Rio Tinto Likely To Close Gove Alumina Refinery In Australia

Rio Tinto (NYSE:RIO) has indicated that it has scrapped plans to convert its Gove alumina refinery in Australia to run on natural gas and will likely take a decision on the future of the facility this week. It had been engaged in negotiations with the Northern Territory government to obtain cheap natural gas to replace expensive fuel oil at the refinery.

The company finds it uneconomical to run the alumina refinery owing to rising fuel oil costs, a high exchange rate and low prices for alumina, the end product. The facility was a part of Rio’s aluminum operations that had been bundled into a single unit called Pacific Aluminum with the aim of finding a buyer for them. However, given the weakness in the market for aluminum assets, the company brought these assets back into Rio Tinto Alcan, its global aluminum division. ((Rio Tinto plc : Rio Tinto Drops Plan to Convert Refinery to Gas, 4-traders.com))

Rio also carries out bauxite mining operations in the area and this part of its business will remain unaffected even if the refinery is shut down. The bauxite produced would now be exported instead of being refined into alumina locally.

We have a Trefis price estimate for Rio of $55, which represents a 7% upside to the current market price.

See Full Analysis for Rio Tinto Here

The Problem With Gove

Rio’s Gove operations are located on the Gove Peninsula in North East Arnhem land in the Northern Territory. The alumina refinery is situated in the vicinity of extensive deposits of high grade bauxite which has high aluminium oxide content. Using the Bayer Process, the facility refines the ore into alumina before it is transported from Rio’s deep water port for smelting into aluminium. Gove produces more than 8.2 million tonnes per annum of bauxite, and 2.7 million tonnes per annum of alumina. ^[1]

The process of making alumina is very energy intensive. It accounts for up to 25% of the total cost of production. So far, Rio has been running the Gove refinery on fuel oil which has now become very expensive and prices are still rising. On the other hand, the price of aluminum has been depressed since 2008 and alumina price being largely linked to aluminum price has suffered as well. In addition, the Australian dollar has been strengthening relative to the U.S. dollar. This is a typical case with countries which are major exporters of commodities because their currencies tend to be in strong demand among importers. The rising exchange rate undermines Rio’s competitiveness in exporting alumina. In short, the company’s refining operations have been suffering simultaneously on the revenue and cost fronts, making them economically untenable. Rio is losing $30 million a year at the refinery and the company’s bauxite and alumina business as a whole reported a loss of $86 million for the first half of 2013. ^[2]

In February, the Northern Territory’s former chief minister, Terry Mills, agreed to supply subsidized natural gas to the Gove refinery for 10 years to substitute for fuel oil after Rio Tinto warned that it would have to close the plant if it was unable to lower fuel costs. He also expressed readiness to take the financial risk for a gas pipeline that could cost up to $1 billion. However, the new chief minister, Adam Giles, said in July that he was modifying that offer. He cut the quantity of gas to be supplied to Rio and asked the company to consider a dual-fuel option for its operations.

Rio has finally decided that the government’s offer falls short of its expectations and needs. Some industry sources say that even if the government had stuck to the original deal, current market conditions would not allow the operations to be profitable.

With many jobs and the Northern Territory region’s economy at stake, Rio’s announcement has set the ball rolling among political circles and one would have to wait and watch to see how it plays out. With political forces involved, it is difficult to say if Rio will go ahead with shutting down the plant or not. We will be keeping a close watch on further developments in this regard. ^[3]

Understand How a Company’s Products Impact its Stock at Trefis

1. Rio’s Aluminum Business, Rio Tinto Website [↩]
2. Rio Tinto H1 2013 Earnings Report, Rio Tinto Website [↩]
3. Rio Tinto ends talks to salvage Gove refinery, The Australian [↩]