Alcoa (AA) Q1 2018 Earnings Conference Call Transcript

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Alcoa (NYSE: AA) Q1 2018 Earnings Conference CallApril 18, 2018 5:00 p.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, and welcome to the Alcoa Corporation First-Quarter 2018 Earnings Presentation and Conference Call. [Operator instructions]. Please note, this event is being recorded. I would now like to turn the conference over to James Dwyer, vice president of investor relations. Please go ahead.

James DwyerVice President, Investor Relations

Thank you, Watson, and good day, everyone. I’m joined today by Roy Harvey, Alcoa Corporation president and chief executive officer, and William Oplinger, executive vice president and chief financial officer. We will take your questions after comments by Roy and Bill. As a reminder, today’s discussion will contain forward-looking statements relating to future events expectations that are subject to various assumptions and caveats.

Factors that may cause the company’s actual results to differ materially from these statements are included in today’s presentation and in our SEC filings. In addition, we have included some non-GAAP financial measures in this presentation. Reconciliations to the most directly comparable GAAP financial measures can be found in the appendix to today’s presentation. Any reference in our discussion today to EBITDA means adjusted EBITDA.

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Also, note on our financial statements. Our presentation today for the current period as well as prior periods has been updated in accordance with the Financial Accounting Standards Board’s recent change to the presentation of non-service pension and OPEB costs. This change resulted in Alcoa moving such costs out of EBITDA and into other income/expense. Finally, as previously announced, the earnings release and slide presentations are available on our website.

With that, here’s Roy.

Roy HarveyPresident and Chief Executive Officer

Thank you, Jim. I’d like to welcome everyone to our call. Amid unprecedented events affecting our markets, Alcoa’s profits remained resilient in the first quarter. We reported Adjusted net income of $15 million, or $0.80 a share.

On an adjusted basis, excluding the favorable impact of special items, net income was $145 million, or $0.77 a share. We generated $653 million in adjusted EBITDA, excluding special items. While this is down sequentially due to reduced alumina prices for the first quarter, recall that our fourth-quarter adjusted EBITDA was our highest since our launch in November 2016. And from a cash perspective, we reduced our days of working capital by one day versus the year-over-year quarter and maintained a strong cash position of $1.2 billion.

Now I’ll turn to safety, which is our No. 1 priority for everyone who walks through our doors. Because keeping our people safe is key to Alcoa’s overall long-term success, beginning today, we’ll report on safety in each of our earnings presentations. We’ll focus on serious injuries.

And by that, we mean injuries that are life-altering or life-ending. Last quarter, we had one serious injury that took place at one of our facilities in the United States. Specifically, an employee’s gloved hand was pinched in machinery during a maintenance task, resulting in a partial amputation of his thumb. Our goal is to ensure that everyone leaves Alcoa facilities safe and unharmed.

We will continue to refine our safety systems and programs and make further improvements to eliminate serious injuries and fatalities from every one of our operations. From a business point of view, this past quarter, we continued to aggressively execute on our strategic priorities to reduce complexity, drive returns and strengthen the balance sheet. In the U.S., our smelter restart at Warrick operations in Indiana is on target to be completed by the end of this quarter. That restart will supply metal to the on-site rolling mill, enabling it to add production volume while supporting our goal to reduce complexity and drive returns.

To strengthen the balance sheet, in January, we announced to freeze the defined benefit pension plans and other post-employment benefits for salaried employees in the U.S. and Canada effective in 2021 to further reduce volatility risk from our pension obligations. Earlier this month, we also signed group annuity contracts for retirees and their beneficiaries in Canada. Those contracts transferred approximately $555 million in obligations and related assets from the Canadian pension plans to three insurance companies.

As I mentioned earlier, we’re seeing a confluence of events in our markets, U.S. government imposed sanctions impacting the entire aluminum value chain, tariffs affecting aluminum and supply disruptions in alumina. But with strong assets stretching from bauxite to alumina and to aluminum, Alcoa is well-positioned to capitalize from this volatile market environment in which we are now projecting global deficits for both alumina and aluminum. And lastly, based on current market prices, we have updated our full-year projection for adjusted EBITDA, excluding special items.

The range is now $3.5 billion to $3.7 billion, up from the projection of $2.6 billion to $2.8 billion that we provided at last quarter’s earnings release. Please keep in mind, however, that the high volatility in pricing across the aluminum value chain could impact this range either positively or negatively. There is a lot to review this earnings period. And with that, I’ll turn it over to Bill for a more detailed look at our first-quarter results

William OplingerExecutive Vice President and Chief Financial Officer

Thanks, Roy. Let me start with the income statement. Sequentially, revenues are off 3% on seasonally lower shipments while higher aluminum prices partially offset lower alumina prices. Compared to last year, revenues are up 16% on higher prices for both alumina and aluminum.

In the quarter, the net income attributable to Alcoa Corporation was $150 million, or $0.80 per share. And as Jim mentioned earlier, for comparability, we’ve revised 2017 numbers to reflect the 2018 pension and OPEB accounting presentation change. Special items in the quarter totaled a favorable $5 million after tax. Warrick smelter restart costs, the tax impact on special items and ABI bargaining agreement-related costs were more than offset by credits associated with the January changes to certain pension and other post-retirement medical benefits and gains on mark-to-market energy contracts.

Now let’s look at our adjusted EBITDA and the income statement after special items. Our first-quarter ’18 adjusted net income was $145 million, or $0.77 per share, 26% lower than the fourth quarter ’17 but 24% higher than the prior year. Adjusted EBITDA, excluding special items, was $653 million, down $143 million sequentially, primarily due to lower aluminum prices and higher raw-material costs but up $99 million versus the prior year. In the first quarter, SG&A and R&D expenses improved to 2.4% of revenue.

A few items of note, below the EBITDA line, DD&A increased $7 million sequentially, primarily due to amortization of premining costs. Our operational tax rate depends heavily on market conditions which drive where we generate profits and losses. In the first quarter, the rate was 31.9%. Let’s take a deeper look at the factors driving adjusted EBITDA.

