Alcoa Corp Q3 FY2022 Earnings Call

Good afternoon. And welcome to the Alcoa Corporation Third Quarter 2022 Earnings Presentation and Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mr. James Dwyer, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Jim, and thanks to everyone for joining our call today. As always, we will first review the quarterly financial results, then discuss our markets and our company, and finally, we will answer questions after we conclude our prepared remarks. Before we get into the details, however, I’d like to quickly highlight the work that we have done at Alcoa over these past several years to strengthen our company so we can be successful through all market cycles. We have built a much stronger foundation; our balance sheet is strong and we are well positioned to address current challenges focusing on driving improvement on items within our direct control. We also remain future-focused, as the long-term fundamentals for the Aluminum industry remain bright, and we know that we are the company to deliver in a world where strong ESG performance is required. Now turning to some thoughts on the quarterly results. First, and most importantly, we did not have any fatalities or life-altering serious injuries in the third quarter. Our commitment to safety is an unwavering priority. On our financial results, our quarterly net loss was driven primarily by a non-cash charge for pension annuitization, coupled with the sequential decline in Aluminum and Alumina prices and higher costs for energy and raw materials. In the quarter, we continued to maintain a strong balance sheet and provided returns to our stockholders. We finished the third quarter with a cash balance of $1.4 billion after paying cash dividend of $18 million and repurchasing $150 million of stock. We completed another pension annuity purchase, which transferred approximately $1 billion in pension obligations and related assets. Next, we are continuing to take actions on our operating levels. Russia’s war against Ukraine has created uncertainty and a significant energy crisis, which has impacts globally, but is most acutely seen in Europe. This situation is also having dramatic knock-on effects for the global Aluminum industry, which requires reliable and affordable energy. While our company has limited overall exposure to spot energy costs, two of our plants in Europe experienced significant losses in the quarter driven by the volatility in the European energy market. Our Lista plant in Southern Norway is our smallest smelter, and in September, we curtailed a third of its 94,000 metric tons of annual capacity to mitigate spiking electricity costs. We have, however, put in place a new fixed price contract that is expected to improve the situation as we move forward, beginning in the fourth quarter of this year. The other challenge is at our San Ciprián Alumina refinery in Spain. Costs for natural gas have been exorbitant and remain volatile. In the third quarter, we reduced production to 50% of the site’s capacity. In other operational adjustments, we continued to progress on the full restart at the Alumar smelter in Brazil and on the restart of some modest capacity at the Portland Aluminum joint venture in Australia. For those sites, we have competitive medium- to long-term energy agreements. Also, the power at Alumar will be fully renewable and we are working to boost the percentages of renewables for the Australian smelter. From an innovation perspective, we announced last month a new high-performance alloy for the billet market that has advantages for a wide range of markets, including high-demanding structural applications in the automotive and construction industries. And from a sustainability standpoint, we are proud to now see all our Brazilian locations certified to the Aluminum Stewardship Initiative’s performance standards with the addition of our Poços de Caldas site, which includes Bauxite mining, Alumina refining and Aluminum casting. Finally, we remain bullish on Aluminum’s long-term fundamentals. While the industry is certainly seeing challenges in the short term, we continue to believe the future of our commodity is bright as energy scarcity and decarbonization goals are expected to positively influence the Aluminum industry’s fundamentals. And in this context, Alcoa’s history and focus on our portfolio, our R&D programs and sustainability credentials can help us realize greater shareholder value. For now, though, let me turn it over to Bill to walk through our third quarter numbers. Bill, please go ahead.

