In times of economic crisis, it is tempting to embrace new megaprojects such as new power plants and aluminium smelters. But will this realistically improve Iceland’s economic prospects?

Prime minister Geir Haarde recently explained on Stöd 2's chat show Mannamál that one of the main reasons for the fall of the Krona, was due to the execution of heavy industry projects: the construction of Kárahnjúkar and Alcoa’s smelter in Reyðarfjördur. If more large projects are executed, what will the cost be for the Icelandic taxpayer?

Haarde’s comments were not surprising. Before construction of Kárahnjúkar many economists predicted the negative impact on inflation, foreign debt and the exchange rate of the ISK.

Of course there is some economic benefit from new smelters, but “it is probably outweighed by the developments’ indirect impact on demand, inflation, interest rates and the ISK exchange rate,” stated a report by Glitnir in 2006 on the impact of aluminium expansion in Iceland. The report expected an increase in inflation and a depreciation of the ISK.

“Kárahnjúkar will never make a profit, and the Icelandic taxpayer may well end up subsidising Alcoa,” said the eminent economist Thorsteinn Siglaugsson after publishing another report on the profitability of the Alcoa dam in East Iceland before construction commenced.

How did the Fjardaal smelter contribute to Iceland’s economic crisis? The two billion dollars for the construction of the country’s largest dam had to be borrowed by the state. That led to a more than significant increase in the current account deficit, which is now felt in increased inflation and depreciation of the currency. The economic cost now needs to be coughed up.

Note that any schemes that demand new power plants associated with a significant amount of borrowed capital will have this effect, whether an expensive dam or power plant is meant for aluminium, a silicon refinery, data centre or some other purpose.
It is quite simple. If you borrow money, you will have to pay back in one-way or the other.

Of course, once they are built, smelters bring in some degree of income to the country and, so it is argued, there are local economic benefits from a new smelter. Smelters provide jobs. What has hardly been researched in Iceland, though, is how much these new jobs displace jobs in existing local industries.

All local industries such as the fish processing industry in Reyðarfjördur have had to shut down as a consequence of employment competition from the smelter. Many new houses that were built are empty. Between 2002-2008, on average 73 more people moved each year from the Eastfjords to the southwest than the other way round. The smelter still depends on many foreign workers.

Local communities where large projects such as Fjardaal get constructed become completely dependent on foreign investment, an undesired and unsustainable condition that destroys local resilience.

There is another reason not to construct more smelters in Iceland. The price that the aluminium giants pay for energy to Landsvirkjun is linked to the world price of aluminium. If supply is increased this will lower the price of aluminium, decreasing revenue for Iceland.

One might think that a few hundred thousand tons of aluminium more or less will not impact the global market. The reality is that it is not the sum of production that determines the price but rather the friction between supply and demand. A small amount of difference can have a significant effect in terms of pricing.

Demand for aluminium is already slumping in the US and Europe. It will too in China when growth slows down there, which is likely to happen before Alcoa’s and Century’s planned new smelters could come online, considering the world economic outlook.

The metal corporations compete between themselves. Because of this is not just the global price that determines their profitability. The bottom line is eventually determined by how cheaply they can produce. For aluminium, profitability is fundamentally determined by one thing: energy costs. In Iceland, energy prices are rock bottom – the lowest in the world. It is not a coincidence that as Alcoa’s Fjardaal smelter went online, 400 workers in Rockdale, Texas were laid off as smelter operations there closed down. In the US, Alcoa pays much more for power.

This is why Alcoa, Century, Rio Tinto and Norsk Hydro all want new smelters in Iceland and in third world countries with cheap energy such as Trinidad and the Congo. When demand slumps, expensive plants can then be shut down in favour of cheap ones such as the proposed smelters at Husavik and Bakki. As inflation stays high and energy revenues low, the Icelandic taxpayer pays the price.

Construction of new power plants, smelters or other large scale projects will have some short term economic benefit as funds are infused into the economy.

But, as Geir Haarde recently confirmed, after execution comes the economic backlash. These megaprojects in a small economy have been compared to a ‘heroin addiction’. Short-term ‘shots’ lead to a long-term collapse. The choice is between a short-term infuse or long-term sustainable economic development.

The ‘shot’ of Fjardaal overheated the Icelandic economy. What was called the ‘Kárahnjúkar problem’ led to an all time high in the value of the Krona, hurting export and the fish industry in particular. With the all-powerful currency, banks overplayed their hand and went into a spending spree. Drugs make you lose sight of reality.

There has been a lot of critique on the proposed plans to develop Iceland’s unique energy resources. Those in favour of it have generally argued that it is good for the economy. Anyone who gives it a moment of thought can conclude that that is a myth. Supposed economic benefits from new power plants and industrial plants need to be assessed and discussed critically and realistically. Iceland is coming down from a high. Will it have another shot, or a cold turkey?

Jaap Krater, spokesperson of Saving Iceland
http://www.savingiceland.org