Adjusted EBITDA is down $143 million sequentially and alumina index prices contributed $146 million to the decline. API-based sales prices declined in the first quarter while, due to the lag, the smelter’s expense was impacted by the higher alumina pricing of the fourth quarter. In effect, higher metal prices offset all other impacts. Taking a more detailed view of items not related to price indices.

The volume impact is very close to the $40 million outlook I provided last quarter due to fewer days in the quarter and scheduled maintenance overhauls across the company. Maintenance work was also the key driver for operational impacts. Higher raw-material costs, also expected, we’re seeing in smelting carbon products and refinery caustic prices. Positives this quarter were in alumina price mix where we increased our percentage of contracts priced on API to roughly 95% and in energy costs where Brazilian hydro earnings rebounded from their fourth-quarter low.

And some of our smelters saw seasonally lower power costs. Looking at each segment’s contribution. Bauxite adjusted EBITDA improved $5 million, with higher sales prices more than offsetting lower volume. Alumina adjusted EBITDA declined $170 million, primarily due to lower alumina index prices, seasonally lower volume and unfavorable currency.

The previously mentioned improvement in our contract mix more than offset all other cost increases. In aluminum, adjusted EBITDA was $153 million, down $93 million as higher alumina costs from last quarter’s prices flowed through the P&L. Higher metal prices and higher Brazilian hydro earnings offset higher raw material costs and all other cost impacts. For EBITDA impacts outside of the segments, transformation EBITDA impacts were unfavorable in the first quarter as a major maintenance outage occurred at the Suriname hydro project and remediation activities ramped up, especially in closed locations in Australia.

To provide more visibility in the corporate expenses and the group’s similar accounting impacts together, we have combined all corporate inventory adjustments, LIFO, metal price lag and intercompany profit eliminations into one line item and revised fourth quarter ’17 for comparability purposes. Previously, LIFO and metal lag were together but profit eliminations were in other corporate. In the fourth quarter ’17, LIFO and profit eliminations were both large negative EBITDA impacts. In the first quarter of ’18, corporate inventory accounting impact turned favorable as falling alumina prices resulted in lower intercompany profit eliminations, and there was very little LIFO impact in the quarter.

Metal lag had a smaller but positive impact as well. Now let’s look at our cash balance and flows for the quarter. At the end of March, our cash balance decreased to $1.2 billion, primarily due to seasonal increases in working capital, higher dividends paid to our minority interest partner, semiannual bond interest payments as well as our final $74 million payment to the DOJ and SEC. Now let’s move on to the progress on capital allocation and other financial metrics.

Our first-quarter ’18 performance is aligned with our 2018 capital-allocation framework. We’re maintaining our cash balance above $1 billion and continue to target our 2018 sustaining and value-creation capital spending levels. Our pension and OPEB net liability is now $3.3 billion, reflecting the pension freeze and changes to an entirety of medical benefits we made in January but not our most recent action regarding Canadian pensions. Last week, as Roy said, we funded $95 million to facilitate our first utilization of pension benefits.

As noted in our April 3 press release, we will see the full cash earnings and net liability impact of the Canadian annuitization in our second-quarter results. The non-cash special charge to earnings will be $175 million pre-tax, or $128 million after tax. This transaction is our first step in $300 million of additional contributions to optimize our liabilities. We’re also planning on working on annuitizing a portion of our U.S.-defined benefit pension plans.

Now let’s look at our outlook for the rest of the year. As is our practice every quarter, we’ve updated our adjusted EBITDA outlook based on recent market prices. It’s now between $3.5 billion to $3.7 billion based on $2,300 LME and $500 Alumina Price Index, a Midwest regional premium of $0.21 and an Australian dollar of $0.78 as well as our latest view of other regional premiums, currencies and raw material price impacts. Our final three quarters would not be identical however because of price lags, timing differences, seasonality and other factors.

We expect our third- and fourth-quarter EBITDA to be roughly 20% higher than the second quarter of ’18. As Roy talked about, and he’ll talk in more detail here in a minute, we’re in a very volatile price environment, and future price changes could move our ’18 outlook higher or lower. As a point of reference, had we used the pricing assumptions from our fourth-quarter ’17 earnings call in this outlook, we would still be in the range of $2.6 billion to $2.8 billion adjusted EBITDA. In non-segment EBITDA impacts.

The outlook for transformation cost at $30 million has improved by $20 million due to lower net expenses at our closed locations, and other corporate has improved $10 million. The corporate inventory accounting outlook, now including LIFO, metal price lag and intercompany eliminations, varies and will depend on future prices. Our current full-year estimate is a cost of approximately $60 million based on our updated EBITDA outlook. Below the EBITDA line, there are two changes to the previous quarter’s outlook.

We’ve refined our depreciation forecast and increased the depreciation outlook to approximately $775 million. We’ve also refined the tax rate. Our tax rate is very dependent upon our mix of earnings across the world. Our current EBITDA estimate drives a full-year operational tax rate of approximately 35%, although the second-quarter rate could range from 37% to 40% to catch up from the lower 31.9% tax rate in the first quarter of ’18.

Our shipments and cash flow impact outlooks remain unchanged from last quarter. Our only direct shipments contracted to Rusal entities for the rest of this year were 800,000 tons of bauxite, and we’re in the process of placing those tons with other buyers now. Let me turn it back over to Roy.

Roy HarveyPresident and Chief Executive Officer

Thanks, Bill. And as we both noted, we’re experiencing considerable price volatility, as illustrated here, with spikes in both aluminum and alumina markets. The chart on the left shows average LME plus regional premiums weighted as per Alcoa’s primary aluminum regional market exposure, and the right chart shows the spot alumina price FOB Western Australia. Neither incorporate price increases from this week.

As you’re aware, there are major external factors and uncertainties affecting our markets. Starting with a series of U.S. government actions that include Section 232 tariffs, Section 301 tariffs and the recently announced sanctions on Russia. We’re also seeing disruptions in alumina supply in Brazil and potentially elsewhere.

In China, environmental and supply management regulatory reforms are having varying impacts. While winter curtailments were less than expected, the Chinese government appears to be driving more aggressive supply side reform. In addition to curtailing smelter capacity operating without licenses, the government is now considering a draft plan that would implement controls on unlicensed coal-fired power plants that supply the grid as well as many aluminum smelters. If those draft regulations were to take effect, they could potentially raise Chinese smelter costs and slow net capacity additions.

