Think long

15th July 2016 By: Terence Creamer - Creamer Media Editor

Think long

For some time now, State-owned electricity utility Eskom has been signalling that it intends overhauling the way it sources coal. Ever since Brian Molefe took over as CEO, he has questioned whether it is appropriate for Eskom to invest directly in mines through cost-plus supply contracts with coal miners. Using a food analogy, he has argued that Eskom should buy bread rather than own the bakery.

The first practical outward sign of the shift came with the controversial decision to terminate a 40-year contract with the Arnot mine, operated by Exxaro.

It might even be argued, however, that Molefe’s earlier public spat with Glencore over Optimum’s R150/t supply contract with the Hendrina power station was at least in part motivated by this change in mindset. Although critics suggest other motives, particularly in light of the fact that the subsequent decision to place the mine into business rescue helped facilitate the acquisition of Optimum by the Gupta-family-linked Tegeta Exploration & Resources.

Whatever the motive, the utility, which burns more than 114-million tons of coal yearly, is showing increasing dissatisfaction with the cost-plus contracts, which it claims are not delivering the volume and price benefits for which they were initially designed.

Rightly or wrongly, some place the blame squarely with Eskom’s reluctance to make the requisite investments to sustain volumes and contain costs. It is possible, though, that the utility’s weak financial position, as well as its subinvestment-grade credit rating, has also been an important factor driving this investment reticence.

The upshot of it all is that the new strategy is gaining momentum, notwithstanding the difficulties of matching the exact coal specifications of the power stations with material sourced on the open market.

Besides Arnot – which is currently being supplied through interim arrangements, including the highly controversial contract with Tegeta – other supply agreements are in Eskom’s crosshairs.

Eskom has issued a request for proposals to replace supply to the Hendrina power station. It has also indicated that this tender will be followed by an enquiry to replace supply from Anglo American’s Kriel mine, where the contract expires in 2019.

In addition, Eskom group executive for generation Matshela Koko has suggested that it will approach the market to supply coal to the Kusile power station, which is currently under construction in Mpumalanga – this, after failing to reach an “amicable” deal with Anglo American Inyosi Coal regarding supply from New Largo.

Eskom has also aired a grievance regarding the performance of Anglo’s New Denmark colliery, which supplies coal to the Tutuka power station. While Anglo says it invoiced Eskom an average of R668/t last year, Eskom insists that the total cost for the period was R1 600/t, after the costs of operating the mine, as well as the amortisation costs of historical capital expenditure, are included

In other words, more change is on the cards. Just how painful this shift will be for the coal industry, Eskom and, ultimately, the electricity consumer is not immediately clear. What is clear is that the new model carries risks and that long-term, sustainable solutions should not be sacrificed on the altar of short-termism and opportunism.