Thanks, Roy. The results for the quarter were a net loss of $746 million or $4.17 per share. Special items in the quarter totaled $686 million, with $629 million in non-cash charges related to the $1 billion U.S. pension annuitization that occurred in August. Other special items include the mark-to-market of energy contracts and the closure of a long-curtailed magnesium smelter in Addy, Washington. Third quarter 2022 revenues declined $793 million to $2.85 billion on lower Aluminum and Alumina prices. Those lower revenues translated into EBITDA of $210 million, $703 million lower than the prior period. Adjusted net loss was $60 million and diluted loss per share was $0.33. Let’s take a closer look at the sequential change in EBITDA. When comparing the third quarter EBITDA to the second quarter, the largest driver was $516 million of lower metal and Alumina prices, followed by higher energy and raw material costs of $126 million. These factors combined for $642 million of the $703 million EBITDA decline. The other category consists of the volume and cost impacts on intersegment eliminations and the net of various non-recurring items, primarily in the Alumina segment in both the second and third quarters. In the segments, Bauxite improved $10 million on higher intercompany pricing and better volume, partially offset by lower unfavorable mix of contracts at CBG and higher production costs. In the Alumina segment, the $274 million EBITDA decline was due to lower index prices, higher production costs, higher gas prices at San Ciprián and higher caustic prices, partially offset by benefits of the San Ciprián refinery production. The largest EBITDA decline was in Aluminum, $444 million, due primarily to lower metal prices and the inability of production cost improvements to fully offset higher energy costs, higher carbon costs and slightly weaker value-added pricing. Below the segment level, other corporate expense reductions more than offset slightly higher transformation and intersegment elimination impacts. Let’s take a deeper dive into raw material costs. The cost of major raw materials increased substantially in the third quarter in both the Alumina and Aluminum segments. When converted to a percentage of our selling price, cost for carbon materials used in the smelters has averaged 12% for the 2017 to 2021 five-year period. In the third quarter, costs increased 18%. The difference between carbon costs being at a five-year average versus the third quarter of the percentage was an unfavorable impact of approximately $100 million in the quarter. Likewise, caustic costs have run about 9% of the Alumina selling price over the prior five years. Third quarter 2022 caustic costs in the Alumina segment rose approximately 60% compared to the five-year average to 15%. That impact was approximately $75 million in the third quarter. Over time, we expect carbon and caustic costs as a percentage of sales price to normalize and revert to the mean. Let’s move on to the balance sheet and capital returns. We returned $168 million of capital in the third quarter, $150 million of share repurchases and $18 million of quarterly dividends. Year-to-date capital returns totaled $555 million and year-to-date return on equity is 25.9%. The balance sheet remained strong with a $1.4 billion cash balance and proportional adjusted net debt of $1.3 billion. Days working capital did increase in the quarter to 50 days on lower revenues, even though working capital itself declined $143 million. Free cash flow, less non-controlling interest distributions was essentially breakeven in the quarter. Turning to cash flow, the third quarter cash balance declined $206 million sequentially to $1.4 billion, primarily due to capital returns to stockholders of $168 million. EBITDA and releases of working capital funded capital expenditures, cash income taxes, rehabilitation spending and other cash uses. On a year-to-date basis, our largest use of cash remains increased working capital closely followed by returning capital to stockholders, cash income taxes and capital expenditures. For the fourth quarter, we expect working capital to continue its recent trend of being a source of cash. Now for the outlook for the remainder of the year, we are refining our full year 2022 outlook, starting with shipments. As a result of the lower operating rate at San Ciprián refinery and lower-than-expected Australian refinery production, we are lowering our full year Bauxite shipments 1 million tons to a range of 43 million tons to 44 million tons and moving Alumina shipments lower by 1.5 million tons to 13.1 million tons to 13.3 million tons. The Aluminum shipments outlook remains unchanged. There are several improvements versus prior projections totaling $40 million expected on the full year income statement. In EBITDA, we expect transformation expenses to improve $5 million and other corporate expenses to improve $10 million. Below the EBITDA line, we expect depreciation to improve $20 million and non-operating pension and OPEB expense to improve $5 million. For full year cash impacts, we expect environmental and ARO payments to improve $15 million to $140 million. For the fourth quarter, excluding index sales prices or currency impacts, we expect improvement in many areas. In Bauxite, we expect adjusted EBITDA to improve approximately $5 million on higher third-party shipments. In Alumina, we expect approximately $20 million in lower energy costs at the San Ciprián refinery. Additionally, we expect the benefits of the San Ciprián curtailment to offset the impact of lower Bauxite quality in Australia and higher raw material costs. In the Aluminum segment, we expect Alumina costs to be favorable by $30 million, also higher raw material costs, lower Warrick power plant sales and lower value-add product premiums are expected to be offset by lower energy costs at Lista. Further, due to rapid metal price changes at the end of the third quarter and inventory adjustments made to net realizable value, we expect EBITDA in the fourth quarter to be $40 million higher than calculated using prorated annual metal sensitivities. In addition, there’s a potential negative impact from government action. The Norwegian Government has issued a budget proposal that limits CO2 compensation to be paid in 2023 based on 2022 power purchase. If the proposal is approved, the unfavorable sequential EBITDA impact in the fourth quarter would be approximately $35 million as we reverse this accrued benefit. Finally, a word on taxes; based on recent pricing, the company expects fourth quarter 2022 operational tax expense to be approximately $50 million to $60 million. Now I will turn it back to Roy.