We will be closely watching these developments. Alcoa’s globally diversified portfolio and long positions in bauxite, alumina, and aluminum make us uniquely positioned to capture benefits during such period of volatility. Our bauxite portfolio, with locations in Australia, Brazil, and Africa, has a first-quartile cost-curve position with high-quality bauxite, which is particularly valuable when cost of prices are higher for refineries. Our alumina portfolio is also positioned in the first quartile of the cost curve and is one of the world’s largest refinery portfolios.

With locations in each of the four key markets, we have a unique global position and significant exposure to increasing alumina prices. Our aluminum smelters primarily serve the U.S. and European markets. And of our 3.4 million tons of total smelting capacity, we have about 900,000 metric tons of curtailed capacity in each of these four markets.

Taking all these factors into account, we see clear advantages for Alcoa in each of our products and markets. We have significant North American metal market exposure with nearly half our tons sold at the Midwest premium. As you know, the Midwest premium has more than doubled this year. And our exposure to the LME aluminum price is even greater as it applies to all of our aluminum produced globally.

Thus, we continue to monitor global and regional market prices and other factors in deciding whether to restart some of our curtailed capacity, which is mostly in the United States and Brazil. If the market, power costs and restart requirements are favorable, we could increase our exposure to positive market factors. In alumina, our third-party sales are market-based with roughly 95% priced on the Alumina Price Index or spot prices. Publicly quoted alumina indices are at all-time highs.

As with the smelter business, depending on expected long-term dynamics and refinery-specific factors, we could consider restarting some curtailed capacity. In bauxite, the picture is less clear. There is uncertainty around global trade flows due to previously mentioned market developments. Nevertheless, we are well-positioned across the globe to serve a nascent third-party market with potential expansions at each of our mines.

Additionally, much of our bauxite is low in reactive silica so our customers can avoid the increased expense from higher cost of prices. Now I’d like to turn to our outlook for the three products. The market-moving factors mentioned previously are likely to push the alumina and aluminum markets into deficit conditions this year. In bauxite, as we said last quarter, 2018 will likely see Chinese bauxite stockpiles grow.

Our outlook for Chinese bauxite demand has increased slightly, but we expect it to be supported by Indonesian exports and increased supply growth from Guinea. For alumina, our global forecast is for a deficit market with competition among consumers for available alumina tons. In China, we have seen curtailments of some refining capacity during the winter heating season, which lasted through March 15. And while we expect most to restart, we anticipate those same Chinese refineries will likely curtail again next winter for environmental reasons.

We expect that China will import 1.5 million tons of alumina, a smaller number than we have seen in previous years, driven in part by slower Chinese alumina demand growth. Outside of China, large supply disruptions in the Atlantic region have cut alumina supply substantially. In aluminum, the market is projected to be in deficit in 2018, and we continue to expect strong global demand growth in the range of 4.25% to 5.25%. Announced smelter restarts in the U.S.

are not likely to achieve full production run rates until 2019, and we see potential supply reductions on the horizon driven by challenges in procuring alumina. We also expect world, ex China, primary aluminum demand growth in 2018 to be higher than last year, driven by robust end-use market growth in both developed and emerging markets. In China, we are forecasting a lower surplus versus 2017 as projected demand growth should exceed supply growth this year. Supply growth is expected to remain disciplined as China continues to enforce its aluminum smelter capacity and permitting framework and possibly implement controls on coal-fired power plants, many of which directly supply smelters.

Again, as mentioned earlier, considerable uncertainty remains in the market, driven by multiple trade actions, sanctions and third-party supply disruptions that could impact these balance estimates as this year progresses. So to sum up. First, we remain focused on what we can control and we continue to execute on our three strategic priorities. Second, we are seeing an unprecedented confluence of events and volatility, which is creating a positive market environment for us.

Third, Alcoa has a unique and well-positioned global portfolio across all three of our products. Fourth, based on current market prices, we’ve raised our outlook for full-year adjusted EBITDA, excluding special items, to $3.5 billion to $3.7 billion. Lastly, we’ll continue to adhere to our 2018 capital allocation framework to improve the business and, if available, to return cash to our shareholders in the second half of this year. We recognize that market volatility can move in either direction.

Still, current market conditions offer us an opportunity to accelerate the execution of our three strategic priorities and will help us to fundamentally strengthen Alcoa for the long term. We believe that Alcoa’s future is increasingly bright. With that, Bill and I would be happy to take your questions. Operator, if you could please remind the participants of the protocol, and let’s go ahead and get started.

Questions and Answers:

Operator

[Operator instructions] Our first question comes from Chris Terry with Deutsche Bank. Please go ahead.

Christopher TerryDeutsche Bank — Director

Hi, guys. Thanks for taking my questions. Mainly, I wanted to focus on the potential for restarts. So as we’ve seen the topical events coming to the market in the last couple of weeks, what is it that you’ll be mainly focusing on? Is it the sustainability of pricing, what your customers want? Or what are the data points you’d look for? And can you comment specifically around Point Comfort, please?

Roy HarveyPresident and Chief Executive Officer

Yes, Chris, absolutely. And I think the answer is all of the above. When we think about restarts and we think about how to put together a financial analysis of how that restart could affect us, we look at current pricing but, more importantly, we look at long-term pricing. We also look at the cost of the restart, the available tax incentives that might be in the jurisdiction, the local supply demand calculations, the potential modifications of power contracts, etc., as well as availability of workforce.

So we really look across a broad range of inputs and outputs to try and make a decision that is best for the long-term business.

Christopher TerryDeutsche Bank — Director

OK, OK. And then the last one from me just around the bauxite. You touched on it in your remarks, but can you give a little bit more color on where those tons could go from Ireland to where exactly?

William OplingerExecutive Vice President and Chief Financial Officer

Yes. We didn’t actually say from Ireland, so the — what we said was that there is about 800,000 tons of production that we had committed to sell at Rusal this year. Given the sanctions that we’re going to be abiding by, we’re in the process of placing those in the market currently, and we’re confident that we can get those placed this year.

