ASSESSMENT OF CUMULATIVE COST IMPACT FOR THE ALUMINIUM INDUSTRY EXECUTIVE SUMMARY A. Aims and scope of the Study This Study contains an assessment of the cumulative costs of EU legislation on the European aluminium industry, as well as an evaluation of how these costs affect the competitiveness of this industry from an international standpoint. Cumulative costs are compared to production costs and current margins of the European aluminium industry, as well as to the production costs of international aluminium competitors located in i) Africa; ii) Asia; iii) Australasia; iv) Canada; v) China; vi) the Commonwealth of Independent States (CIS); vii) European Union; viii) Iceland; ix) Latin America; x) Middle East; xi) Norway; and xii) the United States. This Study, however, is not an assessment of both the costs and the benefits generated by the relevant EU legislation. As a result, it contains no evaluation of the efficiency, consistency and proportionality of the rules analyzed. Our research question as resulting from the terms of reference given to us by the European Commission, DG ENTR is limited to an assessment the cost generated for the aluminium industry by the relevant legislation. As such, our Study differs noticeably from a full-fledged fitness check, which aims at evaluating the efficiency, effectiveness, burdensomeness and coherence of a corpus of EU legislation in a given policy domain (not a single economic sector). In particular, an assessment of the appropriateness, effectiveness and efficiency of the relevant legislation falls outside of the scope of this Study. The following types of regulatory costs are considered to be relevant for the scope of the Study: 1. Administrative costs: costs incurred by firms due to the legal obligation to provide information to public authorities and third parties, as measured with the EU Standard Cost Model; 2. Compliance costs: costs incurred by a firm as a direct consequence of the need to comply with a legal act; 3. Indirect costs: costs of regulation which have an impact on aluminium producers not as direct addressees, but as counterparts of direct addressees. 1
This Study estimates, in particular, the cumulative costs generated by the following areas of legislation on the European aluminium industry: i) general policies; ii) the commodity markets regulation; iii) legislation related to climate change; iv) competition policy; v) energy policy; vi) environmental legislation; vii) trade policy; viii) product regulation and life-cycle assessment (LCA). In terms of industry coverage, the Study focuses on firms falling within class 24.42 of the NACEv2 classification. More specifically, we have focused our analysis on primary aluminium production; secondary aluminium production (both remelting and refining); and a selection of downstream activities (rolling and extrusion). The following entities are excluded: upstream, alumina production; and downstream, the companies that transform intermediate and semi-finished aluminium products into finished manufactures. Focusing on this class allows the Study to treat similar entities, thereby increasing the degree of accuracy of the findings. The analysis is based on a sample of 11 primary aluminium plants out of the 16 plants that were still active in the EU27 at the end of 2012. The selected sample represents about 60% of total EU primary production at the end of 2012. For secondary aluminium production (recycling) we selected 20 plants, representing about 80% of EU production. Finally, for downstream operations, our sample covers 15 plants (both rolling mills and extruders), corresponding to roughly 60% of EU output. The response rate for secondary and downstream sections of the value chain was lower than for primary production. Hence, while all collected and verifiable information for the different segments of the value chain is reported in the relevant Sections, the cumulative cost assessment could only be completed for primary aluminium production. The cost structures are a fundamental pillar of our analysis: our estimate of the magnitude of cumulative costs is indeed reported both in absolute terms and as a percentage on current operating expenditures and annualised capital expenditures. In addition, estimating these representative cost structures