Ahead of the deadline of March 31, Alcoa (NYSE:AA) has announced that it will go ahead with its modernization plan for the Massena operations. The company has committed itself to investing $42 million for the next phase of modernization and another $10 million for economic development in the North Country. This clears the way for the company to receive low-cost power from the New York Power Authority (NYPA) for 30 years beyond 2013, provided it spends at least $600 million overall on modernization.
Given that electricity costs can account for up to 25% of total costs in the aluminum smelting process, we think that Alcoa has taken the right decision from a long-term perspective. An Alcoa executive also acknowledged that modernization of the plant will help the company in moving further down the aluminum cost curve. 
The funds allocated for the modernization will be used for site work and support projects in preparation for the construction of a new potline at the location's Massena East plant. The plan now needs approval from the U.S. Environmental Protection Agency (EPA), which has put forth a remediation plan for cleanup of the Grasse River that makes Alcoa liable for paying the cost. The EPA's decision is expected next month. 
What Does The Massena Plant Produce?
Alcoa's Massena facility is the longest continually operating aluminum facility in the world. The company operates two facilities here - an integrated aluminum smelting/ fabricating plant and a smelting/casthouse facility. It began operations here in 1902 to take advantage of the abundant hydroelectric supply in the region.
Massena is home to two aluminum smelters, the East plant and the West plant. The West plant produces 130,000 metric tonnes of molten aluminum everyday while the East plant produces 125,000 metric tonnes. The aluminum produced is then processed by the downstream business segments of the company to make ingots, rods, bars and screws. These are then supplied to customers in the construction, electronics, packaging and transportation industries. 
What Does The Modernization Plan Involve?
The modernization project includes the construction of a new potline at the Massena East plant which will produce 144,000 metric tons of aluminum per year, upgrades to existing facilities at Massena West, and modifications to other existing facilities that will help integrate the two plants and support the new potline. In addition to building a new potroom at the East Plant, Alcoa will replace the current "Soderberg" technology at that facility with the more modern "pre-bake" technology which is already in use at the West Plant. "Pots" are steel-lined containers in which molten aluminum is smelted. They are arranged in long rows in large buildings called potrooms. 
Once Alcoa starts using the pre-bake technology at the East plant, there will be significant improvements in air quality and emissions and a reduction in the quantity of waste generated in the aluminum-making process by up to 56%. It will also reduce the amount of dust generated, thus creating better working conditions for workers.
What Took Alcoa So Long To Decide?
According to an agreement between Alcoa and NYPA, the company had to submit its proposal by March 31 in order to receive 239 megawatts of additional power for restarting its Massena East plant. The supply of cheap power makes manufacturing in Massena an attractive proposition for Alcoa. Also, the agreement signed with the NYPA in 2008 for supply of low-cost power would have been up for review if Alcoa hadn't submitted its modernization proposal by March 31. Given these factors and the expected benefits from modernization, one would have expected Alcoa to have decided in favor of the plan much earlier.
For all the expected benefits from modernization, Alcoa was in a dilemma because it faces extra environmental costs beyond the $600 million for the project.
Alcoa has been conducting investigations and studies of the Grasse River, adjacent to Alcoa's Massena plant site, under a 1989 order from the U.S. Environmental Protection Agency issued under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). This act deals with the usage, disposal, storage or treatment of hazardous substances at a number of sites in the U.S. Sediments and fish in the Grasse river contain varying levels of polychlorinated biphenyls (PCBs) due to Alcoa's operations, and the EPA wants the company to bear the cost of cleaning up. 
In choosing to modernize, Alcoa will also have to undertake the Grasse River remediation project, the scope of which will be chosen by the U.S. EPA. The proposed remediation project comes with an estimated price tag of $245 million, which would have to be borne entirely by Alcoa. Other proposed options for the cleanup range from a 3-year, a $114 million option, to an 18-year, a $1.3 billion option, according to the EPA.
Although the combined smelting capacity of the two plants at Massena represents a relatively small portion of its worldwide smelting capacity of 4.2 million tonnes, it is a significant part of its total smelting capacity of 639 million tonnes in the U.S. Also, it is a low-cost operation due to availability of cheap power which gives the company a competitive advantage and generates higher profit margins. Thus, even with environmental costs, modernization should turn out to be a net positive development for Alcoa.
We have a Trefis price estimate for Alcoa of $8.
- Alcoa Prepares To Proceed With Next Phase Of Massena Modernization, NASDAQ
- Alcoa to Invest $42 Million to Improve Massena, N.Y. Plant, Bloomberg
- Alcoa Massena Operations, Alcoa Website
- Massena Operations Modernization - Overview, Alcoa Website
- Alcoa 2012 10-K, SEC
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