Alumina Management Discusses H1 2013 Results - Earnings Call Transcript

Aug.22.13 | About: Alumina Limited (AWCMF)

Alumina (AWC) H1 2013 Earnings Call August 21, 2013 8:00 PM ET

Executives

John Andrew Bevan - Chief Executive Officer and Executive Director

Chris Thiris - Chief Financial Officer

Analysts

Paul Young - Deutsche Bank AG, Research Division

Brendan Fitzpatrick - Morgan Stanley, Research Division

Lyndon Fagan - JP Morgan Chase & Co, Research Division

Clarke Wilkins - Citigroup Inc, Research Division

Stephen Gorenstein - BofA Merrill Lynch, Research Division

Matthew Hope - Crédit Suisse AG, Research Division

Peter Harris - JCP Investment Partners LTD

Scott Hobart

Glyn Lawcock - UBS Investment Bank, Research Division

Operator

Thank you for standing by, and welcome to the Alumina Limited half year results investor conference call. [Operator Instructions] I must advise you this conference is being recorded today, the 22nd of August 2013. I would now like to hand the conference over to your first speaker today, Mr. John Bevan, CEO. Please go ahead, Mr. Bevan.

John Andrew Bevan

Thank you. Good morning, and welcome to the Alumina Limited half year results. I'll cover the highlights, Chris Thiris will cover results in detail, and I'll then return to cover the market conditions and the outlook. Firstly though, I would like you to note the following disclaimer regarding forward-looking statements that may be in the presentation. And I'll also remind you that we'll be presenting our results in U.S. dollars, so all financial amounts will be U.S. dollars unless otherwise indicated.

So let's turn to results and the summary. The first half of 2013 has seen a continuation of the difficult market conditions experienced in 2012. The net underlying loss after tax for Alumina Limited for the first half was $7.2 million, down from $13.1 million compared to the first half of last year. Included in the net underlying loss this half was a charge of $30 million in relation to the Alba matter. The reduced underlying loss was driven by Alumina Limited's lower overheads and finance costs and AWAC's improved financial performance. AWAC's EBITDA for the half was $230 million, up $69 million or 43% compared to the first half of last year. This was achieved as a result of planned actions within the joint venture, including an excellent performance in cost control and productivity, resulting in lower production cost per tonne. It was also assisted by an ongoing transition to the spot index based pricing for its third-party smelter grade alumina sales. This EBITDA improvement was achieved despite the poor market pricing environment.

Alumina Limited finished the first half of 2013 with a strong balance sheet, with debt significantly reduced from the beginning of the year. This was the result of a AUD 452 million share placement in February, ongoing dividend receipts from AWAC and limited cash flows from the venture. Market conditions remained tough and uncertain. As a result of this uncertainty, Alumina Limited's board has not declared an interim dividend for 2013.

Now looking forward. On the cost front, ongoing productivity improvement is important and that internal drive is critical to our success. Cost and CapEx will be positively impacted if the Australian dollar and the Brazilian reais remain weak relative to the U.S. dollar. About 2/3 production is in Australia and Brazil, with a large proportion of costs in local currency. So this should have a significant impact if sustained. Capital expenditure is also skewed to these locations. The impact of these improvements and the weaker Australian dollar and Brazilian reais should see the improved cost position in the second half.

I would now like to hand over to Chris to take you through detail of the results.

Chris Thiris

Thanks, John. I'll start with AWAC's earnings. First of all, you can see from this slide the improvement in EBITDA, being $69 million higher than the prior corresponding period, and this is after the overall negative effect of some significant items that I will cover later. So AWAC's underlying performance is actually stronger than what the headline numbers would otherwise indicate. Total revenue was $3 billion, marginally higher than the first half of last year, helped by higher alumina shipment. The average realized alumina price was slightly higher, with spot-based pricing better than LME. The smelters revenue was affected by the lower LME aluminum price, which was predominantly offset by premium increases. Total costs were $42 million lower than that of the first half of last year and includes the benefits of productivity initiatives and cost control. The savings are actually better than this when you adjust for the significant items, such as the Anglesea power station shutdown that occurs every 4 years for maintenance and Alba. This is evident on the next slide.

