Sydney - Rio Tinto's Sam Walsh faces his first difficult decision as chief executive -- whether to shut the 1 400-staff Gove alumina refinery in Australia, as under-performing units come under tougher scrutiny following $14bn in write downs this month.The refinery supplying the raw material to make aluminium has been set a January 31 deadline by Rio Tinto to come up with a plan to lower operating costs by switching from heavy oils to gas for fuel or be mothballed. Analysts expect the stance taken by Rio Tinto and Walsh at Gove to serve as a template for dealing with other struggling businesses in the firm's portfolio, which include coal in Mozambique and other parts of the aluminium business.Gove is the worst performer within the Pacific Aluminium division, set up by Rio Tinto in 2011 to prepare 13 smelters and alumina operations in Australia, the United States and Europe for closure, sale or spinoff into a separate entity.Rio Tinto on January 18 said it would write down between $10bn and $11bn for its aluminium business and replaced its long-running chief executive, Tom Albanese, with Walsh.The government of the Northern Territory, where the refinery is located, has asked for an extension to come up with a plan to lower energy costs, which at this stage Rio Tinto does not appear willing to grant.
Responding to a request by Northern Territory Chief Minister Terry Mills for eight more months to shore up sufficient gas supplies, Rio Tinto last week reiterated its intention to "complete the strategic review at the end of the month" and make a decision "shortly afterwards."
Walsh comes from running Rio Tinto's flagship iron ore division, which is expected to account for more than two-thirds of the company's forecast $15bn in earnings before interest and tax in 2012.
Albanese may be best remembered for his ill-timed acquisition of Alcan for $38bn in 2007, just before the global financial crisis set in and commodities prices crashed.
The former CEO also steered Rio's $4.2bn acquisition of Mozambique coal explorer Riversdale Mining, which resulted in a $3bn in unforeseen 2012 impairment charge.
In changing top management, the focus on making deals, expanding reserves and output under Albanese is set to shift to controlling costs and running assets at peak efficiency under Walsh.
Challenge to secure enough gas
According to Wood Mackenzie, 49 % of the Gove refinery's cash costs relate to energy, equating to $150 per tonne of alumina.
CIMB estimates that switching from heavy fuel oil to gas would reduce energy costs by 20% to 30% and reduce overall cash costs by 10% to 15%.
The key challenge for Gove is sourcing enough gas to power the operation and CIMB estimates government gas sources would cover little more than half the refinery's current requirements.
The Northern Territory government has already authorised the release of gas from a government-owned utility but is still holding talks with energy firm Eni for additional gas supplies.
"I am confident that if Rio Tinto and Eni are willing to continue to work together in good faith to reduce the risks to the Northern Territory, an aggregated gas supply solution can be found by September 30, 2013," Chief Minister Mills said on January 23. He was unavailable for immediate comment.
The cost of converting to gas involves the relatively simple and inexpensive process of adjusting boilers to run on gas.
However, the cost to develop a pipeline would be more significant, estimated by CIMB at between $700m to $900m.
But even if the refinery is granted a reprieve to pursue a conversion to gas, Rio Tinto is still left to wrestle with a weak market for alumina, where world supplies are still rising even as prices languish.
Industry estimates suggest roughly half of all the alumina produced worldwide outside of China operates at or near a loss.
Global alumina production increased 20% to 96 million tonnes between 2007 and 2011, with most of the supply increase from China, the world's largest producer.
More refinery capacity is planned over the next three years, with another 14 million tonnes in China alone.
"If it is all commissioned as scheduled, then the market will be over supplied in the short term, until demand from the aluminium industry catches up," consulting group Roskill said in a report on the sector released this week.
In 2012, Gove's production decreased by 7% to 2.5 million tonnes. However, Rio Tinto's overall output of alumina rose by 19% last year, owing to higher output from its Yarwun refinery, which sits outside the Pacific Aluminium umbrella.
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