Christopher TerryDeutsche Bank — Director

OK. Thanks, guys.

Operator

Your next question is from Novid Rassoull with Cowen & Company. Please go ahead.

Novid RassouliCowen & Co. — Vice President

Hi, Roy, Bill, thanks for taking my questions. Starting with the aluminuma depth, the projection of 300,000 to 1.1 million tons for 2018, what is the assumption made for the length of the outage at Alunorte that’s built into that assumption?

Roy HarveyPresident and Chief Executive Officer

Yes, Novid. So what we’ve assumed is a six-month outage. We’re really trying to look at what’s happening on the ground and take what is apparent [Audio gap] whether they put it essentially on a longer-term curtailment program. We’re still trying to have it ready to restart quickly.

So that’s a question for them, not us.

Novid RassouliCowen & Co. — Vice President

Got it. And then your outlook for a balanced bauxite market, does that include any impacts from the Rusal sanctions in that outlook?

William OplingerExecutive Vice President and Chief Financial Officer

At this point, we haven’t baked in any Rusal impacts into the outlook. It’s just too early and too fresh of information to build it in.

Novid RassouliCowen & Co. — Vice President

OK. And then one last one for me. Are you beginning to see any alumina exports out of China, given the spread between the domestic prices in China and FOB Australia?

Roy HarveyPresident and Chief Executive Officer

When we look at the financials, it’s certainly a possibility. We have no confirmations right now of alumina exiting China but certainly, it is a possibility in the future.

William OplingerExecutive Vice President and Chief Financial Officer

Yes.

Roy HarveyPresident and Chief Executive Officer

Thanks, Novid.

Novid RassouliCowen & Co. — Vice President

Got it. [Audio gap]

Roy HarveyPresident and Chief Executive Officer

Sure. Thank you.

Operator

Your next question is from David Gagliano with BMO Capital Markets. Please go ahead.

David GaglianoBMO Capital Markets — Analyst

OK. Thanks, [Inaudible] I just — I wanted to just drill down a little bit on the commentary on the idle capacity, potential restarts in alumina. As you do your analysis, I was wondering if you could share a little more detail, what are the restart costs for that capacity, say, the 2.5 million tons called out on Page 18 on average or in aggregate? What’s the timing of restarts? When should we expect to hear a commentary on that? What’s a reasonable cash cost assumption for that production once it’s restarted? And then my last question, as you think about the pros and cons of restarting aluminum and alumina, would you restart that idle alumina capacity all for third-party sales? Or would it only be done in conjunction with smelting restarts?

Roy HarveyPresident and Chief Executive Officer

Yes, I think it’s very dependent upon each of the idle facilities. And smelting, very different than refining. So each one had its own set of costs associated with it. It depends how the curtailment actually took place.

It also depends on how quickly you can get it put back into service. And then I think what you’re going to find is that there’s typically a window of between six months to even 12 months or more that would take in order to rally, prepare everything and actually bring the capacity back online. So when we think about the analysis that we do from a financial perspective, while we take into account current pricing, we have to be thinking about what the pricing will look like six, 12, 18 months out as a starting point. And so it’s — and so we take great care in making those decisions.

As far as when we perform those analyses for whether it be refining or smelting, we look at this pretty frequently. We have a series of programs that are ongoing to understand what would be necessary in order to restart capacity and what would we need to believe from a market standpoint. And we would let you and the rest of the market know as soon as we were to make a decision.

William OplingerExecutive Vice President and Chief Financial Officer

That’s all good, Roy. The — just to put on the smelting side a little bit and the perspective on Warrick, we had talked about when we restarted Warrick, Warrick ultimately is going to cost us probably between $70 million and $75 million in total restart costs. And that’s roughly 160,000 metric tons of smelting capacity. And from start to finish, it will take us nine months to a year on the Warrick side.

I think if we were looking at, for instance, at Point Comfort on refining, probably again nine months to a year before we get the first alumina out of there. And it would be a fairly expensive restart. So those are all the things that go into our analysis.

Roy HarveyPresident and Chief Executive Officer

And keep in mind one more thing as well, David, the interplay between alumina and aluminum pricing. So when we look at costs for a smelter, we also think about availability of alumina and price of alumina, and so — as well as, obviously, bauxite for alumina as well. So it’s a pretty complex set of equations.

William OplingerExecutive Vice President and Chief Financial Officer

And one last — we keep adding on, but one last comment. Largely, the smelters — when I say largely, the smelters that are curtailed were higher-cost smelters, that’s why they’re curtailed, same with Point Comfort. So when you asked about cash costs, Point Comfort is not a low-cost refinery. So if we — as we go through the analysis, we have to bake in all of that, all those thoughts into a restart consideration.

David GaglianoBMO Capital Markets — Analyst

OK. Thank you very much for the additional details. Just to round it out, so just specifically focusing in on Point Comfort. I got nine months to a year.

What about sort of the — what’s a reasonable cash cost and capital cost, cash cost to report, capital cost to restart?

Roy HarveyPresident and Chief Executive Officer

Yes, I don’t think we’ll reveal details about very specific assets. Sorry, Dave.

David GaglianoBMO Capital Markets — Analyst

OK, no problem. OK, you know what? Just in general, can you give us your early read, your early thoughts? Obviously, unprecedented moves in alumina here and aluminum in early stages for different reasons but now recently, obviously, tied to some of this Russian stuff. Can you give us a sense to what your thoughts are with regards to the ultimate outcome here on the Russian sanction? So is this — materials show up elsewhere? What are you hearing from your sources?

Roy HarveyPresident and Chief Executive Officer

So I think it’s incredibly complex and difficult to predict. So when you look at it from Alcoa’s perspective, we will be very careful to comply with U.S. government sanctions, and that’s why Bill specifically mentioned the 800,000 tons of bauxite that was destined for Rusal but now will be redirected. When you step back and think what are the broader issues in the industry, the key question is whether those facilities continue to operate and where will the material actually go.

