Eskom’s R284bn coal spend is thin end of wedge

[] – ESKOM’S recently published electricity tariff increase
application – a 16% per year increase from 2013 to 2018 – is about the most
transparent the utility has been on its business to date. Plaudits for that.

For instance, it discloses its contract price for coal over the proposed five-year period.
It averages at R349 per tonne and carries a total investment in primary energy costs
of R284bn.

In the past, it was virtually impossible to get coal suppliers to disclose Eskom buying
prices, or even to which power station they were supplying their coal.

Year-on-year, Eskom’s coal procurement data shows it is prepared to pay 10.2% price
inflation over the period of the tariff application. That’s not quite the single-digit
inflation it said it wanted from its coal suppliers, but it’s also nothing like previous
coal price inflation that Eskom CEO Brian Dames disclosed this week was around 18%.

Bevan Jones, GM for London Commodity Brokers (LCB), makes the rather interesting
point that price appreciation of over 10% offered by Eskom may even be better than
coal producers are likely to get for similar quality thermal coal in the export market.
Certainly, prospects in the thermal coal market have dimmed.

“If I was a junior miner, I would definitely sell to Eskom at 10% inflation. For the
same quality coal, junior miners will no doubt be getting the best price from Eskom in
a few years time. They may even prefer to not wash their coal for exports anymore
and instead sell to a higher-paying Eskom,’ he said.

The question is, however, whether Eskom’s offered price is enough to attract foreign
investment in new mines.

New mines remain crucially important to Eskom. The R284bn it expects to spend on
coal supply over the five years, equal to 810Mt of coal, represents about 80% of the
total it requires.

That means Eskom has to procure another 162Mt of coal (20% of total required) for a
total outlay of about R56bn based on the average price. Notably, of the 80% coal is
has secured, only a portion, about 8%, is from new mines. The rest is from Eskom-
dedicated mines, existing multi-product mines and medium-term mines.

But can Eskom source the balance of coal required when the risk faced by investors
wanting to invest in South Africa is higher than it’s ever been?

A senior banker at a well known merchant bank in Johannesburg says coal mining
finance in South Africa is hard, if not impossible to raise, especially for Eskom-
dedicated mines. They have to be a combination of export and domestic coal mines
for them to fly.

Another coal executive, who asked not to be named, says that Eskom’s calculated
average price of coal is a bit of guesswork. That’s because the price is calculated as a
margin above operating cost and there’s no knowing how costs really will change for
coal miners.

For instance, there are possible regulatory changes to coal exports that may make
multi-product coal mines less profitable, and the crushing irony that they face steep
increases in electricity, the cost of which we can be exact: 16% a year, assuming the
tariff application to Nersa passes muster.