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Executives

Stefan Solberg – Head of IR

Svein Richard Brandtzaeg – President & CEO

Jorgen Rostrup – EVP and CFO

Analysts

Pascal Salewyn – Exane

Tony Rizzuto – Dahlman Rose

Markus Almerud – Morgan Stanley

Tom Jandal – Carnegie

Jonathan Schroeder [ph] – UniCredit

Norsk Hydro ASA (NHY) Q1 2010 Earnings Call Transcript April 27, 2010 5:00 PM ET

Operator

Good day, and welcome to the Hydro Q1 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Head of Investor Relations, Mr. Stefan Solberg. Please go ahead, sir.

Stefan Solberg

Good afternoon, ladies and gentlemen, and welcome to Hydro's earnings presentation and conference call for the first quarter of 2010. Our earnings was released today at 7.30 Central European Time.

And the presentation material we will use on this call and the first quarter report is available on our Website Hydro.com. Today's presentation will be given by President and CEO, Svein Richard Brandtzaeg; and Chief Financial Officer, Jorgen Rostrup.

As usual, after the presentation, there will be an opportunity to ask questions. Before we start, I would like to direct your attention to the cautionary notes in relation to forward-looking statements as we have provided in the presentation material.

And with this short introduction, I'm pleased to hand over to Svein Richard Brandtzaeg, who will take us through the first part of the presentation.

Svein Richard Brandtzaeg

Thank you very much, Stefan, and good afternoon to all of you. Demand has increased in the first quarter, as we indicated to you when we reported fourth quarter results. Overall, we are reporting a 11% increase in sales volume for our Upstream division in a normally, seasonally strong quarter, while Downstream saw an increase of 10%, excluding automotive structures, which was divested in the end of last year and which supported by restocking at our customers.

The result achieved in quarter one, 688 million Norwegian kroner is significantly improved compared to the fourth quarter results. Upstream, we see increased LME prices in addition to improved results from alumina in trading. The realized LEM price in US dollars has increased by almost $200 and approximately 1,100 Norwegian kroner.

Downstream, we see improved results due to increased volumes in all segments, except building systems. In addition, we see improved margins in our vol business and firm margins in excluded products. Our energy results increased due to both higher production and good spot prices in Norway.

Qatalum was officially opened the 12th of April is now on schedule to full output steel production in the fourth quarter this year. As said, we officially opened Qatalum on April 12th, and reinforced a strong partnership between Qatar Petroleum and Hydro. At the end of the quarter, we had 20% of the cells up and running, 137 out of 704 electrolysis cells. We have produced more than 14,000 tons of liquid metal and produced more than 12,000 tons and shipped to our customers of metal products.

The power plant is currently the main focus in the construction process and we have taken over the gas turbines 1 and 2 from the projected operational organization and we are expecting to take over gas turbines 3 and 4 in the second quarter. These steam turbines wanted to be taken over in the second half in this year.

The production ramp-up is in line with fuel production during the fourth quarter this year. Four cells are normally started at the day, but the ramp-up needs to be halted to complete the fuel treatment plan, treatment of emission gases and power plant, leading to a lower number of cells on average being started each year, which then will be about 2.5, bringing the smelter at 100% in the fourth quarter producing 585,000 tons a year.

The investment is $5.7 billion. There is still very high management focus on the project to be sure that we are able to finish loss percentages on time and bid out CapEx increases. When fully operational, this state-of-the-art smelter will produce 585,000 tons of primary aluminum a year, which will be shipped as value-added casthouse products, extrusion ingots and foundry alloys. We are on schedule for ramp-up by fourth quarter this year. And when in full production, the Qatalum smelter will be among the most cost-efficient smelters in the world in terms of operating cost and make a significant contribution to lowering the average cost of our smelter system.

In addition to prices, high and volatile, there are quite large differences between the different price areas in Norway in the fourth quarter looking at the energy situation. The energy business area delivered very strong results due to three factors, due to production with Suldal 1 power plant back in production in early January this year, good prices and also good performance on optimizing the production.

The differences between prices in areas in Norway is due to bottlenecks in transmission capacity and the planned (inaudible) connection will ease the tight power situation in Mid-Norway. As you can see from the graph at page 6, the NO3 in Mid-Norway experienced the highest prices going all the way to 1,400 Norwegian kroner per megawatt hour, while NO2 and NO3, NO5 had somewhat lower prices although still on a very high level.

Mid-Norway prices was lifted to Swedish price level due to transmission capacities to Sweden, but more limited within Norway. Mid-Norway was then also impacted by low utilization rate of Swedish nuclear power impacting water reservoirs in Mid-Norway. Swedish prices reflected an expensive reserve capacity needed to attract sufficient imports to Mid-Norway to avoid energy deficits before spring flood.