So I think we’re just at the very beginning, both for Alcoa but also for the broader market, of trying to determine what is the outcome here and then how does that metal shift and what actually happens on a production basis. So I think that’s as far as we can actually predict what’s going to happen right now.

William OplingerExecutive Vice President and Chief Financial Officer

And in the near term, just to put a little more color on it, in the near term, the alumina market is tight. You see it reflected on a daily basis in the prices. But the alumina market is currently — is tight. And you saw that we are projecting now a deficit in alumina for the year but in the near term, it’s tight.

Thank you, Dave.

David GaglianoBMO Capital Markets — Analyst

All right, guys. Thanks.

Operator

Our next question is from Matthew Korn with Goldman Sachs. Please go ahead.

Matthew KornGoldman Sachs — Analyst

Hi, thanks for taking my question. Let me shift a little bit and ask about raw materials. Last quarter, you’d noted that input costs, carbon costs, I think, etc., are running higher than expected and they served as an offset to the margins in your base case. Should we expect any new phase of cost pressures from the dislocation and the urgency that we’re seeing in the market today? Is there any new — any lift in your input costs that you’re folding into your current guide?

William OplingerExecutive Vice President and Chief Financial Officer

Yes, in the current guidance, we still have approximately $400 million of year-over-year higher input costs. Those input costs have shifted a little bit in that — and that’s similar to the prior guidance. We said $400 million in the prior guidance also. The mix of those input costs have shifted a little bit.

Higher cost on the smelting side, specifically around carbon products, coke and pitch, and slightly lower cost around caustic and refining. So if I were to split it, over half of that is coming from carbon products and less than half of that’s coming out of — on the caustic side, so similar to what we guided to before. This dislocation in the market is slightly different than the ones we’ve seen historically. At this point, we are — as I’m saying, we’re essentially not seeing higher input costs being reflected in the numbers at this point.

Roy HarveyPresident and Chief Executive Officer

And if I could just add one piece to it as well, Matt. I think that what’s happening in the market right now is really disruptions to supply. So if anything, it’s actually lowering demand for some of the raw materials, while demand for the downstream products, aluminum or alumina, continues to be very strong. So when you think about a disruption, for example, in Brazil, that’s actually freeing up caustic on to the market and, therefore, has a — could have a positive impact.

So it’s certainly interesting times.

Matthew KornGoldman Sachs — Analyst

Well, that’s a good point. Segues good into my next question. I saw that you made no change to your total or your regional demand growth projections. And I have to imagine there’s some element of panic buying today when everyone’s looking around and not sure about that supply.

But if you’re looking through that panic, are you seeing any indication downstream that the threat of high prices, the volatility in net price, the uncertainty on policy that’s driving things week to week, that that’s having any effect whatsoever on your end buyers?

Roy HarveyPresident and Chief Executive Officer

So it’s still early in this latest upswing but to this point, we’ve really not seen any kind of demand disruption. And I think you’re seeing some questions, particularly in the U.S. as you think about tariffs and how they can impact consumers in the U.S., some questions about whether the regional dynamic shift a little bit. However, we’ve not seen any — we take a pretty close look at demand, as you can imagine, and we’ve not seen any impacts yet.

Operator

And our next questions is from Piyush Sood with Morgan Stanley. Please go ahead.

Piyush SoodMorgan Stanley — Vice President

[Inaudible] and Bill, congratulations on a strong quarter. A couple of questions. First one, you’ve addressed bauxite sales to Rusal that need to be redirected. I wanted to ask you about trade flows in alumina.

So I just want to understand, if you were buying alumina from either Norsk Hydro or Rusal for any location and with all the disruptions we are seeing, has there been any negative impact on you?

Roy HarveyPresident and Chief Executive Officer

So we have no further impacts that we have to mention. We are not a buyer of alumina because we are long essentially when you look at our portfolio. That doesn’t mean that there aren’t swaps. However, the only impact that we really have that we’ve mentioned here is the Rusal tons that were freed up.

William OplingerExecutive Vice President and Chief Financial Officer

Yes, on the bauxite. So no impact on either alumina or smelting, Piyush, so it’s just on the bauxite side.

Piyush SoodMorgan Stanley — Vice President

That’s good to know. And the second one, prefunding pension is probably a good idea until September since you get a larger deferred-tax asset. So you haven’t changed your guidance for voluntary contributions for this year? Is it —

William OplingerExecutive Vice President and Chief Financial Officer

No, we haven’t changed it. I’m sorry if I interrupted, Piyush, we haven’t changed it. We have said we will voluntarily contribute $300 million. We’ve already done $95 million in the Canadian pension.

In the capital allocation program, we have said that excess cash above the items that we had talked about, keeping $1 billion cash in the bank, sustaining capital, growth capital. That’s the mandatory pension contribution and the voluntary pension contribution. We will split that 50-50 between returns to shareholders and further delevering. Likely that if we get into that further delevering, it would go more toward funding the pension.

Piyush SoodMorgan Stanley — Vice President

OK. OK. So essentially, there is some room to raise it if needed for the year and it’s not really a decision left to next year.

William OplingerExecutive Vice President and Chief Financial Officer

Yes, there is — if — maybe I’m not understanding the question, but yes. I mean, if we get to a point where we have excess free cash flow above all those requirements, it will be split 50-50 and, most likely, it will go on the delevering side into prefunding the pensions.

Piyush SoodMorgan Stanley — Vice President

OK, understood. And sorry, last one if I may. If you happen to kind of restart aluminum smelting in Brazil, I just wanted to understand, electricity sourcing and alumina sourcing, how you feel about that and how easily would that be available.

William OplingerExecutive Vice President and Chief Financial Officer

That all goes into the calculus on restarting any asset, right, whether it’s Brazil or in the U.S. And many things — as Roy talked about earlier, many things go into that consideration. One of the key considerations is availability of raw materials and long-term prices and long-term assumptions.

Roy HarveyPresident and Chief Executive Officer

And just to add on to that as well, Piyush. When you think about having sufficient alumina to run a smelter, we always look at our businesses as separate entities. And so we don’t think about any kind of subsidization. So if we have an opportunity to sell alumina at a better pricing, we’re not going to start a smelter to consume that alumina.