This performance bridge separates out a number of significant items so that a fair comparison could be made to prior periods. To some extent, I've already covered revenue, and I'll say more when we get to the next slide. You can see when you separate out the significant items the level of improvement in COGS, general admin and selling expenses. This improvement mainly relates to productivity initiatives and cost control. We have seen some increases in expenses, for example, due to the short-term separation of the 2 crushers in Western Australia, but this was more than offset by the productivity initiatives. The smelters results were significantly influenced by Anglesea. There were currency gains in the first half of 2013 mainly against the Australian dollar, which averaged about $1.01 compared to $1.03. The Australian dollar closed on 30 June at $0.92 and has traded lower than that since then, so further currency benefit is expected in the second half. This also applies to the Brazilian reais, which weakened to an average BRL 2.03 and is currently trading at around BRL 2.4.

On this slide, we show how AWAC's average realized price for smelter grade alumina was impacted by the changing price methodology by setting the prior period's base to 100. The first 2 variances represent the impact of price changes in alumina spot index and LME aluminum, keeping the prior period's mix between the 2 constant. Last year, we had approximately 35% of sales on a spot pricing basis. As you can see, average realized prices for spot index have outperformed LME. We believe that alumina spot pricing reflects industry fundamentals compared to LME. Spot prices have come off since 30 June, which is a reflection of industry fundamentals, such as smelter curtailments and reaching parity pricing between China and Australia. We expect that the benefits of trading on industry fundamentals should become more evident as the third-party alumina market price increases -- sorry, third-party market increases its share of global demand, especially if you are a low-cost producer such as AWAC. Currently, AWAC's spot-based pricing represents approximately 53% of smelter grade third-party sales compared to the 35% for last year. The mix variance is positive because we are comparing to contracted LME-linked rate, which were set prior to 2011 and are lower than the current API spot price as a percentage of LME. You'll get an idea of how this has changed over time from the table on this slide.

Moving on to cash cost of alumina production. Cost per tonne was down compared to both the first and second halves of last year. Comparing to the first half of last year, the decline is really a representation of the productivity initiatives and efforts to improve operating stability. The different results you see in energy between the 2 chart is mainly due to seasonality, whereas the caustic, it's more about the benefit of the falling market prices that began late in 2012 and into early 2013. The increase in bauxite cost due to the separation of the crushers in WA and the new mine site in Suriname appears against the second half of 2012. We expect the extra cost related to the crushers will be there until the project is completed. Within conversion costs are the benefits of a number of productivity initiatives, such as in labor. There is also some currency benefit in the cost reduction, and as I said earlier, more is expected to flow through in second half.

AWAC's total alumina production was 7.8 million tonnes, in line with prior halves and approximately 90% of nameplate capacity. The Australian and Brazilian refineries were operating well above 90% of capacity. Production between the Pacific and Atlantic regions was roughly in the same proportions, but there was increased production at Point Comfort, which was working off improved stability in the plant and lower energy prices. As I mentioned earlier, shipments were higher, and this was due to a catch-up on delayed shipments from December last year and the running down of inventory levels as part of tighter working capital management. Our production guidance for 2013 remains at 15.6 million tonnes, although this may adjust with changes in market conditions.

Looking at CapEx, AWAC's sustaining capital expenditure was $156 million, with the majority spent in Australia. Growth CapEx of $21 million mainly related to work at Juruti in Brazil. So far this year, Alumina Limited has made no contributions to the operating businesses of AWAC. We have revised our CapEx guidance downward to $340 million for sustaining and $40 million for growth. The improvement in AWAC's free cash flow is mainly due to improvements in operations, including working capital balances.

Investments in Ma'aden are not included in growth CapEx. AWAC has a 25.1% interest in the Ma'aden mine and refinery, and it is expected that upon completion and when the refinery is fully ramped up, it will be the lowest cash cost per tonne refinery in the AWAC portfolio. The refinery is about 60% complete, and it's expected to be commissioned in the fourth quarter of 2014 and reach full production scale in the latter part of 2015. As at 30 June, Alumina Limited contributed $12 million of equity. We do not expect to make further contributions this year.

Turning to Alumina Limited. The company reported a net loss after tax of $2 million compared to $52 million loss and $4 million loss for the prior year's second and first halves, respectively. On an underlying basis, we no longer adjust for retirement benefit obligations due to changes in accounting standards, so underlying loss was $7 million after adjusting for embedded derivatives. There were a number of significant expense items included in the underlying result. As discussed for AWAC, the results would have been significantly improved if not for these items and would have been a truer reflection of the operating performance of our investment. During the half year, Alumina Limited received dividends and distributions from AWAC of $29 million. A further $25 million dividend was received subsequently on the 1st of July. Alumina Limited's own overheads were down primarily due to expenditure rather than currency. After corporate and financing costs, the company had cash from operations of $10 million. $12 million was invested into Ma'aden.

