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How Eskom is transforming the R100bn-plus coal mine industry
By: 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 consumer. 
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 export coal.
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 long-term contracts.
Going 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.
Eskom is 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.