Monday, 12 November 2012

Subsidising smelters?


Invercargill Mayor Tim Shadbolt, right, reckons the government, i.e., taxpayers, should subsidise electricity prices enjoyed by Rio Tinto, the owners of the Tiwai Point aluminium smelter in Tim’s “electorate.”

The smelter company wants to negotiate a new power contract for its Tiwai Point smelter near Bluff in the face of plummeting world aluminium prices.
    But with no resolution after three months of talks, Mr Shadbolt says Prime Minister John Key must intervene.
    "I mean, they own the electricity company that's sitting around the table and they've got a vested interest in making sure our export industries and manufacturing in this county are supported."

“Supported” as used here being code for “bailing out.” Basically, the arse has fallen out of the world aluminium market, and Mayor Tim reckons Tiwai Point should keep exporting and producing at a loss, with us picking up the tab to make up the difference.

Does this make any sense? Do taxpayers, via the government, have “a vested interest” in making sure export industries are “supported”? And if so, at what cost?

The Bluff smelter was built partly to create a market for the huge hydro-electric output of the Manapouri scheme, now owned and operated by Meridian. The terms of the power supply contract were renegotiated in 2007 with the new supply agreement set to begin in January next year.
    The smelter, operated by New Zealand Aluminium Smelters (NZAS), is Meridian's biggest single customer and the contract due to kick in from January 1 is for 18 years. The smelter consumes about one-seventh of New Zealand's electricity and the price has never been disclosed…
    The negotiations come as Rio Tinto looks to sell the Tiwai Point smelter along with 12 other aluminium producing assets in Australia. Japan's Sumitomo owns about 21 per cent of the Bluff smelter.

The aluminium smelter at Bluff was always more about politics than economics.  Aluminium is made by adding electricity to bauxite.   But NZ produces no bauxite—the only reason the smelter is there is because politicians in the 1960 Labour Government agreed to build the ginormous hydro scheme at Manapouri* to make electricity for Comalco’s new smelter (built for them by the government), exporting aluminium made from imported bauxite and subsidised local electricity from a taxpayer-funded plant.  This smelter, now owned by Rio Tinto, uses one-seventh of all electricity produced in NZ to produce around one billion dollars in export revenues at a large yet undisclosed subsidy.

“If New Zealand is to experience an export-lead economic recovery,” says Mayor Tim, “then we need to retain businesses like the Tiwai Point Aluminium Smelter.”  But should they be retained if the only means they can be made economic is by you and I paying subsidies to those exporters?

After all, a subsidy to an exporter amounts to little more than a subsidy to overseas buyers. Should we really be taking money out of our own pockets to put into the pockets of customers in Japan, China, America and Europe?

And if it’s agreed we should subsidise this exporter by means of cheap electricity, by what means could the pleas of any other exporter be denied? Should we simply and without question adopt the ruinous policy amounting to buying dearly in New Zealand to sell cheaply abroad?

After all, it’s not like there aren’t other things NZers could be doing with that money themselves, or all that electricity.

I suggest Mayor Tim pick up a copy of Frederic Bastiat’s Economic Sophisms and study particularly his article on “Robbery by Subsidy,” which is what Mayor Tim is advocating. In fact, to make it easier, let me contextualise the relevant passage for him:

It is true that robbery by subsidy also lends itself to infinite subdivision of the proceeds, and in this respect is no less effective than highway robbery; but, on the other hand, it often leads to such bizarre and absurd consequences that the natives of New Zealand might well regard it as ridiculous. What the victim of a highway robbery loses, the robber gains. The stolen object at least remains in the country. But, under the system of robbery by subsidy, what the tax takes away from NZers is often conferred upon the Chinese, the Japanese, the Europeans, or the Americans. This is how it works:
    Suppose an ingot of aluminium is worth a hundred dollars to the producers at Bluff. It is impossible to sell it for less without a loss, and it is impossible to sell it for more, because competition among sellers on the world market prevents the price from rising any higher. Under these circumstances, if anyone wants to buy this ingot, he will have to pay a hundred dollars or do without it. But if it is an Englishman, say, who wants to buy the ingot, then the government intervenes and tells the producer: "Sell your ingot; I shall make the taxpayers give you twenty dollars by way of cheaper electricity." The merchant, who neither demands nor can get more than a hundred dollars for his ingot, sells it to the Englishman for eighty dollars. This sum added to the twenty francs which robbery by subsidy has extorted makes his account exactly even. The result is, therefore, precisely the same as if the taxpayers had given twenty dollars to the Englishman on condition that he buy NZ-produced  ingots at a twenty-dollar discount, at twenty dollars below the cost of production, at twenty dollars below what it would cost us ourselves. Thus, robbery by subsidy has this peculiarity, that its victims live in the country that tolerates it, while the robbers are scattered over the face of the earth.
    It is really astonishing that people still persist in considering it as an established truth that everything that the individual steals from the common fund represents a general gain. Perpetual motion, the philosopher's stone, the squaring of the circle, have long since ceased to occupy men's minds; but the theory of progress through robbery is still held in esteem. Yet a priori one might have thought that of all puerilities this was the least likely to survive.

Instead, it is alive and well and flourishing in Invercargill.

* * * * *

* I yield to no-one in my admiration for the enormous engineering achievement this scheme represents. But when thinking about it I also can’t avoid recalling Bolshevik leader Vladimir Lenin’s description of Soviet Communism as “socialism plus electricity.” I’ll leave it to you, gentle reader, to draw the connection yourself.