Thanks, Bill. I’d like to start my comments by focusing on the long-term fundamentals of our markets. While the world is currently in a period of heightened uncertainty, the outlook for our industry remains very positive and this view isn’t merely supported by the fact that year-over-year demand is consistently increasing. That’s been the case for more than a decade. Rather, I’d like to highlight the structural changes driven by evolving energy markets on both the demand and supply sides of our industry. Both the source and cost of energy supplies help determine whether a facility can compete economically. Renewable energy provides a further differentiation through lower carbon emissions. Still, decarbonization is not just a facet of energy sourcing, and therefore, Aluminum production, but it is also embedded in the choices of our customers, and ultimately, for their final consumers. For example, one tactic to reduce carbon emissions is to reduce vehicle weight by replacing heavier metals with lightweight Aluminum, especially during the transition from internal combustion engines to electric vehicles. On the left-hand side of the slide, you will see that the amount of Aluminum in passenger vehicles in North America, as one example, is expected to increase by nearly 25% by 2030 using 2020 as the baseline. This change is primarily driven by the transition to electric vehicles, which on average, contains 40% more Aluminum than vehicles powered by internal combustion engines. Another important end-use market for Aluminum is packaging. Demand in that sector is expected to increase steadily and consistently. Aluminum is a sustainable choice for packaging due to its recyclability, its low weight and the format that makes it easier to ship, all of which helps reduce emissions. Next, both the generation and transmission of solar and wind power will require more Aluminum than other forms of energy, such as thermal, hydro or nuclear. Solar generation, for example, requires approximately 13 metric tons of Aluminum per megawatt of generating capacity compared to coal that only requires about 1 metric ton. While these examples are meant to illustrate my point, they demonstrate that demand for our commodities should continue to grow long into the future and is positively supported by decarbonization and the trend toward renewable energy. Now moving to the right-hand side of the slide, to reduce their carbon footprints, we are continuing to see Aluminum producers move to renewable power and away from coal, which is still the predominant source of energy in the global Aluminum industry today. Renewable energy sources, as we know, are constrained by availability, posing a limit for capacity to grow in the future. Of the 15 million metric tons of new primary smelting capacity that we believe is required by 2030, only 6 million metric tons are currently expected to be sourced with renewable energy. This is one area where Alcoa is already a standout. 81% of our global smelting portfolio is powered by renewables, mostly hydro and some wind, and we are continuing to work on boosting that percentage in the years ahead. Finally, energy is also affecting the amount of Aluminum produced. Today’s Aluminum market has been significantly impacted by the European energy crisis, which is rooted in Russia’s invasion of Ukraine. Due to the increased power costs in Europe, it has been reported that more than 1 million metric tons of Aluminum production have been taken offline, with another 1 million metric tons under threat. The combination of increased uncertainty, weakening European demand and the global energy market distortions created by the ongoing Russian aggression in Ukraine demonstrate how quickly our energy markets, and therefore, the Aluminum industry can be impacted. In March of this year, our company made the proactive decision to cease buying raw materials from or selling our products to Russian businesses. That had an adverse financial impact on our business, but it was the right decision to make and now we are seeing an increasing number of customers implement this same policy. We believe governments should consider sanctions on Russian metal as the distortions in the energy market can be directly linked to the invasion of Ukraine. And in the meantime, Russian companies continue to produce and sell their metal, while North American and European producers are curtailing smelters amidst declining Aluminum prices, skyrocketing energy costs and supply chain issues, and thus, we believe urgent action is necessary by the U.S. and its allies. Now let us take a closer look at what is happening in our industry today where, again, energy is the key driver. The fundamental difference in this downturn is that it is being driven by an energy crisis centered in Europe, and thus, its first impact has been to electricity-intensive industries such as Aluminum smelters. And thus, what we see today is an industry with significant supply challenges, followed by impacts to Aluminum demand as downstream costs continue to inflate and significant uncertainty weighs on economic growth. The chart shows data on historical trends for Aluminum supply and demand, including days of consumption for inventories held in LME warehouses. The data illustrate the uniqueness of this energy-driven downturn. During the global financial crisis in 2008 and the COVID-19 pandemic in 2020, sharp downturns in global demand drove significant increases in inventories and sharp declines in the price of Aluminum products. I would note here that we have seen significant delivery of metal to LME warehouses over these last few days. We believe that this metal represents material that was already held in global inventories and is thus more representative of a shuffle between inventories rather than simple overproduction. Anecdotally, we continue to see strength in demand for most of our value-add products in North America and Europe, while noting uncertainty in demand for some products, particularly for billet in Europe. These facts help to explain the environment where we find ourselves. Raw material and energy prices are at historic highs, while prices have notched downwards based on continuing uncertainty. We can further illustrate this situation by examining global cost positions. For Chinese smelting capacity that is operating, we believe that between 20% to 30% is operating on a cash-negative basis; in the rest of the world, between 45% to 55% of Aluminum production is currently operating underwater. In Alumina, the percentage of refineries operating on a cash-negative basis is less than what we are seeing in metal but still significant. In China, approximately 25% to 35% of refineries are operating at a loss, and the rest of the world is lower, ranging from 10% to 20% operating on a cash-negative basis. Now let’s talk about our specific impacts focused on two locations and what we are doing to address the challenges. In 2021, energy comprised approximately 27% of our company’s total Alumina refining costs. In Aluminum smelting, electricity costs were approximately 