We would rather take it to market. So we look at each decision as very separate but then analyze, just as Bill said, how our — how can we make sure that we have sufficient raw materials to have a profitable business.

Piyush SoodMorgan Stanley — Vice President

That makes it very clear. Thanks, guys.

Roy HarveyPresident and Chief Executive Officer

Thanks, Piyush.

William OplingerExecutive Vice President and Chief Financial Officer

Thanks.

Operator

And our next question comes from Timna Tanners with Bank of America Merrill Lynch. Please go ahead.

Timna TannersBank of America Merrill Lynch — Analyst

Yeah. Hey, guys, thanks for all the great details. I know you mentioned that there’s a lot of volatility, and it’s really difficult to comment on the outlook. But I really think it’d be great to get your perspective in terms of the duration, even if it’s a question of just rank ordering the three or four factors driving the market, whether that’s Section 232 or the Alunorte facility being down, Russian sanctions or China crackdowns.

Can you put them in order or put the ones — talk a little more about which ones could be stickier than other ones?

Roy HarveyPresident and Chief Executive Officer

So let me take a try at that, Timna, and see if I can give you a little bit of extra detail. So when you look at the 232 tariffs, the real question that comes down is how are those tariffs enforced, really, what countries are accepted and then are quotas actually placed. And quotas are what can really change the dynamics for a product, specific products, or for where material is coming in. So the important thing to look at there will be whether — how that develops and whether quotas are put into place.

On 301 tariffs, those are still relatively vague. And then also the Chinese response to those tariffs could have more impact as well. So I think those are still relatively undefined and certainly no real understanding of how long they could last and what products they could actually impact, so more to come on that one. From the sanctions side on Russia and on Rusal specifically, I think what we’ve seen in the past is that sanctions tend to be stickier.

However, we live in an environment where I don’t think there’s a lot of guarantees about anything. So we’ll see how that develops. But it’s certainly — it’s certainly throwing a lot of the market into an uproar. And you see a lot of activity right now in alumina, in bauxite and in aluminum to compensate for those sanctions being put in place.

On China?

Timna TannersBank of America Merrill Lynch — Analyst

Yes, and I think you meant Alunorte but that’s a tough one, too, and I recognize.

William OplingerExecutive Vice President and Chief Financial Officer

Yes, in Alunorte, we — as we said, Timna, we’ve got it built in six months into our estimates. Where that goes, that’s tough to say but we got six months built in. And as far as China goes, you’ve heard Roy and I speak in the past, China seems to be trending in the right direction. And the focus on environmental concerns, the focus between the NDRC and the MEP programs, maybe didn’t get as much capacity offline in the fourth quarter as what we had anticipated, but it certainly seems like they’re moving in the right direction.

And some of this latest feedback associated with power plants and actually potentially looking at going after overcapacity in power plants is positive for our industry also. So it’s hard to order the four but the four are, as we’ve said, already converging to have really unprecedented impacts in the market.

Timna TannersBank of America Merrill Lynch — Analyst

OK, super. And my only other question, I know we’ve asked you a lot about Alcoa’s plans to restart capacity. But can you give us any comments about some of the other players and what they might do, just broadly speaking? Obviously, some don’t have the option or the luxury of contemplating restarts. But certainly, people are a bit concerned that given this rapid rise in prices, there could be a lot of restarts, do you think that, that’s a risk and why?

Roy HarveyPresident and Chief Executive Officer

Yes, I think it’s still to be determined. Remember that a restarting smelter needs to find alumina and they need to feel that they have the right business case to pay for the alumina, which is actually rather dear right now. Outside of that, I think its — each restart is its own restart. It takes a period of time.

And I would assume that every other company is doing the same analysis as us, trying to think how are these prices going to develop for the next three to four years, which is typically what’s necessary in order to pay back a restart.

Timna TannersBank of America Merrill Lynch — Analyst

OK. Fair enough. Thank you.

Roy HarveyPresident and Chief Executive Officer

Thanks, Timna.

Operator

Our next question comes from Justin Bergner with Gabelli & Company. Please go ahead.

Justin BergnerGabelli & Company — Vice President

Good afternoon. Thank you for taking my questions.

Roy HarveyPresident and Chief Executive Officer

Hey, Justin.

Justin BergnerGabelli & Company — Vice President

I just want to drill down a little bit more on the aluminum market. How much of the change in the deficit that you forecasted is due to Alunorte versus Rusal? And could you maybe just comment on Rusal as it relates to the refinery supply challenges versus the smelting supply challenges?

Roy HarveyPresident and Chief Executive Officer

So on the aluminum market, right, Justin?

Justin BergnerGabelli & Company — Vice President

Yes, on the aluminum market

Roy HarveyPresident and Chief Executive Officer

Yes, so the only impact that we’ve incorporated into these balances is the six-month outage of Alunorte. And remember, that’s meant to be a placeholder and does not predict actual outcomes. You need to look to Norsk Hydro and the government of Brazil, in the state of Pará, in order to determine how long that will actually be out. From a Rusal perspective, because there is so much uncertainty, we’ve not made any assumptions about refineries not being able to operate or changes in the supply demand.

Those supply demands look at it on a global basis and do not try to predict regional characteristics.

William OplingerExecutive Vice President and Chief Financial Officer

And in the case of Alunorte, Alunorte is around a 6 million-metric-ton plant. They’re curtailed down to about 50%, and we’re assuming it occurs for six months. So that means there’s about 1.5 million metric tons that are out of our supply demand picture on alumina.

Justin BergnerGabelli & Company — Vice President

OK, great. And then just to follow up on that topic. People have speculated as to where Rusal’s metal can go in terms of countries that will take shipments of it. But just how will Rusal supply the bauxite for its refineries if parties like yourself and Rio Tinto are no longer supplying bauxite to them? What are their options as far as you understand?

Roy HarveyPresident and Chief Executive Officer

I think it’s a good question, Justin, and I don’t think we have an answer for you. So it’s all tied up with who feels impelled by the U.S. sanctions and the knock-on direct and indirect impacts on financial institutions, etc., who would be willing to do that.