Swedish nuclear power production was reduced due to prolonged maintenance outages. It was running at 60% in the fourth quarter last year and this last quarter, in 2010, 70% of normal years. The price difference in Norwegian power areas could lead to increased cost for Hydro. We have most of our power production in the NO2 area that are sourcing some power to our Sunndal smelter in the NO3 area. In times when prices are higher in NO3 than in NO2, we will experience area, the costs related to being short in NO3 and long in NO2.

Nordic spot prices went record high in the first quarter in the Nordic and especially in the Mid-Norway area due to the low output from Swedish nuclear reactors, a negative development in the hydrological balance and high power demand due to cold weather on top of it. The cold and dry winter has left snow accumulations and water reservoirs low. It has been the 11th coldest winter in 110 years with 2.5 degree Celsius below normal temperature.

The normal precipitation, the precipitation of snow in the mountains is about 52% of normal, which again is the second driest in 110 years, and in the rest of Norway, we had 28% of precipitation which is the driest winter ever measured. The deficit in the Norwegian and Swedish hydrological balance was 33 kilowatt hour by the end of first quarter after a negative development in both the snow reservoirs and water reservoirs. The negative development in water reservoirs was partly due to the Swedish nuclear situation since the hydro power produces compensation for low production in Sweden and produced more than normal.

The spot prices were above alternative prices later this spring and next winter. And there was clear signal from the market to produce. The import of – from the continent to Nordic area has also been high this winter because of the high spot prices, which also has compensated for some of the Swedish nuclear situation. The hydrological balance is still close to record low, but nuclear separation has improved significantly and currently the nuclear power stations in Sweden are running at 74% output, and the rest of our situation seem to balance through the last few weeks before the spring flood.

The market are now focused on the situation next winter since a new tight situation can appear if the weather continues to dry. Speaking of the aluminum market, there has been a significant improvement in sales volumes in Downstream from fourth quarter to first quarter. Overall, shipments for Rolled Products has improved by 9% compared to fourth quarter. Shipments were substantially higher than expected, with seasonal improvements for Rolled Products segmented, supported by restocking effects and higher end user demand.

In the foil, litho, packaging and building, and auto, heat exchanger and general engineering, in all business segments, we are seeing significant improvements, mainly driven by improved situation in the can business, but also strong performance in the automotive business areas. Shipments for excluded products increased by 10%, and now we are excluding automotive structures. All segments showed improvements except for building system where first quarter is normally the seasonally weakest quarter.

Extrusion Eurasia had the largest increase at 60%, and Extrusion Americas 6% improvement and Precision Tubing, which goes mainly to the automotive is now 12% higher than the previous quarter. All in all, we are seeing now 20% improvement in Downstream sales since the first quarter of 2009. Due to consolidation in market and restructuring of the Hydro extrusion during the last year, Hydro is in the second position in the market since 2007. That’s due to strong performance during the crisis in 2009, we are now back in the Number 1 position in extrusion in Europe going forward. We have 17% market share in the start of 2010.

In Rolled Products, we have seen a substantial improvement since the first quarter of 2009, with 21% volume increase. Due to the firm cost control, we have been able to keep 60% on volume gain on the bottom line. So, with shipments rising 21%, we have only seen that the cost has increased with 8.5%. That means include net margins in the Rolled Products business and it’s probably one of the reason why we are delivering very strong results in the Rolled Products this quarter.

Looking at Upstream situation, we have 11% improvement last quarter, with a strong improvement in extrusion ingots, sheet ingots, and very strong improvement in foundry alloys which goes to the automotive. Since the first quarter in 2009, the improvement in Upstream sales has been 17%, but there is still long way to go before we are back to the pre-crisis volumes.

Looking at aluminum price, first of all, we achieved aluminum price during the quarter was $1,997 per ton. The quarter started with about $2,200 per ton and ended up with $2,320 per ton. We are pricing three months forward plus additional FX in the cost also, it’s between three-and-a-half to four months total delay. So, the achieved aluminum price in the first quarter will give us additional FX in the second quarter.

If you look at the balance of supply and demand outside China, it is still overcapacity in the West, meaning about 1.7 million tons higher production than demand of consumption in the world outside China. This imbalance is expected to continue also through 2010. There is new capacity, Qatalum coming Onstream, that was additional capacity in the Middle East on top of some capacity coming Onstream also in India.