is an essential step for our international comparison of the competitiveness of EU and non-eu aluminium producers. B. Comparison of Cost Structures This section compares the costs for primary aluminium production on a worldwide basis, and assesses the current competitiveness of EU producers vis-à-vis other international players, based on CRU Primary Aluminium Smelting Cost Service platform. To improve the accuracy of the analysis, two subsamples of plants are identified in the Study. The first (hereinafter subsample 1) includes plants that are procuring electricity via old long term contracts or through self-generation. The second (subsample 2) includes plants that procure electricity on the market. 2
On average, EU smelters incur very large business costs of production (2,041$), followed by those installed in the US (1,944$), China (1,923$) and Australasia (1922$). While selected EU plants included in subsample 2 are estimated to be the highest cost producers, bearing business costs equal to 2,229$ per tonne, smelters comprised in subsample 1 (1,615$) have a significant competitive advantage. Only Middle Eastern (1,402$) and Asian (1,582$) plants are currently more cost-efficient. Primary aluminium installations located in the Middle East play the role of least cost producers also when including in the analysis overheads and capital costs, incurring total costs equal to 1,880$ per tonne of final product. Middle Eastern companies are followed by Icelandic plants (1,982$) and selected EU smelters in subsample 1 (1,992$). On average, the highest economic costs are incurred by Australasian producers (2,383$) and are similar to those paid by EU27 aluminium producers (2,318$). EU smelters comprised in subsample 2 (2,462$) are the least competitive installations. Plants located in Norway, CIS, China, the US, and Latin America face comparable per-tonne costs ranging between 2,157$ and 2,207$. Figure A: Business costs per tonne of aluminium ($ 2012) C. Assessment of Cumulative Costs Estimated cumulative costs are presented in terms of cost per unit of output ( /tonne of aluminium). In order to provide an indication of the relative importance of the impact of EU legislation on the aluminium industry, regulatory costs per unit of output were compared with key performance indicators, such as price-cost margin and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). To reflect the uncertainty linked to the origin (i.e. national or EU) of costs generated by Environmental Policies as well as the ongoing debate surrounding the price of CO2 permits passed on through electricity prices, three scenarios were developed. Specifically, i) an intermediate scenario, assuming that the pass-on rate for ETS equals 0.8 and using the average of the lower and upper bounds for environmental costs; ii) a lower bound scenario assuming a 0.6 pass-on rate for ETS and 50% of 3
environmental costs due to EU rules; and iii) an upper bound scenario, built on a 1 pass-on rate for ETS and 80% of environmental costs due to EU rules. As explained above, the analysis distinguishes between plants currently procuring electricity via long term contracts or self-generation (subsample 1) and those purchasing this input on the market (subsample 2). Table A: Cumulative regulatory costs for EU primary aluminium production Intermediate scenario ( /tonne) Policy area Cost typology Sample 1 2 ETS (pass-on rate = 0.8) Indirect 59.99 0.00 90.50 Sub-Total 59.99 0.00 90.50 Transmission 26.24 0.00 48.67 Energy RES 27.29 5.30 46.09 Sub-Total 53.53 5.30 94.76 Investment 3.70 3.70 3.70 Environment (average) Direct Financial 1.70 1.70 1.70 Operating 11.10 11.10 11.10 Administrative 0.38 0.38 0.38 Sub-Total 16.88 16.88 16.88 Product Administrative REACH 1.34 1.34 1.34 Sub-Total 1.34 1.34 1.34 Total 131.73 23.52 203.47 Table B: Cumulative regulatory costs for EU primary aluminium production Lower bound scenario ( /tonne) Policy area Cost typology Sample 1 2 ETS (pass-on rate = 0.6) Indirect 46.46 0.00 70.09 Sub-Total 46.46 0.00 70.09 Energy Transmission 26.24 0.00 48.67 4
