Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Commodity Price and Raw Material Costs Sensitivities
Aluminum is an internationally traded commodity, and its price is effectively determined on the LME plus any regional premium (e.g. the Midwest premium for aluminum sold in the United States and the European Duty Paid premium for metal sold into Europe) and any product premiums. From time to time, we may manage our exposure to fluctuations in the LME price of primary aluminum and/or the regional premium through financial instruments designed to protect our downside price risk exposure. From time to time, we also enter into financial contracts to offset fixed price sales arrangements with certain of our customers (the "fixed for floating swaps").
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We are also exposed to price risk for alumina which is one of the largest components of our cost of goods sold. Some of the alumina we purchase is priced based on a published alumina index. As a result, our cost structure is exposed to market fluctuations and price volatility. Because we sell our products based principally on the LME price for primary aluminum, regional premiums and value-added product premiums, we are not able to directly pass on increased production costs to our customers. From time to time, we may manage our exposure to fluctuations in our alumina costs by purchasing certain of our alumina requirements under supply contracts with prices tied to the same indices as our aluminum sales contracts (the LME price of primary aluminum).
Market-Based Power Price Sensitivity
Market-Based Electrical Power Agreements
Hawesville and Sebree have market-based electrical power agreements pursuant to which EDF and Kenergy purchase electrical power on the open market and pass it through at MISO energy pricing, plus transmission and other costs incurred by them. Through March 31, 2021, 75% of Mt. Holly's electrical power requirements are supplied at rates based on natural gas prices. See Item 1. Business - Key Production Costs - Electrical Power Supply Agreements for additional information about these market-based power agreements.
Power is supplied to Grundartangi from hydroelectric and geothermal sources under long-term power purchase agreements. These power purchase agreements, which will expire on various dates from 2023 through 2036 (subject to extension), primarily provide power at LME-based variable rates. Since November 2019, the price of approximately 30% of Grundartangi's power requirements has been linked to the market price for power in the Nord Pool power market. From time to time, we may manage our exposure to fluctuations in the market price of power through financial instruments designed to protect our downside risk exposure.
Electrical Power Price Sensitivity
With the movement toward market-based power supply agreements, we have increased our electrical power price risk for our operations, whether due to fluctuations in the price of power available on the MISO or Nord Pool power markets or the price of natural gas. Power represents one of our largest operating costs, so changes in the price and/or availability of market power could significantly impact the profitability and viability of our operations. Transmission line outages, problems with grid stability or limitations on energy import capability could also increase power prices, disrupt production through pot instability or force a curtailment of all or part of the production at these facilities. In addition, indirect factors that lead to power cost increases, such as any increasing prices for natural gas or coal, fluctuations in or extremes in weather patterns or new or more stringent environmental regulations may severely impact our financial condition, results of operations and liquidity.
The consumption shown in the table below reflects each operation at 100% production capacity and does not reflect partial production curtailments.
Electrical power price sensitivity by location:
Hawesville Sebree Mt. Holly Grundartangi Total
Expected average load (in megawatts ("MW"))
482 385 400 537 1,804
Annual expected electrical power usage (in megawatt hours ("MWh")) 4,222,320 3,372,600 3,504,000 4,704,120 15,803,040
Annual cost impact of an increase or decrease of $1 per MWh (in millions) $ 4.2 $ 3.4 $ 3.5 $ 4.7 $ 15.8
Foreign Currency
We are exposed to foreign currency risk due to fluctuations in the value of the U.S. dollar as compared to the Iceland krona ("ISK"), the Euro, the Chinese renminbi and other currencies. Grundartangi’s labor costs, part of its maintenance costs and other local services are denominated in ISK and a portion of its anode costs are denominated in Euros and Chinese renminbi. We also have deposits denominated in ISK in Icelandic banks, and our estimated payments of Icelandic income taxes and any associated refunds are denominated in ISK. Further, Vlissingen's labor costs, maintenance costs and other local services are denominated in Euros and our existing Nord Pool power price swaps described above are settled in Euros. As a result, an increase or decrease in the value of those currencies relative to the U.S. dollar would affect Grundartangi’s operating margins.
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We may manage our exposure by entering into foreign currency forward contracts or option contracts for forecasted transactions and projected cash flows for foreign currencies in future periods. We have entered into financial contracts to hedge the risk of fluctuations associated with the Euro under our power price swaps described above (the "FX swaps").
Natural Economic Hedges
Any analysis of our exposure to the commodity price of aluminum should consider the impact of natural hedges provided by certain contracts that contain pricing indexed to the LME price for primary aluminum. Certain of our alumina contracts and a substantial portion of Grundartangi’s electrical power requirements were indexed to the LME price for primary aluminum and provide a natural hedge for a portion of our production.
Risk Management
Any metals, power, natural gas and foreign currency risk management activities are subject to the control and direction of senior management within guidelines established by Century’s Board of Directors. These activities are regularly reported to Century’s Board of Directors.
Fair Values and Sensitivity Analysis
The following tables present the fair value of our derivative asset and liabilities as of year end 2020 and 2019 and the effect on the fair value of a hypothetical ten percent (10%) adverse change in the market prices in effect at December 31, 2020 and 2019. Our risk management activities do not include any trading or speculative transactions.
Asset Fair Value Fair Value with 10% Adverse Price Change
2020 2019 2020 2019
Commodity contracts (1)
$ 12.8 $ 19.7 $ 4.0 $ (2.7)
Foreign exchange contracts (2)
2.4 — (2.5) —
Total $ 15.2 $ 19.7 $ 1.5 $ (2.7)
Liability Fair Value Liability Fair Value with 10% Adverse Price Change
2020 2019 2020 2019
Commodity contracts (1)
$ 16.7 $ 3.6 $ 59.1 $ 7.1
Foreign exchange contracts (2)
— 0.6 — 1.2
Total $ 16.7 $ 4.2 $ 59.1 $ 8.3
(1) Commodity contracts reflect our outstanding LME forward financial sales contracts, MWP forward financial sales contracts, fixed for floating swaps, NYMEX Henry Hub natural gas price swaps, and Nord Pool power price swaps.
(2) Foreign exchange contracts reflect our outstanding FX swaps.
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