South Africa: Eskom and domestic coal supply

Barry Baxter, Africa Correspondent, World Coal.

If the issues over empowerment and the general condition of the mining sector were not enough, the government has also revealed that a decision has been made to declare coal, among some other minerals, a strategic resource. This means production will be monitored and prices and marketing controlled. Some see this as no more than a move to be able to divert export coal to state-owned generating utility Eskom, which is running out of both coal and money. Others hint at a creeping form of government control.

Ramatlhodi told Parliament he intended for a state-owned African Exploration, Mining and Financial Corp. (AEMFC) to play a much bigger role in the South African economy. “It will have the same authority as any of South Africa’s state-owned enterprises,” he said. The corporation's General Manager, Sicelo Sikakane said he was looking to expand its coal portfolio.

Some analysts anticipate that this company could be somehow slotted into the strategic mineral issues as sole trader in them or in a similar capacity. Others worry over a resurgence of calls for nationalisation of the mining industry. An opposition group calling for nationalisation formed itself into a political party to fight last year’s general election and took 10% of the vote. It is now repeating its calls that government take over the industry. The party is led by Julius Malema, who says that South Africans are increasingly disillusioned by the failure of the ruling African National Congress (ANC) to deliver basic services and the growing corruption by government officials.

The problem of power

South Africa’s domestic coal trade, 90% and more of which is with Eskom, is, say reports, in tatters. Analysts say that Goldman Sachs is informally advising the South African Treasury on the sale of state assets to raise money to fund projects for Eskom, the state power utility, and clear its debt – which is largely due to the government.

The Treasury tacitly confirmed this, saying that “given Eskom’s constrained balance sheet and government’s constrained financial position, consideration is being given to ring-fencing and selling stakes in Eskom’s non-core businesses or power stations, as well as in Eskom’s business as a whole.”

An initial target is to fill a cash flow shortfall of R225 billion (US$19 billion) to enable Eskom to build new and update existing generation capacity, as it starts to hit home that a national energy baseload cannot be built on renewable energy sources and that a headlong dive into nuclear generation might not be the solution everyone is hoping for.

Two coal-fired power plants under construction, Medupi and Kusile, which will deliver a total 10 000 MW, are 4 yr behind schedule. The official 2015 economic growth forecast of 2% assumes Medupi in at least initial production of 800 MW.

Coal supplies for either plant have not yet been secured, as Eskom has decided that it will buy the majority of the coal it needs from companies that have at least a 51% black shareholding level – 25 points above the BBBEE requirement.

Eskom needs not only to worry about its bank and credit ratings. There will be renewables. In the country’s Integrated Resource Plan 2010, the government proudly announced the end of coal-fired power and the development of a baseload based on renewables by around 2025. Half a decade on, it has already been announced alongside renewables, there will be nuclear. That could compound Eskom’s worries. It has been announced that the utility will not be in charge of the nuclear-energy programme.

Bidding to open an independent power producer (IPP) programme to develop a designated baseload for coal-generated power was expected to begin in November 2014. The government said that the programme, which had, until then, focused on renewable energy, would be extended to include 2500 MW of coal projects and 800 MW of coal generation (the difference between these two types of project was not explained). There are no reports of progress.

However, Tina Joemat-Pettersson, the Minister of Energy, has announced a target of 9600 MW nuclear generation over the next 10 yr. She intends to focus on and accelerate all matters that would lead to the commencement of the nuclear-build programme. Already 25 would-be South African nuclear engineers are being trained in China, which along with Russia, France, the US and South Korea is one of the countries that has been negotiating nuclear co-operation with South Africa.

On the edge

Eskom is, in many respects, a barometer of the South African coal industry’s fortunes. Historically, power plants were built at the mines, which were developed at the behest of, and funded wholly or partly by, the power utility. It then bought the coal produced on a cost-plus basis. These mines kept the industry in business. As export trade started and grew, it gave them substantial profits on top.

This still applies in many cases – maybe not via mine-mouth situations but with the mines tied into Eskom cost-plus contracts. It has been and remains key to the success of many small miners and new (black) entrants to the industry.

The power utility is now being described as on the edge of a disaster. Its fall could shake many existing miners, juniors and majors – and dash the hopes of many of those hopeful of entering the industry.

Many of its coal supply contracts are due to expire, while one new power plant has lagged behind in its demand for coal. Construction of a proposed new coal mine to feed another planned power plant has not yet started.

It is also some concern that coal grades, previously consumed only by Eskom, are now being exported in large volumes for use in Indian power plants and also for blending. This is more than likely happening because the export trade commands higher prices than Eskom will pay. At the recent Investing in Africa Mining Indaba, Eskom estimated it needed ‘only’ 2.35 billion t of coal for the long term. It then added that 22 million tpy of coal would be sourced from new agreements. The good news was that the majority of the uncontracted coal had, at least, been identified. Yet, a senior coal mining executive estimates that Eskom needs to contract at least 40 million tpy of coal for the next 10 yr.

Eskom’s new insistence that it will favour suppliers that have a 51% black shareolding is compounding its difficulties. Mines of a size to supply the amount of coal it needs will be huge operations requiring capital investment well beyond junior miners and new (black) entrants to the industry. Even large companies will find it hard to find that amount of financial support given the present parlous state of the industry.

Losing friends and influence

Anglo American is one – and it already supplies Eskom with large amounts of coal but wants out. It understands Eskom well: for many years it built its coal business on selling to the power utility, while other companies were concentrating on building their exports.

In response to Eskom’s decision, the mining major said: “from our point of view the domestic supplies (to Eskom) have been good business, but no longer are major in our portfolio. Anglo American may sell its South African domestic coal business.”

The portfolio is estimated at US$1.5 billion, 30% of the coal produced is sold to Eskom. In the wings as a potential buyer, but clearly ready to take centre stage, is the totally black-owned Pembani Group, which already has investments in BHP Energy Coal South Africa, Exxaro Resources (number two to Anglo American in the South African mining industry) – and is owned by Anglo American Non-Executive Director Phuthujma Nhleko. It also has an association with the Shanduka Group, created by Cyril Ramaphosa, now Deputy President of South Africa.

Ngoako Ramatlhodi, the Minister of Mineral Resources recently told a group of investors in London that, as Anglo American and BHP Billiton had “outgrown” South Africa by listing in London, it was time for another company to step up and establish a similar presence in the industry but with a “foot in the community”. “We are working on it in collaboration with the guys who are pulling out,” he said.

BHP Billiton, Glencore and Exxaro are three more companies which supply Eskom. So far, Eskom has alienated all three. BHP Billiton, the world’s largest mining company, is washing its hands of South Africa and hiving off its coal mines into a separate company, South32, which might do a deal with Eskom in its own right.

“South Africa’s remaining mineable coal is deeper and more expensive to mine. Eskom’s people cannot seem to get their heads around that,” a Glencore executive said and was immediately labelled by Eskom as uncooperative.

Exxaro is already hugely exposed to Eskom. The mining company's coal business with the utility accounts for more than 90% of its coal revenues. Strategically, it is almost certain that neither of the two would want to become more exposed to the other. The only comment from Eskom was that there was no crisis. It was not as if South Africa was going to run out of coal.

Written by Barry Baxter. Edited by Jonathan Rowland. This article first appeared as part of a regional report on the South African coal industry in the June 2015 issue of World Coal.

Read the article online at: https://www.worldcoal.com/special-reports/11062015/south-africa-eskoms-woes-and-domestic-coal-supply-coal2404/