31% of the total cost of production. Company-wide, our two greatest areas of exposure to spot energy prices are the Lista smelter and the San Ciprián refinery, both in Europe. Let’s start first with our smelter in Southern Norway. While our company overall only has about 5% of its smelting portfolio exposed to spot energy prices, this smelter represented approximately 65% of this spot exposure in the third quarter. In fact, we had some periods when we were paying as much as $600 per megawatt hour and the site lost $47 million in EBITDA in the third quarter. In August, we made the decision to curtail one of the site's three potlines to mitigate the high cost of energy. Importantly, we also negotiated an agreement with our power utility to provide more predictable energy costs throughout the remainder of the year and into 2023. We expect the site to see significant improvements in the fourth quarter as a result and we are continuing to monitor the situation. Next, let’s turn to the San Ciprián refinery. In January of this year, one of San Ciprián’s two natural gas suppliers terminated its contract that supplied approximately 50% of the refinery’s natural gas demand until June 2022 and 25% from July to December of this year. While we have been negotiating new contracts, we have been exposed to spot rates since February. The cost of natural gas in Spain has been exorbitant. In the third quarter, we began to cut our production at this facility so we would use less gas and avoid these high costs. At the end of the quarter, we had adjusted production to approximately 50% of the site’s 1.6 million metric tons of annual capacity. However, gas prices continue to escalate eroding the savings from reduced production. In the third quarter, the San Ciprián refinery lost $69 million in EBITDA due to these conditions. The high volatility for gas cost in Spain makes future estimates difficult to predict. We are actively reviewing the location’s operating levels and commercial options, including further adjustments to production, as well as evaluating options for support. We will continue to look at ways to improve the cost structure at both facilities. Let me now discuss some other items that we are working to improve. In our global smelting portfolio, we are continuing to address our overall capacity, including progressing with restarting previously idle capacity at two sites. In Brazil, we continued to add new operations at the Alumar joint venture where the restart continues to progress. Alcoa’s fully owned subsidiary in Brazil owns 60% of the Alumar smelter or 268,000 metric tons, with the remaining percentage belonging to South32. We expect most of the smelter’s capacity to be operational by the end of the first quarter of 2023. Separately, in the United States, on July 1st, we safely curtailed one of the three operating smelting lines at our Warrick facility. We experienced staffing shortages to the smelter, and the decision to curtail one line allowed us to focus on stability for the two remaining operating lines. In Spain, we have now reached two agreements for wind power that would support 75% of the energy needs for the restart of the San Ciprián smelter. We reached an agreement in 2021 to curtail the smelter until early 2024 to work on a plan to develop an energy solution, which will depend on a viable Spanish energy framework and a permitting process for wind farms. It’s good to see continued progress on this solution, but there is still much work to be done. Next, turning to the right-hand of this slide. In Australia, we are now implementing plans to improve the performance in our refinery system so we can recover from lower volumes that were due to unplanned outages and maintenance. We are bringing a renewed focus on system-wide performance, including our people, processes and equipment. From a people perspective, we are actively working to effectively manage the impacts of accelerated employee turnover due to higher than historical levels of attrition and retirement. In our processes, we are working to redeploy maintenance and operating strategies for all equipment and make our reliability excellence program even more friendly to users. So it can support a system that includes visible and relevant metrics, which are tracked with clear trigger levels for escalation. Also, we are working to address the challenges from lower-grade Bauxite delivered from our co-located mines. Variability in Bauxite grades requires processing higher mud and sand loads, and removing higher levels of impurities, resulting in lower production volumes and higher costs. While we have a focused effort and a clear understanding of the drivers for improvement, it will take some time to restore stable operating performance at full system capability. Moving on to the next item, in July, we announced a return-seeking capital project to increase casting capabilities at our Deschambault smelter in Canada. That new ingot production line will meet needs for value-add products such as foundry alloys and is expected to be complete in the first quarter of 2023. Looking towards the future, we have numerous initiatives that support our strategic priority to advance sustainably and our vision to reinvent the Aluminum industry. We have now added all of our locations in Brazil to the rigorous certification process from the Aluminum Stewardship Initiative, which is the most comprehensive in the industry. Last month, we also introduced our new ExtruStrong alloy that is intended for the lightweight and high-strength applications that use billet. We also received recognition last month for an existing alloy that is gaining traction in one-piece casting known as mega or gigacastings for the automotive market. Most of the world’s Aluminum alloys were first developed by Alcoa and we have decades of metallurgy and engineering leadership to help our customers solve challenges, including developing light weighting solutions for electric vehicles. In closing today, I want to quickly reiterate a few important items. Our balance sheet is solid, our proportional net debt is low and we finished the quarter with $1.4 billion of cash on hand. This quarter, we also continued to provide capital returns to our stockholders in the form of a quarterly dividend and completed stock purchases. As we move forward, our three segments remain well positioned on a cost basis and we are addressing operational improvements across our system, including in our Australia refining system. We are working to deliver today as we prepare for tomorrow, including realizing our vision to reinvent the Aluminum industry for a sustainable future. We have a robust technology roadmap of breakthrough R&D projects that have the potential to decarbonize the Aluminum industry and differentiate Alcoa. We are proud of the existing innovation and problem solving that we bring every day to our customers, including the industry’s most comprehensive portfolio of low carbon products in our Sustana line. Now Bill and I look forward to taking your questions. Operator, who do we have on the line?