Looking at inventories, we see that it has been stabilized during the last quarters and we are now seeing that inventories at 6 million tons. A large portion of this is LME inventories held by financial investors and this metal is not accessible in the market due to commercial contracts. So, the time horizon for this volumes will depend on the difference between Contango and the price or the cost of financing, including warehousing cost. There are also unreported inventories which has increased during the first quarter and there are indications that this unreported inventories are leveling up to 2 million tons on top of the 6 million tons registered inventory.

If you take a look at ingot premiums, we see a steady increase in the European market, also increase in Japan and the US Mid-West markets. This also shows that even high inventories, this metal is not accessible, available in the market, and this strong development on premiums is then adding to the LME and to the bottom line of the primary smelters.

Looking at China, we see that there is a better balance in supply and demand in China in the beginning of this year. China imported about 1.3 million [ph] tons during the three first quarters in 2009 and 100,000 tons on top of that in the fourth quarter. We still see significant import of scrap from the West to China and there is not big changes on the export of semi fabricated product out of China. We expect that China will produce with a modest surplus of primary metal in 2010.

If you take a look at the market outlook for 2010, we see the main markets increasing at the level of about 12% this year. There is supply demand imbalance as mentioned and we expect that to continue through the year, and we don’t expect that the main part of the curtailed capacity will be restarted this year. And there is also limited new capacity coming Onstream as I mentioned in Middle East and India. China, again expected to have a modest surplus during the year, and will be still a lot of scrap from the West going into the Chinese market and reducing the metal units available for the Western market.

If you take a look at Upstream position, it’s very important for us to continue to repositioning the reduce in the cash cost. We demonstrated that we were able to reduce the cash cost in 2009. If you take a look at the situation today, the cash cost has increased through the first quarter of 2010, mainly due to increased raw material prices. For example, aluminum is part of the LME and linked to LME. It has increased in the first quarter and there are also other raw material costs that add to the picture. Of course, also there is the currency effect into this, especially with regard to the strong Norwegian kroner.

So, for us, it is very important to continue the efforts to reduce the cash cost of primary production and we have introduced as mentioned also this previous quarter the $100 program, which means that you are going to reduce the cost of primary production with $100 per ton. And part of that will be delivered in 2010 and the rest of that program will be delivered in 2011 next year.

So for Hydro, it has been important to position ourselves as we emerge from the crisis of our company and first of all, the volumes showing significant improvement versus first quarter 2009 at 18%. The increased premiums shows that there is a tight physical market, and it is important for us also to continue to strengthen our position in growing areas and Qatalum plays a very important role here with access to the Asian market. We are increasing our market share downstream and will continue to do so, and we also continued to produce the cost and focus still on the cost position primarily and also keep a strong cost focus along the whole value chain in Hydro.

So, then I will leave the work to CFO, Jorgen Rostrup to go through the numbers.

Jorgen Rostrup

Thank you, Svein Richard. Good afternoon everybody and good morning for you who follows us from the US and North American side, appreciate your attention. I will go briefly through the key financials and the variations in the earnings as we used to, and just looking at the underlying EBIT slide, the first one, you will see an improved performance quarter one over quarter four of more than 1.3 billion, almost 1.4 billion Norwegian kroner, and this is due to obviously the upstream in LME and downstream in energy performance.

If you look at the performance compared to first quarter of last year, it is an increased performance of 1.2 billion Norwegian kroner on the same US dollar LME, the Norwegian kroner was weak, the dollar was stronger. So, we had good, better earnings from that side, and then we had lower results on the downstream area.

And if we then look at all the business area, just briefly you will see improved financials from all areas as compared to fourth quarter, and for the other segment, which I will not address later on, we had a lower charge of 110 million Norwegian Kroner, and this is entirely due to lower pension charges in this quarter according to what we communicated around fourth quarter results. The charges and pensions this year will be significantly lower than it was last year. So, you will see that every quarter.

If you look at next page, we have produced a waterfall analysis for you and in billion Norwegian kroner, you will see that the effect of the LME price and currency due to LME earnings in the primary metal area, the effect of that is an improvement of 0.4 billion Norwegian kroner. The LME move from 1,800 to 1,997 in our books in the quarter. If you look at then at the volume part, which is the most significant element on this waterfall analysis, it is positive in all areas, totaling 0.6 billion where the improvement in the energy area is about half of that improvement, and the rest is distributed more or less evenly on the different business areas. So, a major impact from volume improvements this quarter. Some of them are sustainable to next quarter, some are not, and we will come back to that.

Margin has improved, some 0.2 billion Norwegian kroner associated with our lower charges on our Qatalum smelter in the ramp-up phase and also improved earnings in our Alunorte refinery in Brazil and Sunndal smelter in Norway is in total 0.1 billion and then there are some other elements to it. When it comes to key financials, we have a 10% improvement on the topline and that is reflecting the volume and price development in the quarter compared to fourth quarter. Obviously with our trading and commercial business on top, this is fluctuating a little bit also from quarter-to-quarter, but substantially it is reflecting the development we have seen in the volumes.

