Eskom’s miner issues

[miningmx.com] — FOR a person avowedly against entering the mining
industry, Eskom’s Brian Dames spends an awful amount of time thinking, talking and
making decisions regarding the impact of coal mining on his business.

That’s because one of the single biggest issues with which he, and CFO Paul
O’Flaherty, has to contend, is sourcing enough coal of sufficient quality to meet SA’s
growing energy requirements.

In the assessment of Robert Jeffrey, an economist at Econometrix, Eskom has to grow
the country’s electricity generation capacity to between 100,000 MW and 120,000MW
from the current 43,000MW between now and 2049, assuming annual economic
growth of 3%.

Enormous as that sounds, there’s nothing particularly unusual about it, especially by
world standards.

“Fossil fuel consumption for energy between now and 2030 will equal all consumption
previously,’ says Jeffrey in one of those “gee whizz’ forecasts that only serves to
underpin the role of the energy provider in a world that is fast growing hungrier, more
ambitious for better living standards and more populated.

In the shorter term, Eskom estimates it faces a 40m ton/year (Mtpa) deficit in coal
supply from about 2019. Until then, it has “contracted enough coal to an acceptable
degree,’ according to Kiren Maharaj, divisional executive for primary energy at Eskom.

After that, there’s trouble. So why doesn’t Eskom vertically integrate: after all, it
controls or has some influence in the rest of the power chain anyway.

That influence even extends to rail, with the power utility spending more than R9bn
laying down 740km of new rail in reticulating Mpumulanga, and linking the Waterberg
coalfields in Limpopo province to Mpumalanga in a road-to-rail strategy that mirrors
the similar ambitions of Transnet SOC.

The suggestion of vertical integration, to accommodate mining assets, draws smiles
all round the table at which Dames and O’Flaherty sit during the interview; mostly
ironic grins.

Dames dismisses the notion, although he provides an interesting caveat. “We’re not
miners, but the government has established a state-owned mining company [African
Exploration and Mining Finance Company, which has identified coal as a strategic
mineral], and there’s potential for cooperation there,’ he says.

There are other plans, too, to involve Eskom in direct mining. Tata Power, a division
of Indian conglomerate, Tata Group, recently suggested at a coal conference in
Johannesburg that it would be interested in joining with Eskom as a means of
liberating so-called stranded coal mines; operations that ordinarily are not feasible.

Nandkishore Menon, Tata Power’s regional head for Africa, said that combining India’s
appetite for relatively low-quality coal as an export product (which until recently was
unusual), with Eskom’s need for fresh coal resources could provide another source of
coal supply.

Eskom is also relying on the junior coal mining industry to provide new supplies of the
fuel.

The issue of energy security is a complicated one, however. Anglo American recently
floated plans to build its own power generation plant to support its platinum
operations.

Dames dismisses the idea: “We’ve heard of these plans – Exxaro and Xstrata also
suggested establishing themselves as independent power producers [IPPs],’ said
Dames. “But they are miners, not power generators. They have to do it first, so we’re
not concerned about that.’

The risk, though, is that were Anglo American to establish itself as an IPP, it would
divert much-needed coal for Eskom’s own power generation growth, to its own
systems. What Dames doesn’t mention, however, is the regulatory difficulty Anglo, or
any other mining company would have in establishing itself as an IPP.

According to Doug Kuni, MD of the SA Independent Power Producers Association
(SAIPPA), an amendment to the Electricity Regulations Act of 2006 (ERA) makes it
mandatory for industry wanting to act as an IPP to apply for ministerial consent if it
sought power for its own use; or it has to prove the power is for general use in the
grid.

Says Kuni: “The regulatory environment has tightened, making it very difficult for
IPPs. Either you have to be part of a big programme or you’re chasing special
ministerial permission.’

In any event, relations between Eskom and Anglo must be – shall we say – quite
cosy, currently. Apart from contending with Anglo’s own IPP ambitions, Eskom is
trying to extract an agreement from Anglo for it to supply coal from its proposed
R12bn, 15Mtpa New Largo mine, enough to keep Eskom’s 4,800MW Kusile power
station up and running.

Dames says Eskom has already locked in coal supply from other sources for Kusile,
but it’s worth remembering that Kusile’s first unit is scheduled to come online from
2014. So far, there’s no sign of an Anglo coal supply deal.

“It has to be soon,’ says O’Flaherty, who in addition to his financial responsibilities,
also carries the can for Eskom’s multi-billion rand project build programme. That’s an
ulcer-causing “to do’ list for O’Flaherty.

In the case of New Largo, the likelihood is that Eskom and Anglo will revert to a cost
plus structure to finance the mine.

In a way, this kind of financing model for a new coal mine is a back-to-the-future
moment. It’s how many of SA’s previous Eskom-dedicated mines were financed, a
system that miners and Eskom find unsatisfactory.

So why do it?

As it turns out, this might be the only solution if Eskom is going to get Kusile, a
crucial piece in the power generation jigsaw, to supply the energy it needs to provide
on time. How this financial structuring works is that Eskom helps finance the mine
construction on condition it pays only a few percent above the cost of production.

The problem is no-one can be completely content with such a structure.
Anglo is able to finance a mine at low (or no) risk, but it receives a narrow margin,
forever.

For Eskom, the concern is that mining companies deploy their less talented mine
managers to Eskom mines, putting their better brains at the higher margin operations
where they make a greater business impact.

And if Anglo’s cost control is not what it should be, Eskom ends up paying more for its
coal, even after having financed it. But Anglo’s worries are not necessarily those of
the national interest. Its shareholders are foreign, and Anglo has to prove 15% to
20% project returns if it is to justify New Largo ahead of other global projects on its
books. “They get double digit returns; we get 3%,’ says O’Flaherty.

It’s a tough job, but there’s no doubting Eskom is in a better place than it has been
for years. Despite slippages at Medupi, the project build is progressing, and the
damaging embedded derivatives, the secret power supply contracts between Eskom
and big business, have been mostly removed from Eskom’s balance sheet.

It’s not nirvana, but it’s a foot on the road.

There are words of warning, however.

Kuni believes that government is already falling behind installing plans for the new
power mix as laid out in the IRP 2010.

“Alarm bells started ringing about our current power deficit in 1997, but the orders for
Kusile and Medupi only came in at around 2006. That’s nine years of late decision-
making,’ says Kuni.

“Now, there have been no new decisions on power generation post-IRP 2010, which is
creating a new future problem,’ he says. Kuni urges government to make it easier for
IPPs.

Eskom can’t do it on its own.

– Finweek