And our first question will come from Carlos Alba with Morgan Stanley. Please go ahead.

Thank you for taking my question. My first inquiry is regarding the situation in Norway. Can either Roy or Bill provide more clarity on the government's efforts to pass a proposal to change carbon dioxide compensation? Does this require Congressional approval, or is it solely a government decision? When do you anticipate a decision will be announced, and could this be a temporary measure that might be reversed later, or do you see it as a long-term change? Additionally, concerning share buybacks and returning money to shareholders, the company has been emphasizing this recently. Given the tough conditions in the industry, how do you view the prospects for share buybacks moving forward? Thank you.

Thanks, Carlos. It’s Bill and let me address both of those. The Norwegian Government action that we referenced is that there is a draft Norwegian budget out there that eliminates indirect CO2 compensation for the first NOK200 per ton of carbon. So up to that $200, I am sorry, up to that NOK200 level, they will no longer cover that indirect compensation. So during the course of this year, we had been accruing a benefit of $25 million and would accrue an additional benefit in the fourth quarter of $10 million. So in the fourth quarter, we will have a negative impact of $35 million in our results if that were to come to pass. We are in the process of tracking it and we will keep you posted on whether that happens or not, and I am not going to speculate on whether that would go into future years; it appears that it probably would. As you know, that puts pressure on Mosjøen, but probably more so puts pressure on Lista. Lista is a high-cost facility with the energy situation where it’s at, and it would be an incremental $12 million to $13 million of cost per year on Lista. So that puts a lot of pressure on Lista. So we will keep you in the loop when we learn more about that. Regarding share buybacks, as you saw, we did $150 million of share buybacks in the third quarter. I think we have done around $550 million year-to-date. At this point, there’s a lot of uncertainty in our markets and a lot of geopolitical uncertainty in the world. So we will continue to evaluate the capital distributions and we will make our decisions based on cash flow and how strong the markets are. So that’s where we stand.

All right. Excellent. Thank you. Good luck with the quarter, guys.

Thanks, Carlos.

The next question will come from Lucas Pipes with B. Riley Securities. Please go ahead.

Hey. Good afternoon, everyone. So the sticky costs for power and carbon are intuitive in this environment, but obviously, costs for caustic soda and some of the alloying materials have also remained really elevated. And I wondered if you could comment on what is causing these costs to be so sticky; I would really appreciate your perspective on this?

It varies by individual cost item. The carbon costs are primarily linked to oil prices, so typically, as oil prices fluctuate, carbon prices follow suit. The situation with caustic is more complex due to the various products derived from it. Looking ahead, we anticipate that carbon costs will peak and start to decline in the fourth quarter, while caustic prices remain significantly high. When considering these costs as they affect our cost of goods sold, we expect raw material costs to be approximately $25 million to $28 million higher in the fourth quarter. This expectation is incorporated into the guidance we have provided and is based on our continuing lagged costs. We are beginning to see carbon costs peak and project they will decrease in the future, but caustic prices are expected to stay persistently high.

On the alloying materials, I think that’s also in the Aluminum segment, about 3% higher of your total cost year-on-year.

Alloy materials have increased over time, but their prices can fluctuate similarly to LME prices. We have begun to see some of the alloying costs decrease. A significant portion of these costs is passed on to our customers, both positively and negatively; it ultimately impacts them one way or another.

That’s helpful. Thank you. And then a quick second question on Lista. That’s the power solution that covered two-thirds of capacity that is currently operating or would you consider returning to full nameplate and then with this power solution get the smelter to be EBITDA neutral from the loss in the third quarter? Thank you very much.

Yeah. So let me fill that one, Lucas. So, first and foremost, the contract that we have for energy for the fourth quarter and then the whole of 2023 covers the full consumption of the facility or the remainder of the consumption of the facility that was exposed to spot. So that gives us the flexibility to move back up to full production if and when we choose to do that. And of course, that ends up being a decision about what’s happening with market factors, what we are seeing on an Aluminum. From an Aluminum basis, for regional premiums, as well as demand, and then what the rest of the input costs are going to look like. So that program, the decision to move forward to fix those costs was designed to continue to make Lista an EBITDA positive contributor to our bottom line. But I have to put a caveat in there in which we have to understand that with raw material prices as high as they are Aluminum prices also slipping. That calculation can be different and we have the option to be able to move to a curtailment if we need to as part of what we have. And as always and I know we always get this question, but we look across our portfolio, particularly at those highest cost plants to determine what is the best outcome, what is the right thing to do for us to protect the plant to think about the short-, medium- and long-term, and then to act decisively when we make decisions.