William OplingerExecutive Vice President and Chief Financial Officer

What we do know is, it won’t be from us.

Roy HarveyPresident and Chief Executive Officer

Yes. Thank you, Bill, exactly.

Justin BergnerGabelli & Company — Vice President

Would Indonesia be fair game? Or is it TBD?

Roy HarveyPresident and Chief Executive Officer

I think it’s to be determined. I think you’d need to ask the players in Indonesia.

Justin BergnerGabelli & Company — Vice President

OK. Thank you for taking my questions

Roy HarveyPresident and Chief Executive Officer

Thank you.

William OplingerExecutive Vice President and Chief Financial Officer

Thanks, Justin.

Operator

Our next question comes from Curt Woodworth with Credit Suisse. Please go ahead.

Curt WoodworthCredit Suisse — Director

Yes, hi, good afternoon.

Roy HarveyPresident and Chief Executive Officer

Hi, Curt.

Curt WoodworthCredit Suisse — Director

So there was a, I guess, report by CRU saying that alumina cargo traded $800 a ton a day yesterday. I was curious, where do you think the Atlantic Basin alumina price is today? And if the economics of that market get to such a level, would you contemplate taking smelting capacity down to free up more merchant alumina? Would that make sense at all? And then with respect to Rusal supplying, I guess, metal in the downstream consumers in Europe, are you seeing any change in the value of shape premium or demand from your cast houses, from fabricators or downstream users that need to offset that metal?

Roy HarveyPresident and Chief Executive Officer

Yes, Curt. So let me get the first one first. I think one of the interesting things about the alumina market is that it happens on a transaction-by-transaction basis. And the way that the indices are put together is that each of those transactions impacts the final index outcome.

So I think the latest transactions are the best approximation that you have of the market, and you need to try and get into the thought about what are financing terms and what are delivery terms, etc. I don’t think I have any additional conclusions than we — we’ve seen what that transaction is, and it indicates where we are. From the standpoint of what we think about bringing down smelting in order to take advantage of alumina prices, we talked a lot about restarts. I would also say that we also take a pretty close look at each of our operating facilities to make sure that they are generating value.

And again, we break our business into the three products, and we’re pretty rigid about making sure that we’re not subsidizing a smelter by sending them alumina. So we take a good look — a good, hard look at that. The other question was —

William OplingerExecutive Vice President and Chief Financial Officer

Shape premiums and are we seeing impacts to our customers.

Roy HarveyPresident and Chief Executive Officer

Yes, I think we’re still pretty early in the process, so I don’t believe that we’ve seen any impacts on shape premiums. And if you can imagine, there could be impacts because of the tariff structure happening inside the U.S., as you think about the 232 tariffs and 301s and whether quotas are put into place or not. And when you look at Europe specifically as well, I think that, that story is still to be written, and it’s really a question of whether — how that material gets to market.

William OplingerExecutive Vice President and Chief Financial Officer

And if I could add on two minor points to that. On the API question and the $800 trade that allegedly occurred, we are seeing Atlantic premiums be much higher than they’ve historically been and another indication of exactly how short the alumina market is. So we’ve seen Atlantic premiums, which normally trade at a discount to API prices, jump up to around $50 a ton, so that gives an indication. And as far as the question around would we consider curtailing smelting capacity, it’s exactly the converse of our restart discussion, right? And so you think about would we curtail to sell alumina, all those same factors are going into that decision of whether you would restart or do we think alumina prices are sticky in here to stay and all the impacts that go with that, so constantly evaluating those decisions.

Curt WoodworthCredit Suisse — Director

OK. And then just one quick one. Bill, on the pension, I think you said your $3.3 billion for legacy liability and you have $300 million more to fund. And at the same time, you’ve seen interest rates move up a lot.

So could you give kind of a pro forma or estimate of what you think that lability would look like if you took spot interest rates, market value the assets and then assume the paydown that you had planned?

William OplingerExecutive Vice President and Chief Financial Officer

Yes, so it’s always a dangerous game projecting when you have got interest rates included. If we were to hit our expected rate of return, which is 7%, and if we were to leave discount rates at the same level that we ended at the end of this year, and we make the mandatory and discretionary contributions that we’ve talked about, that liability should be somewhere south of $3 billion. Now that does not bake in any higher interest rates, and it assumes that we hit our 7% expected rate of return. One more piece of data I can help to inform any analysis is that currently, a 25-basis-point change in discount rates would mean about a $200 million impact on the liability.

That’s slightly less than what we have said historically. And the reason is we are in the process of derisking the pension plan with the contributions that we’ve made in Canada. To be clear, in Canada, we’re going to take roughly $550 million of both liability and assets off the books through that derisking strategy. So knock on wood, I think we’re making good progress on the pension and OPEB liabilities.

Curt WoodworthCredit Suisse — Director

And given the move in interest rates year to date, would you expect that if we stay at this level, you would change the discount rate?

William OplingerExecutive Vice President and Chief Financial Officer

Given the move in interest rate, yes. So let me — just to be clear, on the discount rate calculation, it’s essentially a 15-year corporate bond, roughly a 15-year corporate bond, right? So it’s got both the 15- year Treasury included in that and the spread on top of that. And through the first quarter, both of those went in our favor, so rates were up in the first quarter. Now remember, we only do revaluation at the end of the year.

We did a revaluation in the middle part of the first quarter for the Canadian assets because we were making those contributions.

Curt WoodworthCredit Suisse — Director

Got it. Very helpful. Thanks, guys.

William OplingerExecutive Vice President and Chief Financial Officer

Thanks, Curt.

Operator

Our next question comes from David Lipschitz with Macquarie. Please go ahead.

David LipschitzMacquarie Group — Analyst

Thank you. Good evening, everyone.

William OplingerExecutive Vice President and Chief Financial Officer

Hey, Dave.

David LipschitzMacquarie Group — Analyst

A quick question on the alumina market, do you have anything that’s purely like maybe it’s under a long-term contract or something like that, that’s not tied to API that’s on a pure spot that if somebody needs the cargo tomorrow that you could just sell it?