Now, we have reported EBIT of close to 1 billion Norwegian kroner, but we have taken out positive items excluded to derive at underlying EBIT. So, we have taken down the EBIT number and focusing performance-wise [ph] on an EBIT of 688 million Norwegian kroner. Items excluded that I will refer to shortly. When it comes to financial income, it is positive 545 million. On the financial income side, it is influenced by the final sale of some shares to Bilfinger, our power production partner system. And then somewhat lower interest income due to lower deposits on the bank account.

On the financial expenses side, they are actually positive this quarter. So, it is not expenses and income due to the company’s internal loan arrangements and in Euros that we have and that is varying from quarter-to-quarter depending on the Euro development compared to Norwegian kroner. This has no cash effect as we had talked about earlier, because it has an opposite effect on the – when we convert the loans and accumulate the balance sheet.

Income from continuing operations is down 1.5 billion Norwegian Kroner positive and we have a tax rate of 40% approximately. Still a fairly high tax rate due to the high earnings in energy this quarter. If you look briefly at items excluded, these are obviously items and elements that we take out in order to have a better view and better presentation of underlying performance in the quarter. We do it the same way quarter and it is unrealized FX such as LME and currency effects, and then there is some one-time effects of special character in payment charges or restructuring costs are similar.

This time, as I said, we have excluded positive effects of 297 million in our underlying results versus negative effect of 288 million in the previous quarter. We have some mark-to-market derivative contracts on the power side. They have developed negatively in the quarter, simply due to the increasing LME and dollar rates. Coal is bringing it the opposite way, but the total effect is slightly negative development. This is derivative effects on this contracts that are moving from quarter-to-quarter and is fairly small part of our total power sourcing regime.

And then we have unrealized gains on LME contracts. It stems partly from Rolled Products and partly from the Upstream segment, in total, 230 million positive. As you know, we hedge our metal costs one year forward based on customer orders. And so that gives us a long position on the LME, and we have unrealized gains on these contracts, because they have been entered into lower, at lower LME than what we had seen previously.

In the Upstream segment, we routinely sell the metal three months forward as you know. The LME prices have been increasing over the last month, meaning on this short position, have unrealized losses in several quarters up till this first quarter. Some of these contracts have then been realized in this first quarter. So, it is kind of a reversion of previous unrealized losses, giving us unrealized gain in this quarter.

And we have the metal effect in Rolled Products where we essentially take out off the cost some elements to make the revenues which are based on market prices in Q1 comparable to the cost base. So, we have a gain of 314 million here, which means that we bring the cost up somewhat in order to reflect LME prices higher level in the revenues.

At the end, impairment charges 61 million is related to write-down of NorSun shares, the solar company and there we have a gain of divestment of 67 million, which is reduction in pension liabilities related to the divested company structures, Automotive Structures in the fourth quarter, so that’s a gain.

Then, back to business again, and looking a little bit into our business area, I would start with Primary Metal which has a significant improvement of 670 million in the quarter. Much improved results in alumina area, and as you will see, we are bringing some more specification on the alumina area in this quarter, both here on the slide and also in our quarterly report, we bring some additional information.

Of the 670 million in change, 300 million of that related to alumina and 370 obviously related to our primary smelter system. We see both improved results from our Alunorte alumina commercial business, partly due to better performance in the businesses and also partly because of higher margins, both higher margins when it comes to sell sales to external cost customers and also when it comes to sales to internal customers.

In addition to that, we have positive effect from LME hedging related to this or LME forward contracts related to this alumina sales. We had quite significant unrealized losses in Q4 as you will remember. So, we have more or less reversed these effects from Q4. When we look at the smelter side and the improvement of 370 million, 350 million of that is related to the LME price development. So, more or less, the total change is due to the LME price development. We see $200 higher LME prices, and we see a fairly stable cost situation, which means somewhat higher alumina feeding cost to the smelters to the general LME development, but on the other hand, lower fixed cost according to the development in our fixed cost reduction program as Svein Richard just addressed, and in total a fairly stable cost situation.

If you look at Qatalum, we have a charge of 146 million in the quarter compared to 174 million in the fourth quarter and this is according to our guidance in the fourth quarter. Going forward, we should still, for the second quarter expect negative charges from Qatalum. It could be in the range of plus or minus 100 million kroner. And we have also sold in the normal we do it our primary production for the next few months forward. And you will see that we have sold it at $2,175 level, which is $180 on top of what we saw in this quarter. We will experience some increasing alumina cost against simply due to the LME development. We expect other costs to be more or less stable.

