JOHANNESBURG (miningweekly.com) - Global aluminium giant Rio Tinto Alcan and South Africa's power utility Eskom confirmed on Thursday that plans for the proposed $2,7-billion Coega smelter project, which was destined for South Africa's Eastern Cape province, had been terminated, owing to Eskom's capacity constraints.

In a joint statement, Rio Tinto, Eskom and the South African government revealed that the ‘Electricity Supply Agreement', signed in November 2006, had been terminated in accordance with its "terms and conditions".

The statement made no reference to cancellation penalties, but confirmed that Rio Tinto Alcan and its partner, South Africa's Industrial Development Corporation, had invested about $130-million in the project since the conclusion of the power supply deal.

Rio Tinto Alcan business development ¬- Africa vice president Guy Larin said that the company remained "ready to assist South Africa in realising the considerable benefits of a smelter project in the Port Elizabeth area".

He added that many of the "attractive conditions" for the project were still in place, but that a long-term, competitive power supply agreement would be essential and would need to be re-negotiated.

"We fully understand that conditions surrounding the availability and forward pricing of power in South Africa have shifted significantly in the last two years," Larin added.

The project - which was first pursued by Pechiney, then Alcan and, eventually, by Rio Tinto Alcan - was initially scheduled for commissioning in 2010, with construction beginning in 2008.

However, as Eskom's power stresses became more apparent, that schedule was pushed out, with many speculating that it would eventually be cancelled altogether. Officially, though, Rio Tinto Alcan was still hoping to commission the first potline, which would have required up to 650 MVA of continuous power, during 2012.

Discussions between Eskom, Rio Tinto Alcan, the IDC, and government continued over the past several months, but the participants made insufficient progress to enable it to proceed.

The project, no doubt, lost further appeal as it became increasingly clear that South Africa's tight reserve margin, of below 15%, was likely to persist for some years and as it emerged that Eskom's tariffs could rise by more than 250% by 2015.

The 720 000-t/y smelter had been premised on access to relatively low-cost power, as well as sufficient power capacity for a continual drawdown of 1 350 MVA.

The project had also been the first industrial facility to receive the so-called Developmental Electricity Pricing Programme incentive from the Department of Trade and Industry, under which Eskom would extend power on a cost-plus pricing model.

But this incentive, born during an era of surplus energy capacity and a desire to use cheap power as a tool of industrial development, had become more or less irrelevant. It also predated the supply-side instability of 2008, which precipitated the first broad-based closure of the South African mining industry since the Anglo Boer War.

Earlier in the week, Eskom confirmed that it was pushing ahead with plans to renegotiate commodity-linked electricity tariffs with BHP Billiton, whose aluminium smelter investments in South Africa and Mozambique were also premised on access to low-cost power.

CEO Jacob Maroga also acknowledged that a number of resources had been developed on the basis of South Africa's competitive power prices and that it was going to be an economic challenge to make the "painful, yet unavoidable" transition to far higher tariffs.

The utility had made a price application for adjustments of 45% a year over three years, and Maroga said that the application had not taken into account a possible change to commodity-linked power contracts.

However, both government and Eskom had highlighted these as a problem, with the utility's record loss of R9,7-billion for the year ended March 31, 2009, underpinned primarily by fair value losses on "embedded derivatives" arising from these contracts.

The 30-year to 40-year agreements were signed in the 1980s, when Eskom still enjoyed a substantial surplus of production. The tariffs, which Maroga said "looked good at the time", rose and fell in tandem with the aluminium price, adjusted for the rand/dollar exchange rate.

Government had indicated that it wanted the contracts to be renegotiated and Maroga said that was in the process of initiating discussions with BHP Billiton on the matter.

"[These contracts] are a big problem, because now our financial statements are becoming so volatile," Maroga outlined, stressing that "we want to change that and we are talking to BHP Billiton to say that we want a discussion on that, to remove the volatility".

He stressed, though, that there was no direct relationship between the volatility in its financial statements, and the recent swings running into billion of rands, and the value of the underlying contracts. Neither, he averred, was it directly proportional to any possible penalty that could arise should it seek early termination of the agreements.