Alcoa’s decision to close the Point Henry smelter, at a cost of almost 1000 jobs in Geelong and elsewhere, comes amid a perfect storm buffeting Australia’s aluminium industry.

Point Henry will be the second of Australia’s six aluminium smelters to close, after the demise of Kurri Kurri in 2012.

Implications for the industry, its workers and local communities are grave, and the situation is piling pressure onto state and federal governments already reeling from the shrinkage of other Australian manufacturing sectors. Where did it all go wrong?

A formerly world-class industry

The aluminium story weaves together three distinct plots. The first is one of an industry based on world-scale bauxite deposits, that built what were once world-class refineries and smelters, and at its peak employed more than 17,000 people. However, raw reserves are never enough and the Australian industry has seen the global sector change around it, with economies of scale achieved by offshore competitors throwing down a tough cost challenge.

The second plot is a classic study in government industry assistance that was once seen as sound strategic policy, but now looks like just another subsidy for an unsustainable industry.

The third and most recent plot revolves around the global challenge of climate change that means an electricity-hungry product like aluminium becomes a villain in countries where electricity generation is particularly emissions-intensive.

A question of competitiveness

Aluminium is produced in two stages: first, bauxite ore is refined into alumina, and this alumina is then smelted to produce aluminium. Alumina refineries tend to be located close to the resource, and Australia’s refineries are generally well-located and commercially competitive. The recent exception is at Rio Tinto’s Gove refinery in the Northern Territory, which will close this year after struggling with a move from high-cost oil to an alternative such as gas.

For Australia’s smelters, the logistics are different. The raw material, alumina, can be transported relatively cheaply around the world. Aluminium smelting uses huge amounts of electricity, so the cost of that electricity is a key factor in the competitiveness of a smelter. Although China dominates global production, Australia has been among the top five producers in recent years.

When Australia’s smelters were built they benefited from very cheap, long-term electricity agreements with government-owned power companies. These smelters were paying around half to two-thirds of the price paid by other large industrial electricity consumers. The result for aluminium producers was they could be in the top half or even the top quarter in terms of global cost-effectiveness.

In recent years, there have been big – and generally bad – changes. First, global aluminium prices have been sliding since early 2011, threatening the viability of those producers that were struggling to keep costs down. Second, liberalisation of Australia’s electricity market has meant the end of subsidised power contracts. Market-based electricity prices push even the best-performing of Australia’s smelters out of the top 25% of global competitiveness.

The impact of carbon pricing

And then there is climate change. With the exception of Bell Bay in Tasmania, which uses hydro power, Australia’s smelters produce 15-20 tonnes of carbon dioxide per tonne of aluminium because their electricity comes from fossil fuels, mainly coal. This is two to three times the global average. A carbon price of A$20-30 per tonne has a noticeable impact.

Around the world, newly-built smelters have used gas, hydro, geothermal or nuclear power, with low or near-zero emissions. New production has also been targeted to places such as the Middle East, Canada and Iceland with lower electricity prices because there are relatively few alternative uses for the electricity.

This means that arguments to protect Australia’s aluminium from carbon pricing, based on the idea that the emissions will leak to another country, are likely to be wrong. The emissions may well be driven overseas by cheaper pricing, but those emissions are also likely to be significantly reduced as a result.

Together, these factors drive Australia’s smelters into the bottom 25% of global competitiveness.

A bleak future

With two of Australia’s six smelters now gone, what are the ramifications if the other four follow suit? For the electricity sector, which is already under pressure from falling demand, losing a customer base representing around 15% of the market would be a big blow.

As the global aluminium market further evolves and climate change policies become serious, the viability of aluminium smelting in Australia looks challenging. There are clear consequences for a sector that directly employs around 4,500 people and generates some A$5 billion in exports.

An intriguing alternative picture was painted by the 2008 Garnaut Climate Change Review. A long-term positive future could emerge for aluminium production in Australia if rising carbon prices drive a low-cost, emissions-free electricity supply sector in Australia.

But in the context of current climate change politics, with carbon pricing set to be repealed and the Renewable Energy Target now under review, this prospect seems frustratingly far away.