As at 30 June, Alumina Limited had net debt of $197 million following the share placement. This is a reduction of $467 million in net debt since 31st December. The company's gearing is now 6% compared to 20% as at 31st December and with significant liquidity in terms of undrawn facilities beyond 2014.

As a quick overview, when you just look at the underlying performance of AWAC in the first half of 2013, you can see pleasing results in terms of what is controllable. Also, the refineries are running reliably at around 90% capacity on average, and the changing alumina pricing mechanism continued to deliver benefits. Since 30th of June, we are experiencing lower average realized alumina prices, but we expect further currency benefit, as is evident from the charts on the slide, and the continued focus on productivity and cost reduction. We also expect that Alumina Limited will make no further equity contributions to Ma'aden. We have revised downwards our guidance for CapEx. Whilst Alumina Limited has not provided working capital support so far this year, it is possible that some might be needed if current market conditions persist.

Thank you. I would now like to hand you back to John.

John Andrew Bevan

Thanks, Chris. I'd like to now take you through some of the dynamics of the alumina market. And while it is linked to aluminum, the alumina market operates differently in some very key areas. Firstly, demand for alumina is almost totally driven by the expansion of aluminum production. Aluminum demand continues to grow strongly and remains around 6% per annum. This growth rate is stronger than almost all other metals. To meet this demand, it requires growth in alumina production of around 6 million tonnes per annum. Much of the growth in the supply of alumina is to meet each smelter company's internal demand. These integrated aluminum companies are generally self-sufficient in alumina production, and this constitutes about 60% of the market. The third-party market largely supplied to independent smelters is a smaller but faster-growing segment and is the key to setting the spot market price for alumina. AWAC is a significant supplier to this segment. The third-party market continues to require new supply to meet its needs. Conditions, however, are not providing incentive to build new capacity. Current market conditions of low prices, poor profitability and high capital expenditure costs has led to few new capacity expansions proceeding or planned outside of China. Couple this with significant uncertainty of new bauxite supply leads you to a conclusion that new capacity announcements will be rare.

The table shown here reflects harbor's view of all the capacity planned or under construction outside of China. It is limited largely to a few locations and is generally proceeding very slowly. Most non-Chinese capacity takes up to 5 years from announcement to full production due to extensive permitting, design and construction time. The expansions indicated for Indonesia will be dependent on the operators gaining permits for exporting bauxite. For the non-Chinese market to be balanced, new capacity of approximately 2 million tonnes is required each year, assuming that existing capacity remains around 90% utilized. In summary, while the current market is close to balanced, in the medium term, there appears to be insufficient new capacity to meet demand.

Now let's turn our attention to bauxite. Over the last 7 to 8 years, new capacity of Alumina has largely come from China to service the Chinese smelters. China's ability to keep meeting their own growing demand is largely dependent on securing new, large-scale bauxite supplies. Bauxite, as you know, is a common material across the world like iron ore. However, bauxite quality can vary greatly, and establishing scaled mines depends on government approvals, making substantial capital investment in supply logistics, in particular railways and ports, to get the bauxite to market. For most of the globe's bauxite, the capital required to build the supply logistics makes it uneconomic to exploit.

So what is the situation inside of China? Chinese bauxite is abundant in 2 key regions. Generally, it has high alumina content but also high silica. The standard Bayer process for producing alumina needs an alumina-to-silica ratio of above 5 to be economic. As China's industry has developed, the availability of bauxite of above an A/S ratio of 5 has significantly diminished. In fact, much of China's Bayer treatable bauxite is forecast to diminish even more significantly in the next 10 years. Alternative technologies are being considered. However, all are generally energy inefficient or just not economically viable.

As a result of the tightening of domestic supply, domestic bauxite prices are on the rise, and this is clear from the chart above. As availability of treatable bauxite further diminishes, local bauxite prices will continue to rise. This and the reduced availability, in turn, will drive higher and higher imports of bauxite and put substantial strain on the seaborne bauxite market to supply. Today, around 1/3 of total Chinese installed capacity uses imported bauxite. Import volumes are growing rapidly, with approximately 75% of this historically sourced from Indonesia, with most of the balance from Australia. Since 2011, we have seen a rise in bauxite prices, with a noticeable slack in 2012 when there was an actual bauxite supply restriction from Indonesia. In the latest MAAT [ph] guidelines, the Chinese government has also restricted the approval of new refineries using imported bauxite that did not have at least 60% of their total bauxite needs secured under supply contracts of 5 years or more. So the pressure to secure supply is increasing significantly.

