Just about every man and his dog in the coal industry has an opinion about South32 and Eskom’s Duvha coal supply renegotiation — and sometimes the dog makes more sense.
The multinational mining group wants to exit its SA coal assets. While a deal with black-owned Seriti Resources is near completion, the final condition is that a loss-making supply agreement with Eskom’s Duvha power station be renegotiated up to 2024.
Internal documents leaked to media in recent weeks have caused quite the furore. Notably, they show the proposal is to increase the price from R280/tonne to R550/tonne, and up to R600/tonne from 2024 onwards, subject to the Treasury’s approval.
It has raised consternation, and many questions, among different coal market participants.
While the Duvha contract may be onerous for South32, for Eskom it is one of its cheapest coal supply contracts with an option for the utility to extend it to 2034. And it almost certainly would have done so, had it not been for the sizeable spanner thrown in the works when South32 declared hardship.
Hardship is a common contractual clause that can be triggered when one of the parties suffers undue adversity, in this case South32. The declaration in turn brought Eskom to the table to find a favourable solution.
But hardship is meant to be shared between the parties. With a purported 100% mark-up in the price per tonne, one Eskom supplier remarked that the utility appears to have offered an “extraordinary relaxation of hardship” taking on all the hardship itself.
And perplexingly so, considering the utility is bankrupt with a R480bn debt pile it is unable to service itself and is a major liability to the government. To raise revenues, the utility has been fighting for customers to pay higher tariffs, resulting in a 15% tariff increase in this financial year alone.
With the higher price per tonne set to add almost R10bn to Eskom’s costs between now and 2024 and a possible further R30bn between 2024 and 2034, South32 is losing on this contract — R10bn in cash in the past four years, it says. Overall the company is in good health, with an upswing in a number of its commodity prices. It recently declared an interim dividend of 1.4 US cents a share for the half-year ended December 2020.
Because South32 has one foot out of the door, it has some additional leverage in its negotiations with Eskom.
That is, if a favourable deal cannot be negotiated, the sales agreement with Seriti will fall flat and South32 will have no choice but to put the operations into business rescue — a provision in the Companies Act.
It is a triggering phrase if one considers the business rescue process of Optimum coal mine adjacent to the Hendrina power station — which remains in rescue since February 2017 with an adverse effect on the mine’s employees and the local economies that depend on it — as well as Eskom, which now has to truck masses of coal in for Hendrina at added expense.
Dangerous precedent
But the coal supplier warns it sets a dangerous precedent as it makes it worthwhile for other producers to try for hardship knowing there is a scenario where Eskom takes the full hardship on its shoulders rather than proportionately sharing it between itself and the supplier.
One view, from inside Eskom, is that South32 has the utility over a barrel.
“It’s a single supplier and a single customer and the supplier says, ‘sorry, guys, the price just went up dramatically’. The single customer is tied to that single supplier. What choice do they have?” an Eskom insider said. “They look around for choices, as Eskom has tried to do, so it might sign an agreement at that price for a few years, to buy it some time to put in place a cheap option. But because of the shortage of generating capacity, Eskom cannot afford to allow that power station to stand for a couple of years while it makes alternative arrangements.”
The South32 deposit is the obvious supplier given that it is linked to the power station by conveyor belt, and its consistency and efficiency simply cannot be beaten. In fact, Duvha was designed to consume that very coal quality. “South32 are playing hardball. And that’s what capitalists do in every market,” the insider said.
But R550/tonne is arguably the best of many bad options, if one considers the huge added expense of trucking coal, and the quality control systems that need to be in place for that, and not to forget the costly infrastructure that Duvha will require to overhaul it logistics system to receive all its coal from road. The other option is to sterilise Duvha’s power generation capacity, which will be compensated for either by diesel-guzzling peaking plants or economically devastating load-shedding.
Some industry player cannot fathom why Eskom, as that single buyer and as a monopoly, is not driving a harder bargain with South32. With a possible R40bn more in unplanned expenditure, there is enough value at stake.
After all, South32 has for years benefited from a preferential electricity supply contract to its Hillside Aluminum smelter, which has proved to be highly favourable for Hillside and regularly loss-making for Eskom. That deal has this year been renegotiated and now awaits approval from the National Energy Regulator.
Further though, South32 does have something to lose. The company still requires its social licence to operate in SA where it runs the smelter and manganese operations. “Will South32 liquidate, fire all the people and go to war with the unions and the government? My opinion is no,” said one coal miner.
Ayanda Bam, co-founder and director of coal mining firm Kuyasa Mining who has had his fair share of frustrations with Eskom, says it is difficult to compare coal prices across the industry, but ventures that the proposed R550/tonne would equate to R21 per gigajoule, and seems reasonable.
Some market participants also raise issues with Seriti Resources being selected as the preferred buyer, given that its CEO, Mike Teke, is known to have been a large donor to Cyril Ramaphosa’s presidential campaign.
Scepticism
There is also scepticism as to whether Seriti can afford to sustain and reinvest in these assets — it already runs three Eskom-tied mines and has started developing the New Largo mine next to Kusile. Should it come a cropper, it could spell disaster for Eskom, and in turn the country, because Seriti is set to become the utility’s largest coal supplier, supplying a third of its coal requirements.
The risks relating to the transaction were aired before the Competition Tribunal in 2020, though mostly in closed sessions. The regulator ultimately granted its conditional approval for the deal.
Teke, meanwhile, shows no sign of capitulating on the condition that the Duvha contract be renegotiated before he acquires the assets. And why would he? Owning a loss-making operation is simply not good business. South 32 knows that too — that’s why it needs to unshackle itself from this contract post-haste. As one industry source says: “They found a gap and that gap is Eskom.”
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