Eskom group executive for generation Matshela Koko reports that the utility has taken an in principle decision to migrate from investing in costplus coal mines, which are increasingly underperforming, to fixedprice coal contracts.

Speaking exclusively to Engineering News, Koko also insists that the group no longer faces a socalled “coal cliff”, reporting that it has secured 80% of its needs for the next five years, as well as all of its requirements for 2015/16 and 2016/17. This includes 11million tons in the form of shortterm contracts.

He acknowledges that the main reason for the reduction in coalsupply risks relates to lowerthanforecast electricity demand and, therefore, coal burn.

Eskom’s coal burn fell from well above 120million tons in previous years to 119million tons last year and consumption is expected to fall further during the 2015/16 financial year, which ends in March.

The move away from the costplus model – which has hitherto helped bolster supply security and stimulated the development of a large coal export industry – has been driven primarily by Eskom’s weakened financial position.

The utility still has major balancesheet constraints notwithstanding a near quadrupling of tariffs over the past ten years and several support packages from government. In that context, a potential R39billion recapitalisation bill for its six costplus mines was viewed as unsustainable.

Bread Versus Bakeries
Therefore, the utility will move from “owning the bakery” to simply “buying the bread” and will continue to invest capital only at cost plus mines that have years to run, or are delivering both the volumes and qualities of coal demanded. Some of the contracts will continue until 2029.

The first outward sign of Eskom’s changed coal procurement strategy became apparent towards the end of last year, when Eskom confirmed that it had decided to allow a 40year contract with Exxaro’s Arnot mine to expire, issuing a request for proposals in August to buyin coal for the Arnot power station instead.

The contract had been for fourmillion tons a year, but, by the time of its termination, the mine was only supplying around 1.1million tons, with the threemillionton balance being sourced elsewhere.

Exxaro’s future plans for the mine are not immediately known, but Koko confirms that Eskom would be liable for any closure costs if and when such costs were incurred.

A similar costplus contract with Anglo American’s Kriel mine is set to expire in 2019 and Eskom will issue an enquiry to the open market for replacement coal before the end of the year. The utility, Koko indicates, is also unhappy with the performance of the New Denmark colliery, also operated by Anglo.

The diversified mining group is, however, in the throws of it own farreaching restructuring of South African and global operations and a number of the Anglo mines that currently supply Eskom could well be sold in the coming months.

In December, Anglo CEO Mark Cutifani said any cashnegative asset would not remain in operation and that the market would be updated in early 2016 as to which assets would remain in the group’s portfolio.

“Obviously, it’s a tough market in ironore, a tough market in coal. We will have to look at every asset and decide whether it can be competitive in the market in which it operates and we’ll make the decisions and let people know in February,” Cutifani said.

Nevertheless, Eskom is pushing ahead with negotiations on a supply deal for the Kusile power plant with Anglo American Inyosi Coal. The Kusile project is currently under way in Mpumalanga and, despite the corporate uncertainty, both sides are aiming to complete a deal before the end of March.

Koko is sanguine over Kusile’s future supply, indicating that coal stocks are already being built up ahead of the start of the first unit in 2018.

There are also plans to rail coal originally destined for the muchdelayed Medupi project for use at Kusile and/or Kendal. Medupi will burn 14million tons a year once all six units are operational, but Eskom is actively seeking alterative outlets for takeorpay coal being supplied by Exxaro.

Eskom is also standing firm with regard to a R150/t fixedprice contract with Optimum, a mine previously owned by Glencore, but which entered business rescue in August 2015, owing to what Glencore described as the onerous nature of the contract.

In December, Tegeta Exploration and Resources, which is linked to the Gupta family’s Oakbay Investments Group, concluded a R2.15billion transaction to buy all the assets of Optimum Holdings.

Koko says Eskom has insisted on three conditions when approached by the business rescue practitioners: “The price stays the same, the R2billion in penalties still applies and there will be no discussions about coal supply to Hendrina beyond 2018.”

Questioned on how it is feasible for Tegeta to honour a contract considered onerous by a far larger group, while also absorbing the penalties, Koko says he does not know, but that Tegeta has taken the decision to buy Optimum following a due diligence process.

Koko believes there is still significant opportunity to secure coal for its power stations from the Highveld coalfields and acknowledges that new mine investment will be required.

“But Eskom will contract with those mines on a fixedprice basis and will not be investing capital.”