The key issue in the short term relates to whether Indonesia follows through with its ban on exports from the 1st of January 2014. We cannot predict the Indonesian political will on this. However, an interruption of upwards of, say, 30% of China's imports could be disruptive to the Chinese aluminum industry. Even if the proposed Indonesian ban is lifted, increasing production cost and higher taxes are likely to lead to higher export prices for bauxite. In a similar way to iron ore, a significant ramp-up of existing mines would be required to fill the gap. Current revised prices also provide insufficient incentive for the development of new mine. In anticipation of the ban coming into effect, there has been considerable stockpiling of bauxite inside of China plus spot [ph] buying from existing mines around the globe. To take a longer-term view, what is clear is that as the quality of Chinese bauxite reduces, demand for imported bauxite is forecast to almost double over the next 5 to 6 years. Even if the Indonesian ban from 2014 is lifted, it remains unclear where the significant required additional volumes will come from.

Now let's turn our attention to the short- to medium-term outlook for pricing. Over the past 18 months, we have seen spot alumina prices outside of China fluctuate between about $305 to $350 per tonne, depending on changes in demand and cost issues. The current price of around $320 reflects weak market conditions. As you can see on this chart, the reason for movements are largely related to alumina supply and demand fundamental. One of the drivers of the short-term prices is the differential between Chinese domestic alumina prices and the non-Chinese price. When the lack [ph] arises above an import premium typically of around $20 a tonne, imports tend to fall and vice versa. Although China has recently exported small cargoes of alumina, the country is likely to remain a net importer. And so to understand the medium- to long-term price, we need to look at the high-cost, marginal, nonintegrated producer inside of China. Integrated producers supply their own alumina to the smelters and so have some flexibility on where they get their returns, whereas nonintegrated producers supply alumina to the third-party smelters. China's largest aluminum -- alumina producers include those in Shandong and have significant integrated and nonintegrated production. It is the nonintegrated capacity that will operate or curtail depending on price. There is nonintegrated capacity at the top end of the Chinese cost curve. This part of the production is reliant on imported bauxite. It will, therefore, be the cost profile of those refiners that sell into the third-party market that will determine how prices will ultimately move.

Not all alumina, however, is solved on its own fundamentals. The blue line reflects the spot price movement since January 2012. The red line reflects more volatile movement in the aluminum price, which impacts on those who sell alumina as a percentage of the aluminum price. The majority of alumina in the non-Chinese market is still sold on this basis. The improvement in AWAC's average realized price relative to the metal price is due to the move of its sales book towards spot-based pricing and away from the linkage to aluminum. This transition to spot index pricing commenced at the start of 2011. Since then, AWAC has not signed any new contracts for smelter grade alumina based on LME pricing. During the half, AWAC passed the milestone of having more than half of its third-party sales based on the spot or index-based price, and this is delivering tangible benefits to our bottom line. The proportion of shipments on this basis is expected to increase substantially over a number of years as contracts expire.

The other influence on industry alumina pricing is the pricing of aluminum. AWAC still has nearly half of its contracts priced with reference to the LME 3-month aluminum price. On the 1st of July, the LME announced a period of consultation with the industry in an effort to cut queues for metal to be moved out of LME warehouse. This announcement has led to speculation that a significant amount of metal will leave the warehouse system, potentially impacting the LME aluminum price and the premium. However, there is a counterargument to this. At this point, aluminum prices remain in contango and interest rates remain low, and so the incentive for warehouse storage remains. On this basis, if what is proposed is implemented, some expect that metal will simply move out of the LME warehouses with long queues and into other warehouses and expect prices will not be significantly affected in the short term. In the medium term, we believe the lower levels of inventory are required for pricing to reflect the economics of the industry.

And so in summary, Alumina Limited has strengthened its balance sheet and lowered its cost base. The capital requirement of the joint venture are at its lowest level for many years, and we will receive at least $100 million of dividends from AWAC this year. Despite very difficult market pricing, AWAC has delivered 4 quarters of rising EBITDA margins through the transition to spot pricing and improved cash cost production. The market remains -- looks to remain tough for the remainder the year. However, improved exchange rates will, if sustained, lower the cost base and cost of executing the remaining sustaining CapEx.

Thank you, and I'm now happy to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Paul Young with Deutsche Bank.