If you metal markets, you will see an improvement of 85 million kroner, up to 65 million kroner for the quarter. I think this quarter has been marked with very high activities in our production system which is then the remelter system in Europe, but also units in the US and in Asia. It has also – but that has given marginal effect on the EBIT line, simply because we have also higher input costs in the remelting system due to the tight metal situation and the fact that the Chinese are buying off scrap from Europe. So, we have to use coal metal in this system. So, it gives positive and good results, but it hasn’t changed much this quarter compared to last quarter.

If we then look at the rest of the system, we have this quarter negative currency effects of 100 million due to the fact that Euro has depreciated 7% to the Dollar and we primarily sell in Euro and buy in Dollar in the units. So, we had neutral currency effects in fourth quarter, so if we had 100 million to the variation of 85, there is an underlying change quarter-on-quarter of approximately 180 million. This is due to two elements, and they are both in the metal sourcing and trading division. As you remember, in the fourth quarter, we had derivative loss and mark-to-market hedge on our ingot trading at that time. Our ingot trading is trading of physical metal and the hedge part of that, we had to take a mark-to-market loss on it in the fourth quarter, while the aluminum in inventory we cannot take a gain on that due to the increasing LME.

This quarter, we have realized the metal and we have sold the metal, and we have realized this gain. So, there is significant gain in this area in this quarter up to the same level as the loss in last quarter. And then the second part is also something that you probably will recognize from last quarter, but again with opposite development, on our LME trading, which is then the paper trading that we do, we have been having the right positions this quarter and we have secured a gain that is more or less compensating for the losses that we had in fourth quarter, and these two elements explain more or less the deviation of 180 million from fourth quarter to first quarter.

Going forward, high seasonal demand, we will run our system and at full speed as we do this quarter. We see continuous high remelt activity and we believe that Svein Richard had touched that we will see some increases in premiums and again we should be prepared to see volatile trading results in this area.

Rolled Products is probably the era where we have been, should I say, somewhat surprised even that’s management of Hydro delivering what we consider as being strong results, market taken into consideration. Stronger-than-expected results due to seasonal effects, definitely a pickup in underlying demand, but also to some extent restocking.

We see a 9% improvement in the sales volumes fourth quarter till first quarter, and a 21% sales volume increase if you compare this quarter with first quarter 2009. After improvement of 166 million from fourth quarter till first quarter, 140 million of that is related to volumes, and then 40 million approximately is related to increased margins.

I think it is fair to say that we think this also will remain the picture in second quarter. We see stable markets and we see also good Hydro shipments and a good order situation. This also give us the impression that we should probably look at 2010 as being a more normalized year for our entire aluminum business where we have a more normal seasonality development throughout the year, which means that first and second quarter are the strongest quarters and most likely, we based on this expect third and fourth quarters to be somewhat weaker, which would be a typical development that we have seen over many, many years, and for 2009 due to the financial and industrial crisis developed very, very differently, but we might then be back in a more seasonally normal situation as we see it.

If you look at Extruded Products, there is some improvement in the numbers from 68 million fourth quarter till 117 million in the first quarter, which is an improvement of 49 million kroner, but I would like to draw your attention to what happened in fourth quarter. We sold as you know the Automotive Structure at the end of that quarter and that business alone gave a loss in fourth quarter of 67 million in fourth quarter. So, if we compare as the structure as it was excluding Automotive Structures in 2009 fourth quarter with first quarter 117 million, we have a negative development of 18 million in the quarter. This is entirely due to a lower performance by the Building Systems as Svein Richard said. Building Systems is atypical in our system because it is as the seasonality means that it normally improves the results over the year while as I just said the rest of the business would typically have the strongest performance early in the year.

We see however a 10% volume increase on the extrusion part, and we expect this market to remain, positive, strong and probably improve throughout the second quarter above normal seasonality.

Finally, if you look at Energy, I think it’s fair to say that we have taken a good advantage of high energy prices, high power prices in the Nordic region in the quarter. We have had 45% higher production in the first quarter compared to the fourth quarter and also 12% higher production than in Q1 2009. So, we have had very high production and then the prices have been significantly higher as levels. We have all the assets in operation and thereby we have created an EBIT that is two times the level that we saw in fourth quarter. And then we are posting quite clear, should I say warnings or guidance for second quarter and for the remaining of the year. We are actually saying a low power production for the rest of the year. This is obviously based on the low reservoir situation in the Norwegian water reservoirs and in our system. And we should expect low production for several quarters to see more normalized reservoir levels.