  1. the drunken watchman12 Nov 2012, 10:26:00

    well.... susidising a loss-making business can make sense if the only alternative is to spend even more than the subsidy on unemployment benefits for redundant workers.

    So ...if the figures stack up...

  2. 'The Bluff smelter was built partly to create a market for the huge hydro-electric output of the Manapouri scheme, now owned and operated by Meridian'. Sorry, but the original media report is seriously in error - the Manapouri Power Project was constructed, in large part, to guarantee the establishment of an aluminium smelter at Tiwai Point. The original design, cost and construction programme for the Manapouri project were all geared to the requirements of the aluminium smelter, for successive New Zealand governments hoped that the country would thereby acquire a fully-built up aluminium fabrication industry, rather than just a toll smelter. Otago BoB

  3. '... the only reason the smelter is there is because politicians in the 1960 Labour Government agreed to build the ginormous hydro scheme at Manapouri* to make electricity for Comalco’s new smelter (built for them by the government). Again, no - in 1959/60 the then Labour administration under Walter Nash agreed to permit Consolidated Zinc Proprietary Limited to construct the Manapouri Power Project, and in 1963 the National administration under Keith Holyoake agreed to assume responsibility for the construction of the Manapouri project when ConZinc could not afford to build both the power scheme and the smelter. The government did not build the smelter, although central and local government did provide support infrastructure - including roading and wharfage. Otago BoB

  4. Last thought for the day - part of the problem between Meridian and Rio Tinto is the legacy of the Max Bradford electricity reforms of the 1990s, which saw the arbitrary introduction of a competitive model into an integrated national system of electricity generation and distribution which was working well. Any debate on the current Manapouri-Tiwai Point issue needs to take into account electricity base loading, peak loading and spot pricing - economic theory alone is not enough to power an electricity industry! Otago BoB

  5. Lets get real. The smelter is about fifty years old.
    New technology smelter are now being built in China, which has large deposits of bauxite and with the huge dams being built they have a huge supply of cheep hydro electricity.
    They also don't have the RMA.

  6. Bit more thought and analysis required here Peter.
    It would only be a subsidy if the electricity can be sold more profitably elsewhere. Can it?
    Given that, currently, it can only be delivered to Invercargill and would require a heap of infrastructure upgrades to get it further up the island and a whole heap more to get it to the North Island.
    How much would that cost? How long would it take? What return on the investment?
    First thing that would happen it Tiwai closes is that power prices in the South Island, or at least the southern part of it, would collapse.
    That may be considered good for consumers but may affect the viability of other producers or of consumers who have locked in power prices and cannot renegotiate.
    It would probably attract energy intensive industries to the area. That may be more value to Tim Shadbolt than hanging on to the smalter.

  7. @Rab: You don't think producers could find something to do with much, much cheaper electricity? You don't think that by lowering production costs by removing the unprofitable energy hog wouldn't open up terrific opportunities for others--one of which, as you note, is that energy intensive industries might cluster around Invercargill.

    PS: I believe Manapouri is connected to the National GRid via two double-circuit 220 kV transmission lines running through Invercargill.

  8. There is no problem getting power out of Manapouri but are a number of constraints getting power north as it has to compete for space with all the other power in the region, you shouldn't just focus on Southland's local grid.,78766997/Industry_Meeting_24_Sep_2012.pptx.pdf

    And Otago Bob is wrong- economic theory is a damn sight better at getting a fit for purpose grid than centralised and politicised planning which chucks money at the next big thing. See your own comment re the non emergence of the aluminium industry as examples.


  9. New Zealand's national system of generation and transmission was designed and constructed by a succession of visionary government engineers. Economic theory helped fool successive Labour and National Governments into thinking that building a huge power project would automatically guarantee a fully-integrated aluminium industry for New Zealand. Since the Bradford reforms, just how much 'fit for purpose' transmission capacity has been constructed, upgraded or even maintained? Otago BoB

  10. Bob, are private companies responsible for transmission true upgrades? Or is it a (quasi or actual) state owned company with highly regulated profits, incentivised not to invest in more capacity by those regulations? See the housing market myth post. Same applies WRT the RMA.
    As for visionaries, anyone can build great big white elephants when not constrained by consideration of capital costs.

  11. Have a look at the history of electricity generation in New Zealand - John Martin's People, Power and Politics, to see how white elephants such as Clyde can result from a heady mix of politics and economic theory. As Tom Scott observed in a cartoon when ECNZ was split up into competing State-Owned Enterprises - the problem with ECNZ is that it works in practice, but not in theory...

    As for our engineers of the past not ever having been constrained by capital costs, the history of state electricity generation in NZ in the twentieth century shows the exact opposite, since every 'dam' dollar had to be accounted for. Treasury was always ready to pounce. Otago BoB

  12. @Otago BoB: That book by John Martin looks good, but since the publisher is ECNZ it's not exactly easily available now. Any idea where one might get a copy these days?

  13. I'd try your local library, or keep an eye out for a copy on Trade Me.

    John E Martin, People, politics, and power stations: electric power generation in New Zealand, 1880-1998, Electricity Corp. of New Zealand and Historical Branch, Dept. of Internal Affairs, 1999.

    You might also be interested in Neil Rennie, Power to the people: 100 years of public electricity supply in New Zealand, Electricity Supply Association of New Zealand, 1989; and

    Rosslyn J. Noonan, By design: a brief history of the Public Works Department, Ministry of Works, 1870-1970, A. R. Shearer, Govt. Printer, 1975.

    Otago BoB