That’s very helpful. I appreciate the color and best of luck.

Thanks, Lucas.

Thanks, Lucas.

The next question will come from Timna Tanners with Wolfe Research. Please go ahead.

Yeah. Hi. Good afternoon, guys.

Hi, Timna.

Hi, Timna.

I wanted to get your perspective on the Midwest premium declines, just any thoughts there and also on the LME, if the rest of material is not allowed. Does it not just ship to China and China ships it out again, I mean, or is there something I am missing on the bigger impact?

Let me address your first question about the Midwest premium. It's difficult to provide a straightforward answer regarding the situation. As you know, part of it is influenced by the presence of duty paid and duty unpaid. Additionally, it relates to the underlying price of LME, which we can set aside for now. Another aspect involves the dynamics of imports and shipments into the United States, including their timing and the varying customer demands tied to them. Lastly, there is a sentiment component; people's forward-looking views on client demand for those specific products and commodity grade materials in the U.S. all factor into the pressure on the Midwest premium. The situation will also be influenced by the volume of Russian metal that enters the United States and any decisions the U.S. Government might make regarding sanctions. As we mentioned earlier, we support sanctions and believe it is sensible that no additional Russian metal should be permitted in the U.S.

I believe it also relies on the relative premiums in the U.S. compared to Europe, so there is a direct connection, particularly to Europe. As those two markets fluctuate, the movement of metal might shift from one location to another with some delay, which means that you could observe lag effects as shipments arrive from overseas.

Can you repeat your second question, because I was discussing Russian metal and whether it can simply go through China and then be stored in the warehouse.

That's certainly an important question, and I think the answer is yes, there are many ways to navigate potential sanctions in one country compared to others. There are also methods to address any outcomes related to the LME’s process regarding the ability to store Russian metal. There are always options to maneuver around these issues. This is why we aimed to simplify the broader situation into a position for Alcoa that we can advocate for in the U.S. and Europe, for example. We believe the simplest solution is to revert to our earlier stance from the beginning of the year, which was to state that it doesn't make sense for us to engage in buying or selling with Russian entities.

And so for us, it just makes sense that we moved to a sanction regime given what’s happening in Ukraine right now and the knock-on impacts that that’s happening across the world. When we look at the fact how difficult it is right now, and we can see this in Lista and San Ciprián, how difficult it is to operate inside of Europe. We have also seen the same type of knock-on impact inside the United States. It doesn’t make sense that Russia continues to produce and sell without any kind of sanctions regime on that. And so for us, that is the easiest solution to be able to try and bring a little bit of sensibility into this market, and to try and build that sanctions regime in such a way that we are also ensuring that there’s no cheating or games being played to try to bring Russian metal into a different entry point. And of course, the flows of metal around the world can change with time and I think we have already seen that for Alumina going into Russia and metal already coming out of Russia. But at the same time, as you take that first in a common-sense step, you will never start to have any kind of impact.

No, I appreciate that. And I know I snuck in two, but if I could just have one more to follow-up on your additional business consideration. I just want to make sure I understand this: the comment here about the $40 million higher than calculated using prorated annual metal sensitivity. So if you just adjust the sensitivities that you give us, I am coming up with like today’s price, like $150 million delta Q1 over - Q3 into Q4 and then you would add back $40 million because of different factors, because of the rapid changes in the commodity price. Is that the way that we should do the math?

Yes. Largely, Timna. So thanks for the question and let me just take a moment to run through the additional business considerations because there’s a lot there. So I think it’s important to clarify it.

Yeah.

Your summary is correct. Use the annual sensitivities and then add back $40 million. There are two main reasons for this. First, we recorded about $20 million in net realizable value declines in the third quarter. Looking ahead, we note that annual sensitivities don’t always accurately predict quarterly results, which is why we mentioned the $40 million adjustment. Additionally, in the Aluminum sector, we anticipate that Alumina will see a $30 million improvement in the fourth quarter, while the rest of the Aluminum sector remains relatively unchanged, balancing out to offset other factors. Higher raw material costs, reduced sales from the power plant, and product premiums ultimately net out to about zero when accounting for the benefit from Lista. For the Aluminum segment, we expect Alumina to perform about $20 million better and Bauxite to improve by $5 million. Therefore, when you incorporate the current metal prices and currency rates, the performance guidance is actually quite robust.

Thank you again.

Thanks, Timna.

Thank you.

Our next question will come from Emily Chieng with Goldman Sachs. Please go ahead.

Good afternoon, Roy and Bill, and thank you for taking my questions. My first question is about energy costs and related business considerations, specifically regarding the Alumina segment. It seems there has been approximately a $20 million improvement quarter-over-quarter due to better energy prices for San Ciprián. Could you provide some details on what those electricity or energy prices were in the second and third quarters, and how you are estimating the $20 million improvement?