Then I will wrap it up with a couple of slides on the financial side. As you remember last year, we released 5.8 billion Norwegian kroner from operating capital and that was instrumental in managing our cash flow last year. This year, we also have this first quarter positive cash flow with 186 million, so it’s significantly lower, but we have a buildup of operating capital of 1.6 billion Norwegian kroner. This is mainly due to increased accounts receivables and that is based on both higher prices, but not at least higher sales volumes and is a natural part of how this will develop when markets are moving the way they are.

On the other hand, we are happy to see that we also manage this quarter to take inventory on the ton level down further and are fairly close to minimal inventory levels the way we see it. Qatalum investment, 1.1 billion equity. We will also see that kind of numbers, maybe a little bit lower for next quarter and also see some investments charges also for the remaining of the year on Qatalum. If you then look at the financial position, we were still at March 31 this year cash positive with 0.5 billion Norwegian kroner. So, we are getting very close to cash neutral on the balance sheet, and then we are actually used to showing just the net interest-bearing debt where we are adding our share of debt in the companies that we own less than 50% where we also add what we feel is the net pension liability based on the calculation that we do yearly, and there are also some other adjustments that we make and there you see an increase in this number from 15.5 billion to 16.9 billion Norwegian kroner in net interest-bearing debt adjusted, which is similar to the net cash – net operating capital development in the quarter. Svein Richard?

Svein Richard Brandtzaeg

Thank you, Jorgen. We have a delivered a strong improvement in the bottom line performance since last quarter, but we will still continue to keep the focus on the price and the performance. Our $100 program as mentioned and it’s an important part of that in repositioning and Qatalum at full speed in the fourth quarter will add to the picture where Hydro will come down the curve. Important for us is to continue the financial flexibility, so we have firm cost control in the coming quarters, and finally it is important also to position Hydro as a leading supplier of value-added products in the market and capture the market opportunities that may arise.

Thank you all much.

Stefan Solberg

Thank you Svein Richard and let’s open up for questions.

Question-and-Answer Session

Operator

(Operator instructions) And we have our first question from Mr. Pascal Salewyn from Exane. Please go ahead, sir.

Pascal Salewyn – Exane

Yes, good afternoon everyone. Could you please comment on a visual of marginal costs in industry? I think that on your slide, you're commenting on a cash cost for Q1 that would stand now at $1,800 per ton, so I guess marginal cost now clearly has been much higher than that. So, could you comment on this please?

Jorgen Rostrup

Pascal, it was a little bit hard, there was some noise on the line. Could you repeat, I am sorry; could you repeat your question?

Pascal Salewyn – Exane

Yes, so your cash cost for Q1 is $1,800 per ton. And I was just asking what is your estimate for the marginal running cost at the moment in the industry and what it could be – what could it be at the end of the this year, please?

Jorgen Rostrup

Let me start to address the issue and then Svein Richard and others might add to that, but as we have talked about earlier, the cash cost for the industry as well for the different players are a very, it is a number that is sensitive to several factors, and therefore it is not a static picture as you know. If you assume that we are on between 22 million tons and 24 million tons of demand right now, there is a cash cost situation probably in the range of $2,000 or even slightly higher, but we very much would like to warn on being too fixed on this number. And as you know, at the end of the cost curve, it’s normally fairly steep straight upward. So, here it looks like at least technically like the smelters are stacked on top of each other at the end of the cost curve. So, what we are saying is that we see a cost picture in the range of $1,800 and that is kind of at the same level as we saw it in 2009 with a very important comment that Svein Richard gave that when LME is improving, then also we will see a higher cash cost simply due to the fact that alumina is increasing in costs.

Our main objective is obviously to bring down this cash cost on the elements that we can control and hence we have developed the $100 cost program as a measure to mitigate all these other factors.

Pascal Salewyn – Exane

Yes, thank you. And just a last question on your production capacity management, I think that on your release, you were mentioning potential definitive closures of some smelters. Could you just comment on what could basically push you to finally take the decision to close some idle capacity?

Svein Richard Brandtzaeg

With regard to the smelting capacity, we have curtailed capacity during the crisis year 2009. The sort of value line that was stopped early during the last year will not be restarted, but the rest of the capacity is available for restarting in principal. But in the market situation as we see now going forward even with the high, relatively high LMEs, we don’t plan for restarting. There is overcapacity in the western world and there is also huge inventory. So, we would like to see more stable situation before we restarting capacity.

With regard to the Rheinwerk specifically, there is process ongoing that we are awaiting in Germany. Berlin is working with a CO2 compensation scheme for the energy-intensive industry in Germany. That has to be approved in Brussels. This process has not been finalized, and we are evaluating still the future of Rheinwerk. No decision has been taken yet. But of course, with the freight condition in Germany, it’s very hard to continue operation long-term with energy price that we are seeing in this environment.

