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Eskom and the mining industry

Brendan Ryan | Fri, 20 Nov 2009 10:44
[miningmx.com] -- The continuing mess at Eskom has huge negative implications for South Africa’s mining sector and that means trouble for the entire country in terms of economic growth, employment levels and foreign exchange earnings.

It means more trouble because of negative foreign investor sentiment hitting the prices of SA mining shares and affecting the credit ratings of the SA mining companies.

As Chamber of Mines president Sipho Nkosi pointed out in his 2008 presidential address, the seven day shut down of the mining industry in January 2008 caused by Eskom cost the country R12bn in lost mineral production.

Investor reaction to that wiped R85bn off the value of mining equities quoted on the JSE.

It’s fashionable in many circles to dismiss mining as a “sunset industry” and play down its importance to the SA economy. It’s sexier to focus instead on the drive to develop the downstream, high-tech manufacturing and service sectors.

Fact is that mining still accounts directly for 7% of GDP which rises to 18% when you account for the various multiplier effects.

The mining industry employed more than 495,000 people in 2007 and paid them more than R50bn in wages as well as another R21bn in taxes to the state.

The bulk of the country’s mineral production – worth R224bn in 2007 – is exported making mining South Africa’s largest foreign exchange earner.

The Eskom crisis puts all this at risk through a combination of power shortages and the rocketing cost of the power that is available.

SA’s deep-level gold and platinum mines are labour intensive operations and they need a lot of power for ventilation, cooling and the transport of men, materials and ore through the shafts which plunge kilometres into the ground.

The CEOs of the country’s four major gold mining groups - AngloGold Ashanti, Harmony, Gold Fields and DRDGold – have all come out strongly against Eskom’s proposed “3 by 45%” power tariff increases which will treble their power costs over the next three years.

Marginal shafts with high operating costs mining low grade ore will not cope with those levels of increases and will have to be closed.

That situation also applies to the platinum mines. Anglo Platinum has already closed three shafts and retrenched nearly 12,000 workers in its attempts to cope with existing cost pressures and low platinum prices.

Adding to the problem is the strength of the rand which is robbing the gold and platinum mines of much of the benefit of rising dollar-denominated metal prices. South Africa is the world’s biggest producer of ferrochrome but those operations are heavily exposed because the electricity needed to run their smelters is their largest operating cost item.

Then there is the debilitating investment uncertainty linked to the risk factor over whether power will be available in the future to allow expansions.

So far there’s been one major casualty - Rio Tinto’s proposed Coega aluminium smelter – but planned expansions are being delayed by worries over future power supplies and other logistical constraints such as rail capacity.

That situation will be made drastically worse if there are any further delays to Eskom’s “new build” programme to develop the Medupi and Kusile power stations. Eskom maintains these are on track. Sources in the mining industry who need the power for their planned projects are not so sure.

UK financial institution Fairfax summed it up well in a recent research note when it commented “these developments raise concerns over the company’s (Eskom) ability to develop long term power capacity which the local mining industry is heavily dependant on.

“Gold, platinum group metals (PGM), ferrochrome and coal are likely to be key commodities that could see long term production constraints as a consequence.” Other financial commentators are being far more blunt in their “off the record” assessments.

According to one SA financial source, “since (Minister of Mineral Resources) Susan Shabangu launched that unbelievable attack on the entire SA mining industry and the Bobby Godsell/Jacob Maroga circus got going I have been receiving emails from overseas investors that can be summed as WTF. (what the $#@&).

“The situation is bizarre. We are in big trouble. Foreign investors are extremely concerned about what is going on. You may soon see the impact of that in their renewed sales of our mining equities. I am really surprised that the rand has remained so strong despite all of this.”

Bottom-line is that the SA mining industry lost out on much of the benefit of the last global commodities boom for a number of reasons but mainly constraints on rail and port infrastructure.

That situation is being rectified, albeit slowly, but it would be tragic if we miss out on the next commodities boom because of Eskom.

This story was first published in Finweek.