Oh! Emily, it can be risky for me to recall specifics off the top of my head, but I believe the gas price in the third quarter was around $35 per gigajoule, and we're expecting an improvement in the fourth quarter based on our current knowledge. That accounts for the $20 million improvement. Expanding on your question, there are several factors affecting the Alumina segment. First, lower energy costs at San Ciprián are beneficial. Additionally, since we've curtailed operations at San Ciprián to avoid losses on each ton shipped, this curtailment provides a positive impact that offsets some lower Bauxite quality issues in Australia and higher raw material costs, particularly related to caustic costs. Overall, the Alumina segment is projected to be $20 million better due to improved energy costs, while the other factors balance out to have a neutral effect.

Great. Thanks. And my follow-up is just around capital allocation. I know you have touched on the capital returns piece, but maybe quickly, if you could touch on the balance sheet, the pensions, and perhaps, even early 2023 CapEx expectations. I know they were supposed to sequentially increase 2023 versus 2022. I think was the guidance at the last Analyst Day, but any early look there would be helpful?

We have not made any updates to the capital outlook since our last Analyst Day. I remember that we projected sustaining capital for 2023 to be around $550 million, while return-seeking capital was expected to be about $100 million, an increase from the $450 million and $75 million appropriated this year. Regarding capital allocation and the balance sheet, we finished the quarter with a cash balance of $1.4 billion and proportional net debt of approximately $1.3 billion. Our global pensions are significantly improved, especially in the U.S., where the raised discount rate has resulted in being over 100% funded. Therefore, we do not anticipate significant cash contributions to the pension over the next few years. There is an ongoing cash contribution associated with OPEB, but that will range from $50 million to $60 million. Additionally, we do not have any significant debt maturing until 2027. Overall, the balance sheet is in excellent condition and will support us well throughout various business cycles.

Great. Thanks, Bill. Thanks, Roy.

Thanks, Emily.

Our next question will come from Lawson Winder with Bank of America Securities. Please go ahead.

Hello, gentlemen. Good evening and thank you for the update. If I could just sort of push deeper on the capital allocation and the buyback and maybe understand how you think about that cash flow and what drives the buyback, so with the context that in Q3, your free cash flow was about $6 million after total CapEx and you bought back $150 million of shares. Are you just kind of looking at working capital return as more of a driver as opposed to free cash flow?

In the third quarter, we began with a strong cash balance and have communicated our commitment to maintaining a solid balance sheet. For the first time, we have achieved an investment-grade balance sheet and will support operations through sustaining capital. After this, we have three possible uses for capital: returning cash to shareholders, preparing for future growth, and repositioning our portfolio. Specifically in the third quarter, we had excess cash with no uses that would generate significant value, so we opted to return that cash to shareholders.

Okay. Thank you for that additional color. And then if I could maybe ask about the Alumar smelter and the restart there. So I mean you took the decision to restart that about a year ago and there was a lot of reasons driving that and I just wanted to follow up and see if the reasons driving the restart still held today. Some of the things you mentioned were like a strong local market, FX which has now gone the other way and I mean, so does the restart of Alumar still makes sense in the current Aluminum price environment? Thank you.

It's a great question, and we continuously review our decisions and learn from them. For Alumar, several factors contributed to the decision to restart. We have a strong local market and a low-cost, renewables-based energy contract, which positions us competitively. The plant utilizes modern technology, and I have firsthand experience working there; it’s a well-managed facility with a skilled workforce, which is increasingly crucial today. Additionally, we consider financial aspects such as local premiums, domestic sales potential versus exports, and opportunities for value-added products, along with various tax implications.

Tax credit…

We need domestic sales to monetize effectively. Aluminum prices have shifted, so our decision is slightly affected. However, the supporting factors reinforce that this was a wise choice. Reviving a plant after several years of being inactive is challenging, but we have a skilled workforce that is familiar with the process. Many employees have returned, and we are making significant progress in restarting the smelter. There are complexities due to resource availability and securing the necessary raw materials at the desired quality, but ultimately, I believe this will be a valuable project and a significant investment since it is cost-efficient.

Okay. Thank you very much for the comments.

Thanks, Lawson.

The next question will come from Chris LaFemina with Jefferies. Please go ahead.

Thank you. Hey, guys, thanks for taking my question. Bill, sorry to ask another question about balance sheet and capital returns, but just another way to think about it here, if you have $1.4 billion of cash roughly, before you announced your first capital return, I think the criteria was to get to $1 billion to maintain a cash balance of at least $1 billion. So you are $1.4 billion now. In the third quarter, the capital returns came out of the balance sheet, right, so you were free cash flow breakeven. Should we assume that you are comfortable funding capital returns with the balance sheet as long as that cash balance is above $1 billion or do you need to have free cash flow to fund the capital returns? I think you had mentioned earlier that the decision about capital returns depends on cash flow, but in the third quarter, it looks like it was balance sheet and not cash-related to the capital returns? That’s my first question.

