Matshela Koko, Group Executive for Generation at Eskom
Coal mines play a crucial role in the South African economy. South Africa
is the fourth largest coal producer in the world having produced 260Mt of coal
in 2014 worth approximately R100bn. Of this, local consumption amounted to
183Mt (worth R54.7 bn), according to the Chamber of Mines. Compared to other
local minerals, coal contributed to 27% of mineral sales in 2014, followed by
PGMs (21%), iron ore (16%) and gold (13%), according to the mining production
and sales figures released by Statistics SA in April this year. This sector
also employs approximately 87 500 people (excluding Sasol) and is thus a key
contributor to local job creation.
Eskom is the predominant domestic consumer of coal having purchased 121Mt
in 2014. Coal-fired power stations account for 90% of the
electricity generated in South Africa. Eskom, as a State-owned company, is
mandated by the national government to ensure the security of electricity
supply whilst contributing to the socio-economic development of the country. In
order to fulfill this, the power company’s coal strategy includes procurement
of cost-optimal quality coal; security of coal supply; transformation of the
industry and increasing supplier competition; plus coal logistics integration.
An international commodity price rout is underway and the price of
thermal coal is currently at multi-year lows. The high quality coal
exported from South Africa has dropped by 59% from 2011 and prices now hover
around $50 per tonne though the weakening rand has been able to cushion the
lower margins. The power company however, contracts through Indexed Fixed
Price (long and medium-term) and Cost-Plus contracts. These contracts are
ring-fenced and not linked to the export market thereby incubating and
protecting local mines and Eskom from export coal price volatility.
Cost escalation on the medium term Fixed Price contracts are linked to
mining production costs and transportation cost. Long-term fixed price
contracts are also index linked but recently cost escalations on certain
contracts have been generally above inflation.
In Cost-Plus contracts Eskom pays
for operating costs plus a pre-determined return-on-investment with mines owned
by the coal miner. In general, long-term contracts are approximately 40 years
and some of these are now approaching their expiry date.
Over the last three decades, Cost-Plus mines generally supplied above
contracted volumes to Eskom in order to meet rising electricity demand. They
are now underperforming and are below contracted levels with mines unable to
meet contracted volumes, costs and quality parameters. The current
underperformance has forced Eskom to source coal from alternative sources with
higher unit and replacement costs. This is evidenced by the current regulatory
clearing account (RCA) claim which amounts to R2bn for coal procurement plus
additional R3bn for an extended and costly logistic chain.
This has partially contributed to Eskom’s coal cost increases being above
the mining cost inflation of 9% and the expectations of the South African
Eskom has agreed a number of coal supply contracts with different
suppliers. All of these suppliers are required to operate within agreed
contractual terms, which includes production and cost targets. As part of this,
Eskom has a Cost-Plus contract with Exxaro for the supply of coal to Arnot
Power Station which expires at the end of this month (31 December 2015). Exxaro
has not provided financially viable supply options for post-December 2015 that
compare favourably to other alternatives. Eskom and the country cannot afford
to continue buying Arnot coal at R900/ ton – which costs more than top-grade
Impacted mines can
tender to supply other domestic and international markets and therefore the end of an Eskom contract should not automatically result
in job cuts. Eskom remains concerned on impact on jobs, however the final
decision on running a mine and job cuts will be taken by the mine owner.
As part of
the transformation of the economy within the National Development Plan (NDP), Eskom
has established the Junior Mining Strategy with the Department of Mineral
Resources and Department of Public Enterprises. This strategy was designed to
assist new black-owned mines with mine development. Increased national
electricity demand necessitated additional coal supply that existing major
miners could not supply and hence the economic need to expand the coal supply
base. In 2000, Eskom procured 98% of coal from long-term contracts with the
major mining companies. Through these black-owned firms, Eskom has widened its
supply base and now procures nearly 40% of its coal from these Junior Miners.
Eskom will continue to incubate and support these Junior Miners through
forward, it is Eskom’s objective is to create market tension through an open
and competitive enquiry process to source coal from any suitable supplier. To
enable this, Eskom will invest in rail infrastructure in and around its power
plants. This will facilitate equitable access to its power plants for any
supplier who can supply coal at the right price, qualities and volumes.
keenly aware of the urgent need to work on implementing these strategies as its
current cost base is untenable and urgent targeted actions are required. This
may cause initial shocks in the industry but this is critical for the industry
to survive in the new business paradigm.