spain, very dynamic environment. So I’ll start by saying that very volatile and dynamic. What we’ve done? We’ve got around a 1.6 million metric ton refinery in Spain, that equates to about four thousand five hundred tons per day of operating capacity. We’ve curtailed that down to around 2,200 tons. We were seeing given the spot gas prices, large losses in the refinery. I think it was around $60 million, $70 million in the third quarter of losses in San Ciprian.
We’ve curtailed it, subsequently energy prices have also come down. So that’s a little bit of a tailwind hence the guidance that we provided back at the beginning of the month and reiterated here. So we should see a benefit from some of the tailwinds on energy. We’re down to about 2,200 tons per day. We will look at options around San Ciprian. Had energy still be sitting at $35 a gigajoule. I’d be telling you, hey, we’d be looking at options for ways of potential further curtailment or passing on some of those costs to our customers. We’re in a position where we have to really evaluate what’s going on in the energy market. Energy is a lot better today, which gives that facility a little bit of breathing room.
Emily Chieng
Maybe coming back to — as a follow-up to that point that you just made there that you could either look to reducing capacity further or you could pass on some of those cost to your customers. How willing have those two different discussions been? How easy is it to make those changes?
William Oplinger
It’s not easy to make those changes. And we’ve had to make a lot of hard decisions in Spain. Certainly, decisions that are tough on our employees and tough on the plants and the communities, but the economics have been such that they need to be made. So we tend to work with our unions, we work with the governments to try to make the best decision that impact our employees the least.
Emily Chieng
Then maybe switching back to the smelter right now for San Ciprian. That’s still currently offline, but you’ve made some good progress there on signing some renewable energy contracts. Maybe talk us through what’s there and what’s left before startup?
William Oplinger
So we have a commitment to restart that facility starting in January of 2024. We have a commitment to spend about $103 million on combined restart costs and some of the capital that needs to go into that facility to make it more competitive. We’ve signed two long term deals that are wind based energy contracts. They’re both competitive for the long term. Those facilities need to be built. So there’s some permitting and work that needs to be done to get those facility built. One is with [indiscernible] or the others with a company called [indiscernible]. And for the long term, that should position the San Ciprian smelter to be competitive and to be renewable based, which is critically important today.
Emily Chieng
And then coming back full circle to your energy portfolio, remind us, is there anything left on the electricity side that still exposed to spot or —
William Oplinger
It’s small. So I think the numbers are around 65% of our current operating capacity is powered by contracts that are LME based, so they go up and down based on the LME price, which certainly helps us go through the cycles. Another 30% is fixed price and so around 5% percent is exposed to market.
Emily Chieng
And that exposure to the market price, that’s at Lista in Norway, is that correct?
William Oplinger
It’s pretty much Norway at Lista these days.
Emily Chieng
Okay. Now turning over to capital allocation then. This is what you’ve been focused on over the last several years. The balance sheet has changed significantly since six years ago. So as you think about the strength of the balance sheet now, if the macroeconomic environment does deteriorate further, how should we be thinking about how Alcoa is positioned?
William Oplinger
Balance sheet is in great shape and it’s been our sole focus of excess use of cash flow through the beginning of this year. We put a dividend in place in the fourth quarter of last year. We started to do some fairly sizable buybacks in the first half of this year. But really have been focused on improving the balance sheet. And I would say the balance sheet today is where we want it to be. We’re investment grade, so what Moody’s and Fitch have us at investment grade, S&P has yet to figure it out, but they will get there I’m sure. And so the balance sheet is in good shape. We’ve paid down significant pension liabilities. We have had a massive — at the beginning of our company, we had a massive underfunded pension liability, both from a net and a gross basis. And I bring up the fact that the net has been largely closed as far as the unfunded status and the gross we’ve made significant progress on annuitizing. I think we’ve annuitized around $3.5 billion of the gross liability. That’s important for investors because that just means that liability won’t swing with interest rates. In addition to that, we’ve implemented a fairly significant LDI strategy, which is not derivative based. So anybody who is following the U.K. guilt issue, that’s not us. But we’ve initiated an LDI strategy that should inoculate us largely from interest rate exposure.
Can the balance sheet be better in a commodity company? Maybe the balance sheet can always be a little bit stronger, but at this point it would be just around the edges. So that brings me back to the capital allocation framework. And I know many of you have heard us talk about our capital allocation framework. It starts with maintaining a strong balance sheet. We then go to sustaining the assets, we’re looking at an increase in sustaining capital next year on both sustaining and return seeking that we provided. We’ll give you an update at the beginning of next year on the latest thinking there. And then there’s three uses of cash flow. One is to continue to reposition the portfolio, for instance when we curtailed Spain that cost us some money. The second is returns to shareholders. These are not necessarily in rank order. At any given time we’re balancing these three priorities and the third is position for growth.