Paul Young - Deutsche Bank AG, Research Division

One question on sustaining CapEx, another question on Alcoa's portfolio review. First of all, sustaining CapEx, my number is that 80% of your sustaining CapEx is in Aussie dollars. So at spot currency, you could be looking at a $30 million savings of sustaining CapEx per annum. Can you just confirm it if those number are about right? And secondly, on Alcoa's portfolio review, I noticed in the text, you did say that the Point Henry smelter is scheduled to stay open until at least the middle of next year. I thought that smelter was still within the one of the smelters, I should say, that is under review by Alcoa. Can you just give us an update on that? And then lastly, Alcoa has actually announced some smelter closures over the past and Ma'aden announcement over the past 4 weeks. What does that do to the alumina balance because Alcoa would be more along alumina now? So did that effectively increase everyone's supply and then push more alumina to China? Can you just talk about that, John?

John Andrew Bevan

Okay, a few things there. We adjusted the CapEx based on purely doing the projects more economically. So the adjustment done is purely for that. It doesn't truly reflect the movement in exchange rates, so we're not -- we have not factored in the exchange rates. As I think we've told many of you in the past, on a long-term perspective, about $300 million of sustaining CapEx is probably the more appropriate number to be using. Regarding Point Henry, nothing has changed regarding Point Henry. The commitment that was given late last year was that the smelter will continue to operate as per -- it is until at least the middle of next year. It may be reviewed at that point but, at this point, doesn't form part of the general review. And thirdly, the balance of alumina, I think in Chris's piece, he said that while we've confirmed our guidance as still being $15.6 million, once the reductions of smelting come through, then it is likely that we will adjust alumina capacity to maintain the balance.

Paul Young - Deutsche Bank AG, Research Division

John, so just on that, adjusting the supply, so I'm looking at your high-cost refineries, being Jamaica and San Ciprian, what flex do you have on reducing alumina refining capacity? I mean, San Ciprian, you can only flex it down 10%. But what scope is there to reduce capacity more broadly across the group?

John Andrew Bevan

I think the most logical places to adjust, because of the technical configuration of the plants, is Jamaica and Suriname. As I said, we won't make a decision on that until the smelter actually comes off, which will be a few months ahead yet.

Operator

Your next question comes from Brendan Fitzpatrick with Morgan Stanley.

Brendan Fitzpatrick - Morgan Stanley, Research Division

The first one is a follow-up on sustaining CapEx. The guidance has come down $10 million but we're [ph] still looking at about a $30 million sequential rise, second half on first half. I just wanted to make sure we understand where the key elements were that were coming through in the second half. And the second one, just on the free cash flow, one of the references to the increase in free cash flow was a benefit from working capital going lower. Was that simply inventory of raw materials? Or was there also an inventory reduction in the finished good products from AWAC in that element?

John Andrew Bevan

Chris, do you want to answer all or one of that?

Chris Thiris

Sorry, that was the sustaining CapEx, first half to second half. Well, the guidance we gave is $340 million. There's no -- I don't know how to put it. There's no real difference. I understand the point you're making, that $155 million in the first half, that means additional expenditure in the second half. It just comes down to the timing. As John said, the areas -- some improvements in terms of expenditure, the actual expenditure and whatever local currency is. There is certainly some currency benefits that come through, as Paul pointed out, but there is not much more than that.

John Andrew Bevan

Yes, there is no new CapEx. 80% of the CapEx that's been spent has been spent in Australia to do with the crusher move. The crusher move is actually under budget and running pretty much to time. So it is purely a timing issue of bits and pieces. There is scope that come below $340 million based on currency movement, but we haven't factored that in at this stage. On the second question that you had regarding working capital, the working capital is partly just reductions in inventory about raw materials and also finished product. So that's where some of the inventory stock has come down. That's just better management of the flow, continually driving both receivables and payables to be better under control and that's certainly with some one-off benefits. But we expect the main benefits will come from simply the productivity of the operations, which we've seen -- and particularly in the Atlantic, substantial improvement in the stability of all of the plants that we run there, and that stability has meant that margins have improved -- what, cost of production have improved for all of the refineries.

Operator

Your next question comes from Lyndon Fagan with JPMorgan.

Lyndon Fagan - JP Morgan Chase & Co, Research Division

First question I've got is just on the involvement to spot-based pricing. Can you perhaps give us a bit more color about the profile or the mix over the next 2 to 3 years? And I guess, by which year do you expect to be fully on spot prices if that ever occurs? So it would be nice to get a bit more color there. The second question I've got is just you made a comment a little while back around potential to realize benefits from selling power assets within AWAC. I'm just wondering if you could maybe give us an update on whether that process is still occurring and likely to sort of conclude anytime soon.