Yeah. So good question and I appreciate it. Unfortunately, there’s not necessarily a binary answer between the two. We want to maintain a strong balance sheet. We have historically said we are comfortable holding $1 billion of cash on the balance sheet. From time to time, we have been below $1 billion and you didn’t see us rush out to get cash sources. From time to time, we will be above $1 billion and that’s where we are today. So it’s a combination of how much cash we have and as we look forward at the cash generation in the market, how much cash we see coming in and we will make the best decision based on those two factors. So not a single answer necessarily.

Thanks for that. And then just a quick one on the Russian sanctions and what that might mean for the market. Wouldn’t it be the case that commodity trading companies would probably not want to hold metal that they cannot sell to the LME? In which case, the conduit for that metal to get from Russia to China and other regions just wouldn’t be there. I would think that will be severely disruptive to the market and probably lead to very tight conditions quickly because, again, trading companies want to have readily market inventory and if you can’t sell it to the LME, it’s not readily marketable, am I thinking about that correctly?

Yes, Chris, I believe you're considering it correctly. We can't fully predict the effects, but some things are already evident. Firstly, we've decided not to engage in buying or selling from Russia. Secondly, we're observing that many companies are following a similar path, and as the year progresses, more of our customers, along with others in the market, are making that choice as well. The market is beginning to adapt to a scenario where that metal is simply unavailable and deemed unacceptable. Therefore, if sanctions are enacted, this process is likely to accelerate and become quite clear-cut. Various trading companies will certainly hesitate to hold metal that cannot be delivered to either the LME or to most customers, especially those willing to pay full price or even discounts. This raises the issue of recent deliveries to the LME warehouses, where we lack transparency regarding what was delivered, who delivered it, and what kind of metal it was. If there was one thing I could wish for, it would be greater transparency from the LME regarding deliveries, as it would allow us to better understand the origin of the over 200,000 tons that have become available recently. This indicates that there's a strong chance that those holding that metal will lack a market if sanctions are enforced. There is considerable interest in what decisions the U.S. Government and the European Government will make on this matter. In summary, you're right to point out that there might be a significant crunch. The market is already adjusting, though it's challenging to predict the full implications due to the shifting supply dynamics around the world. With half of the global smelters struggling at current price levels, it suggests that there are many factors that could lead to significant market changes, including the inability to deliver Russian metal, which could have substantial implications.

Thank you for that. Appreciate it.

Thanks, Chris.

Our final question will come from Lucas Pipes with B. Riley Securities. Please go ahead.

Thank you very much for taking my follow-up question. I just wanted to circle back on the Bauxite quality issue. Do you have a sense of what the EBITDA impact was during the quarter, sorry, if I missed it. And then in terms of timing, how long it might take to work through this issue? Thank you very much.

Let me address the first part of the question and Roy will cover the second. Overall, the challenges we faced in Western Australia resulted in about a $50 million impact on earnings in the third quarter. However, not all of that should be attributed to Bauxite quality. There are a few factors involved. Issues related to equipment availability and maintenance, which Roy mentioned, accounted for about half of that $50 million. Additionally, we incurred higher spending on maintenance and other areas, contributing another $25 million. Thus, the total impact was $50 million, with Bauxite quality being one of the factors in that figure.

And Lucas, regarding the second part of your question, we cannot provide a definitive timeline for when conditions will return to their original state, as this is influenced by several factors. Firstly, we are focused on optimizing our resources for the long term. Bauxite quality varies based on the mining locations and how we manage the pits and inventory. Therefore, we face inherent fluctuations due to the resource itself and our strategy for sustaining it over time. Additionally, our capacity to operate effectively with the current Bauxite grades is crucial. Lower grades result in increased mud and sand, which require careful management. Both aspects are under our control through our decision-making. We are currently evaluating how to ensure we mine in the right locations and times while achieving predictable grades. Simultaneously, we are dedicating significant resources to effectively handle the lower grades and adapt accordingly for greater efficiency. Our emphasis is on achieving more reliable outcomes. We have incorporated various factors into our guidance regarding the Alumina segment and will continue to keep you and the market informed as we implement changes and observe improvements. I am confident we have the right team addressing the right issues. While it is a particularly challenging era for operations everywhere, we possess extensive resources both centrally and on site to tackle these challenges and improve our management of these matters.

I appreciate the color. Thanks again and again best of luck.

Thanks, Lucas.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Roy Harvey for any closing remarks. Please go ahead, sir.

Thank you once again for listening to our call. We have appreciated the questions today. As we work to finish the year, we will remain focused on the items that are within our control so we can deliver today and prepare for the future. I look forward to talking to you again in January when we will discuss our full year and fourth quarter 2022 results. Until then, please be safe. Stay close to your family and friends. Good night.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.