RES 27.29 5.30 46.09 Sub-Total 53.53 5.30 94.76 Investment 2.85 2.85 2.85 Environment (50% of costs due to EU rules) Direct Financial 1.30 1.30 1.30 Operating 8.54 8.54 8.54 Administrative 0.38 0.38 0.38 Sub-Total 13.07 13.07 13.07 Product Administrative REACH 1.34 1.34 1.34 Sub-Total 1.34 1.34 1.34 Total 114.40 19.71 179.26 Table C: Cumulative regulatory costs for EU primary aluminium production Upper bound scenario ( /tonne) Policy area Cost typology Sample 1 2 ETS (pass-on rate = 1) Indirect 73.53 0.00 110.92 Sub-Total 73.53 0.00 110.92 Transmission 26.24 0.00 48.67 Energy RES 27.29 5.30 46.09 Sub-Total 53.53 5.30 94.76 Investment 4.55 4.55 4.55 Environment (80% of costs due to EU rules) Direct Financial 2.09 2.09 2.09 Operating 13.66 13.66 13.66 Administrative 0.38 0.38 0.38 Sub-Total 20.68 20.68 20.68 Product Administrative REACH 1.34 1.34 1.34 Sub-Total 1.34 1.34 1.34 5
Total 149.07 27.32 227.70 As shown in the tables above, the cumulative regulatory costs range from 114 /tonne to 149 /tonne, with an intermediate estimate of 132 /tonne. In the intermediate scenario, ETS indirect costs represent about 45% of total costs, followed by costs due to EU energy policies (about 41%) and environmental costs (about 13%). The difference between subsamples is substantial: Plants included in subsample 1 incur regulatory costs equalling 20 /tonne in the lower bound scenario and 27 /tonne in the upper bound, with an intermediate estimate of 24 /tonne. Environmental regulation is responsible for the largest share (72%) of total costs in the intermediate scenario for plants included in subsample 1. As old long-term contracts and self-generation shielded these plants from ETS indirect costs, expenses to comply with energy policy regulation are the second cost item in order of magnitude (23%). In subsample 2, cumulative regulatory costs range from 179 /tonne to 228 /tonne, with a value for the intermediate scenario equivalent to 203 /tonne. For plants procuring electricity in the market, costs linked to energy policies account for about 47% of total costs, ETS for 45%, and environmental outlays for about 8%. Whereas expenses linked to the REACH regulation are about 1% of total cumulated costs in all the scenarios for the entire sample and subsample 2, they reach up to 7% in the lower bound scenario for subsample 1. The difference between the three different scenarios and subsamples is illustrated in the figure below. Figure B: Cumulative Regulatory Costs - Comparison among scenarios (2012, /tonne) 250 228 200 179 203 150 100 114 132 149 1 Sample 2 50 0 20 24 27 Lower bound Intermediate Upper bound 6
D. Regulatory costs, production costs and margins Our analysis led to the following main results: The costs generated by EU rules represented on average 8% - and never more than 10% - of total production costs over the entire period (2002-2012). When observed at plant level, the cumulative cost of EU rules is more limited (i.e. in the area of 1-2% of production costs) for plants procuring electricity via long term contracts signed before the introduction of the ETS or via self-generation (subsample 1). As soon as these long term contracts expire, the cost impact for those primary aluminium plants is expected to move closer to the cost figures for subsample 2. Regulatory costs were in the area of 16% in 2006 (an exceptionally good year) to 40% of EBITDA and even higher than this margin in times of crisis (2009 and 2012). The impact on price-cost margin was more significant, not only when considering the losses registered in 2009 and 2012, but also in profitable years. Cumulative costs represented about 23% of profits in 2006 (the most profitable year) and 242% in 2011 (the lowest positive profit value) and were constantly higher than this margin from 2008 onward. The table below summarizes the results of our analysis for the entire period covered by the Study (2002-2012). Calculations are made on the basis of the intermediate scenario and for the entire sample. Table D: The impact of cumulative regulatory costs 2002-2012 Intermediate scenario on the entire sample 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Price-Cost Margin 58% 114% 59% 57% 23% 35% 154% (75%) 109% 242% (86%) EBITDA 28% 39% 30% 29% 16% 20% 37% 123% 31% 37% 93% Price-Raw Materials 10% 12% 11% 10% 7% 8% 9% 12% 9% 9% 9% Production costs 9% 10% 10% 9% 8% 7% 7% 8% 7% 7% 6% Market price 8% 9% 8% 8% 6% 6% 7% 9% 7% 7% 7% 1 For smelters that are still benefiting from old long-term contract or self-generation to procure electricity, cumulative costs between 2002 and 2012 have been a negligible share - between 1% and 2% - of market price, production costs, and price-raw materials margin. Furthermore, regulatory costs over EBITDA went from only 2% in 2006 to 9% in 2009. When compared to the profit-cost margin, costs measured in this Study were in the area of 3% to 10% in the boom years, and of 12% to 36% during 7
