NSW's stance on smelter contract may stall Macquarie Generation sale

Mike Baird is dreaming if he expects a trouble-free, $2.1 billion sale of Macquarie Generation when 23 per cent of its revenue could go up in smoke.

In opposing a renegotiation of the steep rise in MacGen's long-term power contract with its biggest customer, the Rio Tinto-controlled Tomago aluminium smelter, the NSW Treasurer may be on safe ground in a strict legal sense.

But if there's one thing that the three shortlisted MacGen bidders need, it's a bit of clarity on the smelter's future.

Holding the line on the power contract will depress the MacGen sale price because all three bidders will discount the value of the contract between the generator and its most important customer.

The alternative is to help create some certainty around Tomago's future by cutting the business some slack, redrawing the contact and facilitating a smooth sale, even if some value is surrendered.

That's why Baird should show a touch of commercial pragmatism. Instead, the Treasurer confirmed to The Australian yesterday that the government would hold firm.

"As Macquarie Generation's largest customer, this is an important contract," Baird said.

"While the NSW government will continue to work with Tomago in the lead-up to the sale of Macquarie Generation, the government will not be renegotiating the contract prior to the completion of the transaction.

"The timetable for the sale of Macquarie Generation remains on track and is expected to be completed in the current financial year."

Tomago, which is partly owned by CSR, is vulnerable to the same global forces that caused last year's shutdown of the Kurri Kurri smelter, also in the Hunter Valley.

The aluminium industry is being hammered by chronic oversupply, low metal prices, high costs and a strong dollar.

Tomago has the added burden of its 11-year power contract negotiated with MacGen in late 2010, which is due to take effect from November 2017.

Power costs to Tomago will then increase by about $230 a tonne in today's dollars.

Tomago is not the nation's only smelter facing a step-up in power costs.

Old state-subsidised contracts run out in the next couple of years, including the Portland (2016) and Point Henry (2014) smelters in Victoria.

The electricity contract for Bell Bay in Tasmania will mature in 2017. All the smelters are huge power users, with Portland and Point Henry accounting for more than 10 per cent of the state's demand for power, and Bell Bay more than half of Tasmanian demand.

Since the Tomago contract was signed, the deterioration in the aluminium market has accelerated. The world's largest producer, Rusal from Russia, said last September that more production cuts were needed, with low prices making 40 per cent of global output unsustainable.

In the first seven months of this year, supply outstripped demand by 773,000 tonnes, compared with a surplus of 506,000 tonnes last year.

The sale process for MacGen, featuring two coal-fired power stations in the Hunter Valley with a capacity of 4600MW, started last July.

Indicative offers were lodged in October, with shortlisted bidders including AGL Energy, ERM Power and Shenhua of China.

If you were in Baird's position and clutching your list of shortlisted MacGen bidders, you might say that a contract was a contract, given the Tomago deal was negotiated by adults with open eyes.

You also might say that this was not a 2013 problem -- if Tomago wanted to renegotiate, then let it get lawyered up in the countdown to 2017.

In principle, you'd be right on both counts. The problem for the Treasurer is that his timing is terrible. Also, the MacGen bidders reckon the Tomago power contract is so one-sided in the current environment that it's not worth the paper it's written on.

Their argument is that it will be renegotiated at some point, if not in the next few months.

So right now it's a difficult time to be selling MacGen, a point that CSR chief executive Rob Sindel seized on last week when he went public with a firm request -- in the nicest possible way, of course -- for a renegotiation.

In unreported comments at the CSR half-year profit announcement, Sindel agreed with an analyst who suggested that Baird would want to have any renegotiation wrapped up before final bids for MacGen next January. He then said: "If you're a bidder, then you want certainty over Tomago as part of that process.

"Let's not forget that Tomago is 23 per cent of Macquarie Generation's output, so it's its biggest customer by a long way.

"We've seen what's happened to electricity prices in NSW and across Australia; they've actually come down.

"So it's a pretty core part of the NSW electricity demand. It's pretty important for everyone that that issue is resolved or at least some certainty comes out of that negotiation."

To the suggestion that this is a 2017 issue, Sindel would probably respond that there might not be a problem by then -- Tomago could well have shut down.

That's not to say a more favourable electricity price will ensure the smelter's long-term survival.

The industry is under a lot of pressure and no one can predict its long-term prospects.

But what you can safely say is that Baird will have a much better chance of pulling off a clean MacGen sale when there's certainty about the Tomago power contract. While he might have to give up some value, it would be better than having the whole sale process clouded because of a problematic contract with the generator's main customer.