John Andrew Bevan

Okay. Let me handle the second question first. There is a general program of looking at non-core assets within the AWAC for sale if we can realize some cash from those. It doesn't necessarily include any power assets. The only power asset that we actually had is Anglesea, which is linked to the Point Henry smelter. So that's not half of the mix that we're talking about. We're talking about other assets around the place, and we should expect some of that to play through in the next 12 months. These will involve getting agreement from 2 sides of the transaction, so it will take some time for some of these to be resolved. So that's the first thing. In terms of the rollout of spot-based contracts, as what I've said, we're at the beginning of the process. The average length of contracts is roughly 5 years, so about 20% of our book rolls off each year. The reality is that about 8% of our contracts at the end of the 5 years will still be in place that are on LME linkage or other things that won't roll off any time after that. So we have an opportunity to get to 92% after 5 years. It includes one contract that the customer has the option to renew on the old terms for a further couple of years, and that's at his instigation. And therefore, one of those contracts may push the 92% number out a further year or so. So we expect this sort of transfer of momentum to be maintained strongly through the next 2 years, and that's probably the answer I can give you, Lyndon.

Lyndon Fagan - JP Morgan Chase & Co, Research Division

So just to clarify, what would be the first year possible that you could be on 92%?

John Andrew Bevan

At the end of 2015.

Operator

Your next question comes from Clarke Wilkins with Citigroup.

Clarke Wilkins - Citigroup Inc, Research Division

Just a question on sort of bauxite side. You made some positive comments about the sustained increase in bauxite prices and the -- required by China and also in terms of looking at cutting back some of the alumina capacity of Alcoa that supply the smelters. Is there potential to put more bauxite into that market to take advantage at that?

John Andrew Bevan

Well, I think the -- there are always opportunistic issues around the bauxite mines within the existing size and infrastructure that's there. So there's always opportunities to sell 0.5 million tonnes of bauxite here or there. What we're looking at in, from a Chinese demand perspective, is going from 35 million to 40 million tonnes to 90 million tonnes in the next 4 or 5 years. Now that is more than -- that growth is more than all of AWAC mining in any 1 year, more than Rio mined than any 1 year. There's no single mine around the world that can actually deliver that level of growth. So to deliver to China is going to require some very significant investment from somebody to ramp up, and it's not immediately obvious who that will be. Clearly, Rio is going to expand weaker, but that will only go to a relatively small proportion of what the growth is going to be. So there is opportunity, and there's opportunity around the edge today in making small sales here or there, but there is nobody in place to be able to meet the demand.

Clarke Wilkins - Citigroup Inc, Research Division

But suppose within your system, where -- isn't it the opportunity that there is more money to make out of selling bauxite than producing alumina and is there options there rather than be greenfield projects being built? Can you take advantage of existing effective mines to capitalize on the strength of the bauxite market rather than producing alumina?

John Andrew Bevan

Look, there are options to sell 1 or 2 million tonnes here or there, but that won't make a material difference to the supplier requirement. Our ability to ramp up existing mines is fairly limited from where we are at the moment.

Operator

And the next question comes from Stephen Gorenstein with Merrill Lynch.

Stephen Gorenstein - BofA Merrill Lynch, Research Division

Just a couple of questions from me, if I may. Firstly, just on -- you mentioned earlier that the LME changes may or may not have an impact on prices and more so on premiums. What impact -- if that is to impact the premiums, what impact do you think that might have on the alumina market? And second question is on the potential for shutdowns or the curtailments within the AWAC system. Can you just clarify for us whether or not the Jamaica and Suriname operations are loss-making or profit-making at the moment?

John Andrew Bevan

Okay. So if I can cover Suriname and Jamaica first, they're both at around breakeven at this point. So any curtailment would lead to, obviously, some savings there, with some -- these economies [ph] would actually take the capacity out. Just from a market perspective, that would probably be what is best at this point. So they're not costing us any money at the moment, but they're certainly not making us any real money as well. So that's the main question there. What was the first question, sorry?

Chris Thiris

LME impact.

