Under the microscope

29th April 2016 By: Terence Creamer - Creamer Media Editor

Under the microscope

Much attention has been paid – appropriately so – to the circumstances that led to Optimum Coal Holdings becoming an asset of Tegeta Exploration & Resources, a company that is closely associated with the Gupta family’s Oakbay Investments.

Glencore, the mine’s previous owner, placed the operation into business rescue in August last year, following a high-profile spat between the global mining group and South Africa’s State-owned power utility, Eskom, which sources coal from Optimum for its Hendrina power station.

Eskom CEO Brian Molefe did not disguise his displeasure with Glencore when the miner sought a revision of the R154/t contract, which it described as unsustainable in light of the mine’s prevailing production costs, which were said to be nearly three times higher.

Molefe became especially incensed when Optimum halted supply to Hendrina in what he interpreted as a bid by Glencore to put pressure on the utility to change its stance.

As a consequence, Eskom upped the ante by not only demanding that the fixed-price contract be honoured until 2018, but that Optimum pay R2-billion in penalties for its failure to supply coal within the stipulated quality band.

Matters became even messier, however, when it emerged that Tegeta was bidding for the distressed asset and that South Africa’s Mineral Resources Minister, Mosebenzi Zwane, had travelled with a delegation of Tegeta executives to visit Glencore in Switzerland to negotiate Optimum’s purchase.

In a climate of growing suspicion that the Guptas were using their political influence to secure lucrative business arrangements with government and/or State-owned companies, Eskom’s hard-line stance was viewed with a great deal of cynicism. Was the utility party to a well-orchestrated corporate heist? Would Eskom continue to play hardball once Tegeta took over the operation, or would the terms dramatically change and the penalties suddenly vanish? Alternatively, would Optimum begin supplying other power stations on far more favourable terms?

For the moment, Eskom is sticking to its assertion that the contract (in terms of pricing, quantities and coal quality) remains valid until 2018 and that the R2-billion penalty remains in force and payable. In fact, Eskom has indicated that, once the business rescue process has been finalised, legal proceedings relating to the penalty will proceed. The utility has also confirmed that Optimum is still not meeting Hendrina’s quality requirements with regard to sizing and abrasiveness, but that the penalties were suspended during the business rescue process.

Without question, the eventual outcome will be closely monitored. In addition, Eskom should now expect far closer scrutiny of its future coal supply agreements more generally, particularly in light of the fact that it changed its coal sourcing strategy from “owning the bakery to buying the bread”. The strategy raises serious questions about the future of several cost-plus mines, with the acrimonious termination of Exxaro’s Arnot supply contract providing a glimpse of what could follow.

With primary energy being such a large and strongly growing part of Eskom’s cost structure, any outcome that favours enrichment over value would be disastrous not only for Eskom, but for South Africa as a whole.