Landsvirkjun

Revised profitability assessment for Kárahnjúkar Power Plant

29. August 2006

A brief background history:
An agreement was concluded with Alcoa Inc. on energy sales to the Fjarðaál aluminium plant at Reyðarfjörður on 15 March 2003, thus finalising the decision on proceeding with Kárahnjúkar Hydropower Project. One of the conditions of the agreement was that a profitability assessment would show a satisfactory outcome. This was believed to be the case, and indeed Landsvirkjun's experts and the company's consultants came to the conclusion that the internal rate of return would be 7.3%, which was 0.4% more than the weighted average cost of capital. Discounted cash flow figured to a positive ISK 6.6 billion. This indicated that return on equity would amount to 12.8%, which was 1.8% higher than capital requirements. Furthermore, a probability assessment was carried out on the profitability of the project. The conclusion was that there was only a 21-26% chance of performance rates not sufficing to cover the weighted average cost of capital, which would have resulted in a negative discounted cash flow. Moreover, it was deemed highly unlikely that the project would not return greater growth than the rate of interest on loans.

The so-called owners' committee of Landsvirkun was requested by the firm to review this profitability assessment.The conclusion of the committee's report includes the following passages:

"The committee finds the Landsvirkjun profitability assessment to be well grounded. However, it is for the owners of the company to determine whether the estimated profitability of Kárahnjúkar Hydropower Project is adequate, taking into account the inherent risks of the project and other aspects they believe to be important."

The profitability was presented to the owners at special meetings, and guarantees for the power plant were offered on the basis of the assessment. In this way guarantees were approved by the municipal governments of Reykjavík and Akureyri, and the profitability assessment was discussed in detail by the Industrial Committee and Economic and Commerce Committee of the Althingi.

Revised profitability assessment
Landsvirkjun has now revised its profitability assessment for the power project in light of the information now available on accrued project costs and revised assumptions about the main operating items. An effort was made to conduct the assessment using the same methodology as before, so that it would be possible to compare the projected profitability now with the profitability assessment that provided the basis for deciding on investment. Landsvirkjun's methodology in the profitability assessment is the same as that used by companies in general, that is, basing on the discounted cash flow from the project, given the following principal factors:

  1. Start-up costs
  2. Electricity sales
  3. Aluminium prices and their development
  4. Exchange rate of the U.S. dollar
  5. Operating costs
  6. Lifetime of the power plant
  7. Financing and financing costs

The start-up costs were initially estimated at ISK 95 billion (not including interest), based on price levels and exchange rates in November 2002, which amounts to approximately ISK 115 billion today, taking interest into account as well as developments in price levels during the construction period.

A new estimate of start-up costs is now available.This estimate consists of costs accrued during construction of the power plant as of 30 June 2006, counting interest during the construction period and estimated costs from 1 July 2006 until the end of the project. The new cost projection amounts to just over ISK 116 billion, including the anticipated costs of transmission structures and unforeseen costs arising from the remaining construction. With 75% of the project completed, the new budget for the start-up cost of Kárahnjúkar Power Plant is therefore about ISK 1 billion above the original budget, an increase amounting to less than 1%.

Other premises have also been adapted to updated circumstances. Most notably, it is thought that the price of aluminium in the future will be somewhat higher than in the previous assessment, and the exchange rate of the U.S. dollar has been lowered from previous assessments.

Conclusion
The outcome of the revision that has been carried out on the profitability assessment for Kárahnjúkar Power Project is that the positive present value of the plant is nearly ISK 4.4 billion, a decrease of ISK 2.2 billion from the original profitability assessment. Based on this conclusion, Landsvirkjun will nonetheless succeed in fulfilling requirements for interest on loans, besides the owners being able to expect a return of 11.9% on capital, which exceeds the 11% capital requirements that were set.

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