Power Utility Eskom Looks to Re-Work BHPB Contract

BRISBANE, Australia - May 13, 2013 - PRLog -- An inquiry into a controversial power agreement between South African power utility Eskom, and BHP Billiton ( BHPB ) will see if a portion of the contract can be cancelled early - a development that would see the Melbourne-headquartered miner pay market-related prices for electricity consumed by its aluminium smelters in South Africa's KwaZulu-Natal province.

Based on an agreement signed in 1992, BHPB's Bayside and Hillside aluminium operations paid an average 23c/KW/h for electricity. Eskom's other industrial consumers paid an average of between 56 and 58 c/KW/h.

The contract, in which the cost of electricity moves up or down in proportion to the price of aluminium on the London Metal Exchange, has sparked outrage in South Africa following steep price hikes for electricity. Eskom says it has to increase the cost of power to pay for some 10,000MW of additional capacity it is installing over the next eight years. South Africa barely has enough power to keep industry ticking over with Eskom calculated to have a reserve margin of only 1.5%.

According to a report by Afrikaans business newspaper Sake24, the National Energy Regulator of South Africa (Nersa) will study whether the contracts for power supplied to two of three potlines operated by BHPB's Hillside aluminium smelter can be terminated in 2020.

This was the original termination date written in to the first power contract signed between BHPB and Eskom in 1993 at a time when South Africa had an energy surplus and was in dire need of foreign investment.

BHPB argues that the termination date of the contracts – for potlines 1 and 2 at Hillside – was subsequently automatically extended to 2028 when it built a third potline in 2001.

Thembani Bukula, chairman of Nersa's electricity committee, says the power contract for the third potline was approved by the then National Energy Regulator (NER). However, he highlights a potential sticking point for BHPB because he believes the contracts for Hillside 1 and 2 was never submitted to the regulator, and could not be automatic.

"The first contract could therefore not be extended by the regulator because it was never submitted to the NER," he told Sake24 earlier this month.

BHPB differs with this view and claims the electricity contract for all three potlines at Hillside now runs to 2028. This will form part of the dispute in which Nersa was asked by Eskom to review the Hillside contracts.

The power contracts between Eskom and BHPB have been the subject of considerable forensic investigation.

According to Sake24, which has used ENF Consultants to help it interrogate the power supply agreement, it was discovered that Eskom had been paying more for coal supplied to it by BHPB Energy South Africa (Becsa) than the mining group had been paying for its electricity for its smelters.

Becsa traditionally supplies about 18% of Eskom's total 125mtpa thermal coal requirements. Some of this coal is supplied from 'tied' mines – operations where the cost of coal is supplied on a fixed cost plus basis – but the exhaustion of these mines means Eskom is increasingly exposed to buying coal from other South African mines which sell coal on the basis of internationally traded prices.

As most analysts would agree, the average coal price over the last five years has increased considerably, the recent price climb-down notwithstanding. But history shows BHPB has been scoring a great deal. And yet, it maintains, it has a legally binding contract from Eskom.

Investec Securities said on the matter: "While seemingly unfair, BHP is only operating within the terms of its contracts. It would ultimately be up to the government to decide on the benefit of a secondary industry such as smelters, versus the cost of creating the power to enable the smelters to subsist.

"BHP may in the meantime divest of them as the smelters are on our list of possible asset sales."

Investec Securities said it believed Hillside, and Bayside, as well as the Mozal aluminium smelter in Mozambique, would be valued at $1.7B, although they would have less than zero value at current spot aluminium prices.

If BHPB's aluminium smelters were to be shut, South Africa's electricity deficit problems would be eased immediately as the smelters are calculated to consume about 2,000MW of power a year, roughly 9% of the country's total power generation capacity.

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