John Andrew Bevan

Oh, the LME impact, okay. Our expectation is that the metal would, if it does come out of the LME, warehouses would simply move into other warehouses, but the price is still very much in contango. The contango is steeper today than it's been at any time since 2008. And so the incentive to remain inside of these warehouses is as great as it's been at any time in the last 5 years. And if you look at the 2- and 3-year contango, it's some $300 or $400 above where the current cash rate would be. So contango is still very strong. So our expectation is that if metal does come out of the LME warehouses, it will simply move to other warehouses. So in theory, you'll see no change. The premiums, if they do come off, we would expect that the total value of the chain will remain the same. So if the premiums were to come off, then the LME price may well respond and the total value of the price will remain much the same. So in that sense, we would get the benefit of the LME price rising relative to the premium diminishing. The major issues that this is causing to the industry is not that anyone has an expectation that a lot of metal was tumbling and have come on the market. The real issue is for the consumer. They cannot hedge the premium at this point and therefore, their ability to execute transactions and know what their long-term price is going to be is very difficult. And so many customers are upset about the current mix between the LME price and the contango. And if the hedging instrument was to emerge, then we'd probably see much of the anxiety go away.

Operator

Your next question comes from Matthew Hope with Crédit Suisse.

Matthew Hope - Crédit Suisse AG, Research Division

Can you just remind us where we're at in terms of the cost-reduction effort particularly in Jamaica? I understand a year or so ago, you were busy putting some investment. You've been changing energy mix, and where we're at and what cost reduction can we expect at those operations?

John Andrew Bevan

San Ciprian, the -- we've signed gas contracts, and the pipeline is in the process of being built. It's probably taken us a little bit longer to get those -- the contract in place, so we would expect the benefit to come through about the middle of 2014 for San Ciprian, a little bit later than we originally expected. And that would be around $25 per tonne of production cost. San Ciprian itself is running in a cash-positive manner all year, and we have then to put the working capital in there. So I was actually quite pleased with how San Ciprian is running. In terms of Jamaica, like everything in Jamaica, where things have taken a little bit longer than we would have expected. There have been issues around the Jamaican government's ability to continue to fund the refinery and therefore, we've gone a little bit slower on the conversion to call until raising the result.

Matthew Hope - Crédit Suisse AG, Research Division

Okay. So effectively, at Jamaica, there's no action at the moment?

John Andrew Bevan

No, there's plenty of action. There's plenty of planning, but no contracts have been signed.

Operator

The next question comes from Peter Harris with JCP Investment Partners.

Peter Harris - JCP Investment Partners LTD

Just a question on China. In the '12 5-year plan, 2 sort of things really stick out and that's the reduction in other capacity and improved environmental outcome. Just in your travels, what are you hearing about how the government might address the overcapacity and yield and in particular, aluminum, in the conference in -- coming up in October? And secondly, China has currently got 4 carbon trading schemes in the provinces. They'll probably roll that out to a national scheme in 2016, 2017 NDIC [ph] potentially add up to RMB 200 per tonne of aluminum. Again, what were you hearing about how that is sort of thriving, how -- is it impacting on the cost of aluminum production? That's probably [indiscernible] what I'm getting at is our supplier, hopefully, with less overcapacity and also that cost/push story sort of coming through a bit more strongly.

John Andrew Bevan

I think -- look, I think the new leadership is showing -- are saying a lot of things about restricting both steel and aluminum. And I think comments like that have been made many times over the last 10 years really about particularly steel but also aluminum. And the provinces have tended to operate on the basis of the interest of the provinces rather than the national interest. And so there have been difficulties of the national government constraining the expansion in many of the provinces that are there. Our expectation is that the expansion of capacity in China will continue but mainly in the west of the country, and the investments of the east of the country, in places like Shandong, Henan, Shaanxi, et cetera, will become more constrained. And I think in my talk, I indicated that one of the constraints that I've put in place is that if you build a refinery in -- that's on imported bauxite, you have to, in fact, demonstrate that you've got supply of bauxite for the next 5 years with at least 60% of that covered. So they're putting restrictions in place to try and throttle back on the unplanned expansions that are going on, but I think until we actually see real evidence with that supply, I think we should remain cautious as to whether that can really constrain the expansion.

Operator

Your next question comes from Scott Hobart with HFZ Capital.

Scott Hobart

Just on the LME question, I mean, I think your views around that mill continuing to be held under financing structure is pretty misguided. One of the key drivers of those units being locked up in the warehousing system is the regulated LME rents available. Any metal held in those warehouses charges $0.46 a day. If you put it in a non-LME warehouse system, the rates available is cheap at $0.10 today. So I think where the cost of the market going now, showing the real realities of the underlying physical space, so I'd have to disagree with you there. The other point that I wanted to -- or the question really I wanted to raise was on the linkage. If you look at linkage rate, their based off LME 3-month price or the 3-month price, as you noted. If you include the premiums in that comparison between spot alumina and the 3-month price plus the premiums, the linkage is actually quite a bit lower than the headline linkage currently would suggest. So do you think that there is some risk around you actually being able to achieve a market improvement in that, I guess, economic range of the industry if we see the aluminum market move to a more normalized state post these unwinding premiums?