Pascal Salewyn – Exane

Thank you very much.

Operator

We have our next question from Mr. Tony Rizzuto from Dahlman Rose. Please go ahead, sir.

Tony Rizzuto – Dahlman Rose

Thank you very much. Hi gentlemen. I've got several questions. My first question is, with regard to your aluminum costs, what are your thoughts on alumina? Are you seeing pressure by the major producers to delink the raw material from the metal? And I'd be interested in any comments. I have a couple more questions, too.

Svein Richard Brandtzaeg

Okay. I may start with the first one. Of course, this is an issue we are focusing on. It has been an issue for a while and so far, we feel we have good short-term and mid-term situation that of course this is something we are going to follow up in the coming quarters.

Tony Rizzuto – Dahlman Rose

Just to refresh my memory, what is your current position on alumina right now? You are pretty much, you are a net buyer on balance, is that correct?

Jorgen Rostrup

Yes, that’s correct. We have 60% – 60% to 65% equity position when it comes to alumina and then we have a coverage of mostly long-term contracts for the remaining. We are slightly less covered on the bauxite side, but also there we have done a fairly good longer-term contract coverage for the remaining part. So, we don’t feel in any near horizon, any stress here at all, but obviously in order to develop the business coming from an upstream-oriented business, first quarter, our smelter capacity is what we are looking for, and there we have Qatalum 1, and then also you know, we would be oriented towards looking for opportunities to develop our bauxite and alumina business, but for the next actually, I think it’s fair to say as long as 20 years, you have a sufficient coverage the way we are running and developing our business right now.

Tony Rizzuto – Dahlman Rose

All right, thank you. And the other question – the other two questions are really related and have to do with your Rolled Products segment. In your outlook, you referred to margin pressure and I'm wondering where you're seeing it most and is this somehow related to the Chinese? We're noticing from a US standpoint that exports are increasing of semis over here. Are you seeing more of that semi-finished product coming out of China and impacting your markets?

Svein Richard Brandtzaeg

With regard to Rolled Products, I would just comment in general that this has been an industry that for quite some years has not been able to deliver sufficient return above cost of capital. So, in general, there is always pressure on margins, but when you look at the first quarter results, we have been able to make improvements in margins in Rolled Products, partly due to the fact that there is an improvement in the market, but also with the internal efforts to reduce the cost. So, with regard to the situation forward, it depends very much on the market development of course. So, far it looks promising, but again this is an industry that has been struggling with the effects of water supply. With improved market, it will be a better balance and also I assume that our situation with regard to margins.

Tony Rizzuto – Dahlman Rose

The bev can market in Europe, has it experienced the same ending of the price caps that we're seeing in North America or is this more unique to this continent?

Svein Richard Brandtzaeg

In Europe, there has been very limited competition with Chinese producer of semi-fabricated products in general. The lead time is one issue of course. The cost of, in a way, the logistical issue is another way. But of course, we are monitoring this constantly and we see the North American market is more exposed.

Tony Rizzuto – Dahlman Rose

Thank you very much gentlemen.

Operator

Now, we have a question from Markus Almerud from Morgan Stanley. Please go ahead, sir.

Markus Almerud – Morgan Stanley

Yes, hello. Could you just help me to understand a little bit on what's included exactly in the alumina commercial businesses and the raw materials? Alunorte is part of that EBIT, but that's 47 million. What does the rest – what is the rest? And also in the slides where you have underlying EBITDA, is it the Alunorte part of that as well?

Jorgen Rostrup

Yes, Markus, thanks. It’s a good question and I will address it. First of all, Alunorte numbers, yes, they are included, not with EBIT number itself, because it is included with the results of the taxes of financials. So, that is taken into the Hydro’s EBIT numbers. In the commercial area in alumina, it is responsible for in-sourcing and outsourcing marketing of alumina in our business. So, they have both the external contracts, sourcing contracts. They have the alumina that we have on contract from Alunorte. And they turn around and they market this on contracts and also short-term towards our smelters internally in Hydro and also to external customers.

Markus Almerud – Morgan Stanley

So, how does it work? So, the profit you make there, is it a mixture of trading businesses and a margin that you have over the long-term business and then you sell it to these smelting businesses for market price?

Jorgen Rostrup

Yes, Markus, that is market.

Markus Almerud – Morgan Stanley

Okay, thank you.

Operator

(Operator instructions) And now we have a question from Tom Jandal from Carnegie. Please go ahead.

