South African Miners Unhappy with Eskom Proposal for National Pact Governing Coal Prices

Dec. 18, 2012 - PRLog -- The request by Eskom CEO Brian Dames for a ‘national pact’ governing coal price inflation is likely to receive short shrift from South African coal producers. The Chamber of Mines of South Africa, which represents about two-thirds of the country’s coal producers, said it was “fairly annoyed” by the way in which the matter had been raised.

Dames told the National Council of Provinces’ select committee on labour and public enterprises, that if miners agreed to contain coal price inflation to 10% or less, Eskom would be able to lower its tariffs.

This is currently the subject of an application lodged with the National Energy Regulator of South Africa (Nersa), a body appointed by the South African government. Eskom’s application is for a 16% increase in the tariff every year for five years from 2013.

The application, known as the ‘Multi-Year Price Determination’ (MYPD3), is partly based on coal costs not exceeding 10%.

Were coal prices to increase by more than this rate during the period, Eskom would be forced to request a further increase in the tariff.

Conversely, there is a provision for a ‘re-opener’ allowing Eskom to request a lowering in the application, said Eskom spokesperson, Hilary Joffe, in an interview with the South African Coal Report (SACR).

This would mean negotiations on the national pact could begin without holding up implementation of the MYPD3, assuming Nersa approved it.

“A lot of work will have to be done to make sure that coal costs get to 10%,” Dames was quoted by Business Day, a newspaper, to have said.

He argued it was not possible for Eskom to apply for “inflation-linked tariff increases when coal prices had risen above inflation,” according to Business Day which was the first to quote Dames on the proposed ‘national pact’. Coal represents about 56% of Eskom’s primary energy cost and had a significant effect on its profitability and its ability to finance onerous interest payments on its R214B (US$24.5B) debt pile, the newspaper said.

“We’re unhappy with how this matter has been approached,” Roger Baxter of the Chamber of Mines told the SACR. Baxter, who heads the chamber’s economic unit and is responsible for strategy at the organisation, went on: “If you look at how Eskom’s tariff application is framed, about 50% of the revenue is to pay for capital charges, depreciation and to achieve an 8% return”.

Baxter’s argument echo objections raised by business organisation Free Market Foundation (FMF), which were reported in the SACR’s November 20 edition.

Economic arguments aside, Dames’ request for a national pact on coal cost containment raises a number of practical questions such as the extent to which it will discourage investment in new projects which have to compete for capital, or face not being built at all.

New mines are being built further away from Eskom power stations since that’s where the deposits are situated. The distance increases costs, as does higher electricity tariffs, while Eskom’s demand for higher quality coal is another cost factor miners have to absorb and incorporate into their prices. The likely imposition of carbon taxes is another exogenous, structural cost factor that will force up the cost of mining coal.

A national pact on pricing would also rip up numerous supply contracts between coal producers and the utility, making renegotiation unwieldy and fraught with timing and implementation problems, critics say.

Complicating the matter further, Eskom’s Joffe said coal policy issues could also be wrapped into a national pricing pact which includes the possibility of installing an export levy of certain grades of coal Eskom could use, effectively forcing the private sector to accept Eskom’s new price regime.

“We are just in the process of setting up meetings,” said Joffe. “No meetings have happened yet and this is not something we can do quickly,” she added.

Coal producers are non-plussed by the suggestion. “It’s nasty,” indicates Jacques Rossouw, financial director of Keaton Energy. “We have a 100-page contract with Eskom which binds us to terms and conditions. Unless they change the contractual relationship, I can’t see how it could practically work.”

Andre Bojé, CEO of Wescoal Holdings, estimated coal price inflation of 15% for this year, but had no see-through on how prices would escalate in 2013. “But if Eskom thinks we’re going to give up 5% of our margin, they can forget it,” he maintains. “I have sympathy with Eskom, I really do. But we have contracts. And if in the contract renewal they want to restrict coal price increases to below 10% then I will just renew the contracts on an annual basis,” Bojé states.

“I agree with the others on the lack of practicality to the suggestion for a national pact,” Don Turvey, CEO of Continental Coal, said in an e-mailed response.

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