the crisis; they represented one quarter of the loss registered in 2009. These results are summarized in the table below and are based on the assumptions of the intermediate scenario. Table E: The impact of cumulative regulatory costs (2002-2012) Intermediate scenario on subsample 1 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Price-Cost Margin 8% 13% 8% 8% 3% 5% 12% (25%) 10% 13% 36% EBITDA 4% 5% 4% 4% 2% 3% 4% 9% 4% 4% 5% Price-Raw Materials 2% 2% 2% 2% 1% 1% 2% 2% 2% 2% 2% Production costs 2% 2% 2% 2% 1% 1% 1% 2% 1% 1% 1% Market price 1% 2% 1% 1% 1% 1% 1% 2% 1% 1% 1% 2 The impact of cumulative costs due to EU rules were stronger on plants included in subsample 2 because of the combined effect of higher regulatory costs and narrower margins. Over the period 2002-2012, costs measured in this Study represented on average 12% of both production costs - going from 9% in 2012 to 15% in 2003 and 2004 - and aluminium market price from 9% in 2006 and 2007 to 14% in 2009. Whereas regulatory costs are in the area of 13% to 19% when compared to the priceraw materials differential, they are markedly higher than EBITDA in 2009 and 2012 and higher than price-cost margin over the entire period, except for 2006 and 2007 when the primary aluminium industry was particularly profitable. Table F: The impact of cumulative regulatory costs (2002-2012) Intermediate scenario on subsample 2 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Price-Cost Margin EBITDA Price-Raw Materials Production costs Market price 103% 235% 111% 100% 39% 61% 587% (92%) 344% (3753%) (71%) 48% 70% 54% 50% 27% 35% 74% 987% 65% 79% (568%) 16% 18% 17% 16% 11% 12% 14% 19% 14% 13% 14% 14% 15% 15% 13% 11% 11% 10% 12% 11% 10% 9% 12% 14% 13% 12% 9% 9% 10% 14% 11% 10% 10% 8
These results highlight the role of electricity as a crucial input for the competitiveness of the EU primary aluminium industry. Old long-term contracts, which tended to be the norm in the past, and self-generation by carbon neutral power sources shielded plants included in subsample 1 from ETS indirect costs and transmission costs. Moreover, purchasing electricity at low price considerably reduced their costs and improved their margins. Once these contracts expire - for most plants within the next 5 years - things might significantly change. Conversely, electricity prices and the rules affecting them, represent the main source of competitive disadvantage for smelters procuring this input in the market (subsample 2). ETS indirect costs and regulatory costs due to energy policies imposed a significant burden on plants included in subsample 2 and contributed to curtail the competitiveness of the EU aluminium industry by increasing production costs and narrowing margins. Finally, we have measured the cost differentials with least cost producers (i.e., smelters located in the Middle East). EU regulatory costs represented about one third of this competitive gap in 2012 (and one fifth for smelters included in subsample 1). It should be noted that our analysis does not investigate the cost of regulation falling upon third-country producers, which would reduce cost differentials in some cases. Moreover, EU regulatory costs are only one of the drivers behind the challenges currently faced by primary aluminium producers. Other factors, including the implementation of rules at the national level, have a direct impact on the competitiveness of the industry. Yet, EU regulatory costs reduced the profitability of the EU primary aluminium industry not only in time of crisis, when the impact of any cost item is amplified, but also in the boom years when they still represent a rather high share of industry margins. As this Study focuses on the cost side of EU rules, the benefits of operating in the EU, such as proximity to high-added value customers and access to a skilled labour force, should be borne in mind when reading our findings. 9