Tom Jandal – Carnegie

Hi, I just want to touch upon the downstream business which seemed to go very well in Q1. And I was thinking about getting such high margins so early in the cycle, given that the business activities is still quite poor. Is it the sustainable costs which are doing most of the work here, or is it more temporary volume effects due to the destocking?

Svein Richard Brandtzaeg

With regard to the effects we see especially in the Rolled Products, it is a result of the efforts we did during the crisis year last year, and of course, we have a strong focus to keep down the cost and not let the cost go away with increasing volumes. So, again we have several good examples with that as being, the underlying performance improving the net margins in the Rolled Products. In Extrusion, the situation is a bit different, but also there, we have flexibility on volumes. So, there will also be volumes affected, but to a lesser extent than what we have seen in Rolled Products. So, all in all, the margins have increased in Rolled Products, and we are keeping fair margins in Extrusion.

Tom Jandal – Carnegie

Thanks. If I can just follow-up on that, you just mentioned that the returns in the Rolled Products business haven't been really sufficient over the past cycle. So, if you would just be comparing with say, a previous cycle which had been quite poor, and that's one of the reasons that you could defend a higher margin in rest of the cycle? That's more to the Rolled Products business. And also when it comes to Extrusion, there has been some consolidation among the two largest competitors over the past years, and is that also building for a better margin picture in the industry and for you particularly going forward?

Svein Richard Brandtzaeg

Yes. With regard to the general comment on the Rolled Products market, there has been, I think an effort among all the players to include operational performance. The profitability of the Rolled Products business in general hasn’t been good enough. If you get the report from older players, and I think that is now improving, but still there is some way to go before we are happy with the margins. So, we are continuing our efforts in strengthening that part of the business.

With regard to the Extrusion part, you are absolutely right. There has been an effect as a result of the consolidation in the industry. We have been through also some restructuring in our own Extrusion business, taking out capacity in UK and some other places, which means that the capacity utilization always is better in Hydro, but also the supply demand balance is also better in general in the Extrusion business and it seems that the margins in general has improved due to this industrial development in our markets.

Tom Jandal – Carnegie

Okay, thank you very much.

Operator

We will take our next question from Mr. Jonathan Schroeder [ph] from UniCredit. Please go ahead.

Jonathan Schroeder – UniCredit

Yes, hello. I have two questions. The first question is you say in your report for the first quarter that investments in Qatalum were around 1.1 billion kroner for the quarter, which comes to around $183 million. I understood that the investments were going to be about $200 for the first two quarters. And you also said in that report that you expect a little bit less in the coming quarter. Has your timing or guidance for the volume of that investment changed? And the second question is what – you have basically increased your guidance for volumes for the coming year to 12% from what was around 8% previously. What exactly has driven your confidence to make this move at this point? And how confident are you that you can realize that and that this is not basically driven by short-term inventory effects? Thanks.

Jorgen Rostrup

Okay, Jonathan, let me try to address the first question that you had, and you might help me out a little bit on the kind of detailing about the question, but then Svein Richard will try to address your second. I think the guidance and spending in the Qatalum this quarter is more or less in line with our expectations. Of course, when we are guiding on this in third and fourth quarter, there might always be a slight variation in how we conduct the final investment, the final program and also when we pay for it and we are actually injecting equity in the company, but as far as I am concerned, we are more or less in line with our expectations. So, I am sorry, if we have kind of created any misunderstanding there.

What we have in addition to the program that we have focused on and this we have also talked about is some injection due to working capital that comes throughout the year. So, that is the only thing as far as I know, that is an addition to it. And as we are reporting this quarter, the program is still according to plan. So, production is gradually ramping up the way we thought it would do and we should still be on full production during fourth quarter.

Svein Richard Brandtzaeg

With regard to the volumes, you are right, we are guiding towards 12% improvement, and of course, this is a combination of underlying demand and restocking among our customers. We have seen that the stocks went substantially down during last year and working releasing as Hydro also did and now to be operative in a better market situation, there is restocking obviously in the market, but again it is from the firm order situation we have going forward and the situation where we see that there is quite a good reason to believe that there will be 12% improvement in 2010.

Jonathan Schroeder – UniCredit

Okay, good. Thank you very much.

Operator

(Operator instructions) There are no further questions. I would like to turn the call back over to you gentlemen for any additional or closing remarks.

Svein Richard Brandtzaeg

Thank you everyone for joining us on this call and for all the good questions. We look forward to continuing the dialog with you and hopefully you will join us again on July 27th for our second quarter results. So, thank you very much and have a nice afternoon and evening. Thank you.

Operator

Thank you. That will conclude today’s conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.

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Source: Norsk Hydro ASA Q1 2010 Earnings Call Transcript
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