John Andrew Bevan

Okay. So let's tackle those. Look, I fully recognize there are different views on what will happen here. It's not our expectation that the rates that the LME are charging are moving around all over the place at the moment to try and discourage people, keeping metal in the LME warehouses and hence, we've got a very large premium.

Scott Hobart

LME premiums haven't changed in probably 5 years. There's no change in LME rental numbers.

John Andrew Bevan

Not in the rental numbers, that's correct. But in the premium, there has. Look, I'm not going to argue through the backwards and forwards of this for you. It is our view that some metal will come out. There's clearly a queue of metal to come out, but we don't expect that to go into the physical space because there is no additional demand for the metal. So it is likely to move into warehouses and the existing contango that's there, where about half the metal, of course, is built in non-LME warehouses even today, with people doing it for the financing reasons as opposed to the physical requirements. So we simply think it will move from one area of the warehousing to another area. You're absolutely right in terms of the linkage level. The linkage of alumina to the metal price does fluctuate. And if you add the premium on, you will see that the current linkage -- facility linkage rate is 14% or something like that, 14% to 15%. What we -- the reason we are transitioning from one for the other is that we believe that the fundamentals of alumina is the better pricing position to be than the -- against the fundamentals of the aluminum price. There will be times when we'll be better off and there'll be times when we're worse off. But from a long-term perspective, if you're going to make an investment in this industry ever, you need to make it on the basis of the fundamentals of the alumina industry. And that's why -- that's the real reason why we're moving it at this point.

Operator

Your next question comes from Glyn Lawcock with UBS.

Glyn Lawcock - UBS Investment Bank, Research Division

I just wanted to talk a little bit on the cost side. Obviously, 4% cost reduction, it looks like, from your charts year-on-year, at about 1% sequentially. Just looking forward within your control, what sort of cost reduction can we expect with productivity measures, et cetera, ignoring FX? So like-for-like, all else being equal, what could you see? And then I guess just on the closures you made -- not closures, but just curtailments, the volume that you were going to be selling to Alcoa, is that all linkage? So in other words, you increase more your spot exposure as a result as well? And could you still maintain unit cost with the reduction in production?

John Andrew Bevan

Okay. Alcoa pays the average of our total third-party discipline. So in essence, they're half on spot today and half not on spot today. So as we transition, they transition towards spot as well. So that's the pricing piece. In terms of cost reductions, there's a reasonable head of steam on this, and what I think Chris is showing you is we've got some significant one-offs in that cost reduction that's there anyway. And we believe the underlying rate that we're running at is actually ahead on what's being reported. I'm not sure. Chris, do you want to add to that?

Chris Thiris

Yes. Glyn, in terms of productivity initiatives, we expect more the same of what Alcoa has been reporting each quarter. So we're expecting to see more come through in the third quarter when Alcoa reports. But you are right, there is more -- there's currency benefits to come through. And we're starting to see it come through now. But that -- set that to one side, things like productivity initiatives around usage, better usage of cost and energy, better with the purchasing programs, we expect to see more of that to come through when [ph] we think Alcoa will call out more dollar savings in the third quarter.

John Andrew Bevan

So you should see currency improvements...

Chris Thiris

In fact, the way -- sorry, John. The way Alcoa reports, as you know, the manager of the performance bridge, they separate out the currency. So you see that to one side and you see the dollar improvements coming through.

Operator

Thank you. At this time, we have no further questions. Please continue, Mr. Bevan.

John Andrew Bevan

All right. Thank you, everybody. I'd like to wrap up now presumably by saying I think the joint venture has actually done a very good job around the cash generation and from a cost perspective. Looking forward, the current pricing is weaker than it was in the first half, but we should see significant currency improvement flowing through into the Australian operations in particular. And so we expect that the current tough market conditions will be largely offset by the reduction in the cost base. On the CapEx side, it's pretty clear that we've got that under better control than where we've been in the past and that the currency component, given 80% of our sustaining CapEx is in Australia and almost 100% of our growth CapEx is in Brazil. We will get the benefit of the currency coming through because most of those projects are being executed in local dollars. Market does remain tough though, and so we're going to remain very tight on cash management going forward. Thanks very much, everybody, and I'll talk to some of you later in the day. Thank you very much. Bye-bye.

Operator

That does conclude our conference for today. Thank you for your participation.

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