We’ve not talked in this form about some of the breakthrough technologies that we have coming down the pipeline for the middle part of this decade. But at some point, given these breakthrough technologies we’ll work, we will have the opportunity to grow and retrofit the facilities in a much lower carbon fashion. So those are the three priorities. We balance them at any given time. You saw that we returned cash to shareholders really through the first three quarters of this year. When cash flows are good, when the balance sheet is strong, we’re able to return cash to shareholders.
Emily Chieng
Bill, is there any thinking around potentially putting a formula around some of those priorities that makes it easier for us to think about?
William Oplinger
There has been a lot of thinking over time. And for the first five years of this company, I’ve been telling shareholders that paying down debt, fixing the balance sheet was the best use of cash flow. And I think it’s proven to be right. You look at where we are in the cycle and the strength of the share price given the earnings level, the balance sheet improvement was important to happen. We’ll continue to consider different capital allocation metrics, have a lot of discussion internally and with our Board around capital allocation. But at this point, nothing to announce.
Emily Chieng
And then maybe just finally around the Sustana suite of products. We talked about Elisys before. It sounds like there’s some good progress there ahead. But on Sustana, maybe reintroduce the suite of products you have there, the low carbon alumina and aluminum products?
William Oplinger
So we have the broadest set of green products in the industry. And we’re able to say that because of EcoSource, which is the alumina product. So EcoSource is a certified product that’s a 0.6 ton per ton of alumina that is certified that if someone who’s on the curve of the carbon generation, if they’re looking in the smelting industry to lower their carbon footprint, they can buy a certified low carbon alumina from us.
In addition to that, we’ve got EcoLum and EcoDura. EcoLum is our low carbon aluminum product. And we’ve seen good pickup from our customers on that product. We’re largely seeing customers in the automotive space, to some extent consumer electronics who are looking to get a very low carbon product that are willing to pay — to be able to get a certified low carbon product. When Elisys works we will have the lowest carbon — between us and Rio, we’ll have the lowest carbon aluminum in the world and it’ll be a massive step change, because it will reduce — it will eliminate the direct emissions from the smelting process.
And then on top of that, we’ve got two other breakthrough technologies that we really haven’t talked much about here. One is called [indiscernible], which is a process that allows us to enter the secondary aluminum market. Secondary is broken down between post-industrial and post-consumer. [indiscernible] allows us to use post-consumer scrap and make very high purity aluminum. And then we’ve got a suite of decarbonizing projects in the refinery industry that will decarbonize refining. So we’ve got a process called mechanical vapor recompression, a process called electric calcination that should take the carbon out of the refining process even further.
Emily Chieng
Great. So we’ll open it up for questions from the audience.
Unidentified Participant
Hi. Sorry, Bill. Hi. Just in terms of San Ciprian. Just looking at costs, obviously, we did see power prices just sort of revert back slightly over the last quarter. When you look forward to making a decision around that, are you thinking more about how the curve this? Or are you thinking about prices at these levels? Because I know as most of the analysts forecast the prices will actually — or import prices particularly for energy will be higher as we come through 203. So just wondering, where it needs to stay in order for the operations to maintain their current capacity?
William Oplinger
Yes. And that’s one of the — when I talked about the volatility and the dynamism around that particular plant, spot energy prices are down considerably, spot natural gas prices, which can’t lock that in going forward. We don’t have the ability to translate today’s spot price into long term contract. We’ll balance a lot of different things for San Ciprian over the next year. One, we make a product called non metallurgical alumina there for many customers in the water treatment space. And we’ll be looking at what we can do there and comparing aluminum prices to energy prices and try to make the best decision. So not a lot more I can say around San Ciprian.
Unidentified Participant
So just maybe on that point around alumina pricing. I mean, the LME kind of told us last Friday that it sounds like they’re waiting for the White House. What’s the White House waiting for in terms of Russian —
William Oplinger
Yes. I am certainly not in the position to speak for the White House. We can let the White House speak for themselves. I can give you some insight into our thinking about what we were pushing the LME to do and what we continue to lobby the U.S. government to do. Around the LME, it was really — it was interesting to me their response. It was really an economic discussion around the LME. Russian metal for many Western world customers is not a desired source of metal. And if Russian metal continues to go into the LME, the underlying LME contract will be based on a product that is less desired by customers. And hence, you’ve got a reference price that is theoretically lower than what it should be. Now what’s our argument with the LME is that, you’re essentially damaging your own branch, you’re damaging the underlying contract by continuing to allow Russian metal into the warehouses.
The discussion or the lobbying with U.S. government is slightly different, slightly more nuanced. Essentially, the energy crisis that has been caused around the world has been caused by the invasion of Ukraine by Russia. And that the Western world suppliers have had to deal with that energy crisis in aluminum and yet the aluminum industry in Russia hasn’t had to deal with that. So our lobbying with the U.S. government has been, if you’re looking for opportunities to sanction Russia further, there’s an opportunity do so on aluminum.
Emily Chieng
Any other questions from the audience?
William Oplinger
Appreciate the time. Appreciate the interest that you’ve shown in Alcoa and look forward to talking to many of you over the next day. Thank you.
Emily Chieng
Thanks, Bill.
William Oplinger
Thank you.
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