Roy HarveyPresident and Chief Executive Officer

In like alumina, we keep open positions to be able to sell in spot, but that doesn’t necessarily mean we keep them at all times. So right now, we — if we don’t have excess aluminum — alumina to be selling out into the market, but we do look forward in future months and we evaluate, essentially, our own personal supply demand balance to see whether aluminum is to be made available.

William OplingerExecutive Vice President and Chief Financial Officer

And the other thing to keep in mind is that API should largely represent spot on a little bit of a lag, right? The API price for us is a combination of Platts and the CRU estimates. So it should largely represent the spot price. 95% — as of this year, 95% of our contracts are on API, so we only have 5% of the contracts that are on any type of a long-term contract.

David LipschitzMacquarie Group — Analyst

OK. Thanks.

William OplingerExecutive Vice President and Chief Financial Officer

Thanks, Dave.

Operator

Next question is a follow-up from David Gagliano with BMO Capital Markets. Please go ahead.

David GaglianoBMO Capital Markets — Analyst

Hi, just real quickly on the — just want to make sure we’re calibrating our short-term numbers correctly. I heard the comment, 20% higher, 3Q, 4Q versus 2Q. And I’m just trying to figure that out. Just because with alumina, you got your costs that lagged a quarter, your price lagged a month.

I would think it would have been the opposite. You got a big blowout in the second quarter and then a little bit of a reversal, i.e. a bit of a squeeze in the third quarter. What am I missing there?

William OplingerExecutive Vice President and Chief Financial Officer

Yes. So first thing you’re missing is we said 25%, not 20%. And the second piece is, on the revenue side, it does take time for that — for those higher prices to flow through. And so in the case of alumina, what we’ve said is we’re assuming a $500 Alumina Price Index going forward.

So it will take time for all of that benefit to flow through, and that should come in the third and the fourth quarter.

David GaglianoBMO Capital Markets — Analyst

OK. I’ll leave it for the follow-up call later. Thanks.

William OplingerExecutive Vice President and Chief Financial Officer

Thanks.

Operator

Next question is from Matthew Fields with Bank of America Merrill Lynch. Please go ahead.

Matthew FieldsBank of America Merrill Lynch — Analyst

Hey, guys.I wanted to follow up on Curt’s question earlier about the downstream customers. We saw an announcement from Novelis saying that, “Rusal was a small supplier for us in Asia, and we’re going to have to change supply.” Have you started to sort of see incoming queries from some of these fabricators about picking up supply where Rusal was a player in their supply chain?

Roy HarveyPresident and Chief Executive Officer

Yes, we don’t — we typically don’t delve into customer-by-customer discussions. I’ll tell you that there is a lot of interest right now, particularly in our alumina supply and in aluminum, and so I’d say that yes, we were talking with a lot of different people and coming and becoming — working on making deals with each of them, depending on what we have as far as availability.

Matthew FieldsBank of America Merrill Lynch — Analyst

Can you give some color on whether that’s fabricators or distributors and if there’s any regional bias to that discussion?

Roy HarveyPresident and Chief Executive Officer

I think when you look at Europe, there’s a lot of questions about Rusal but there also are in the U.S. So I don’t think I have — I don’t think there’s a bias to one type of customer or not.

Matthew FieldsBank of America Merrill Lynch — Analyst

OK. That’s it for me. Thanks a lot.

Operator

Our last question today will come from John Tumazos with John Tumazos Very Independent Research. Please go ahead.

John TumazosJohn Tumazos Very Independent Research — Chief Executive Officer

Thank you. I got a mundane question about the balance sheet. There is four accounts for fair value of derivatives and assets are $151 million and the liability is $579 million. Why are there four different accounts? And are they segregated based on financials versus hedging the Midwest premium? Or how is it so complicated?

William OplingerExecutive Vice President and Chief Financial Officer

Yes, so how is it so complicated? There are four separate accounts. There’s current and there’s non-current, so that gets you two sets of accounts right there, and there’s assets and there’s liabilities. Some of the power contracts are in an asset position. Some of the — these are largely — just to be clear, these are largely embedded derivatives associated with power contracts.

Some of the power contracts are in an asset position, some of the power contracts are in a liability position. The way these work is that as a percent of LME, as power prices go up — I’m sorry, as LME prices go up and go down, some of our contracts, the power also — price also goes up or down. So you saw some fairly large changes in the liability accounts this time, and that’s because of the change in the LME. They will fluctuate over time.

Essentially, John, it’s just embedded derivative accounting associated with LME-linked power contracts.

John TumazosJohn Tumazos Very Independent Research — Chief Executive Officer

Thank you.

Roy HarveyPresident and Chief Executive Officer

Thank you.

William OplingerExecutive Vice President and Chief Financial Officer

Thanks, John

Operator

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

Roy HarveyPresident and Chief Executive Officer

Thank you, operator. So we’ve got a good solid start to the year, and we’re looking forward to an even stronger remainder of the year, as Bill foreshadowed. We continue to be very focused on our three strategic priorities, and we also clearly see our role to drive as much market upside as possible to the bottom line so that we can make Alcoa stronger faster. It’s an exciting time, as you saw from all the questions, to be part of the aluminum industry.

And we believe that our 130 years of heritage and history helps position us to have an incredible, incredible future in front of us. I appreciate everybody joining us and look forward to speaking again here a few months down the road. Thank you.

Operator

[Operator signoff]

Duration: 62 minutes

Call Participants:

James Dwyer — Vice President, Investor Relations

Roy Harvey — President and Chief Executive Officer

William Oplinger — Executive Vice President and Chief Financial Officer

Christopher Terry — Deutsche Bank — Director

Novid Rassouli — Cowen & Co. — Vice President

David Gagliano — BMO Capital Markets — Analyst

Matthew Korn — Goldman Sachs — Analyst

Piyush Sood — Morgan Stanley — Vice President

Timna Tanners — Bank of America Merrill Lynch — Analyst

Justin Bergner — Gabelli & Company — Vice President

Curt Woodworth — Credit Suisse — Director

David Lipschitz — Macquarie Group — Analyst

Matthew Fields — Bank of America Merrill Lynch — Analyst

John Tumazos — John Tumazos Very Independent Research — Chief Executive Officer

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