Tuesday, June 14, 2016

The "coal cliff"

We are facing an unheralded challenge.  We rely on coal for electricity generation in South Africa. Over 90% of our electrical energy comes from burning coal, and generation consumes nearly half of all internal coal sales. When Medupi and Kusile are fully operational, the coal demand will be about 150Mt per year.  The Department of Energy is encouraging some independent power producers to establish further coal-fired stations, which could boost the demand for coal even further. Great, but we need to know where all this coal is going to come from, and we don't.

Historically, most of it came from large coal mines. Some of these were “tied” collieries in which Eskom had invested capital, and which supplied coal on a cost-plus basis. They were linked to the power stations by enormous conveyor belts, so the costs of transport were low.

Increasingly in recent years, coal has been sourced from small independent collieries. In 2015, 18% of Eskom’s supply was from these small independents. Two challenges emerged.  First, the coal was moved by road, so the cost of transport was considerably higher. Secondly, it proved very difficult to control the quality of the supply.  A typical large power station, generating 3 600MW of electrical energy, will need a 30t truck load of good quality coal each minute of every day, and more often if the coal is of low quality. It is difficult to tell a good truckload from a bad one. In some cases, Eskom had to establish testing facilities at the individual mines to stop delivery of sub-standard material. This challenge does not arise when coal is delivered by belt, because sampling and quality control are far simpler.

In 2015, coal from the larger collieries cost Eskom of the order of R150 per tonne, and that from the smaller producers of the order of R400 per tonne.  The larger collieries, however, not only faced a lower price for their product, but many of them were exhausting the readily mined coal and needed recapitalisation. Eskom, short of cash, is understandably not interested in re-investing and wishes only to purchase on contract. In an interesting twist, Glencore used to own the Optimum mine which was tied to Eskom. Eskom claimed it was producing poor quality coal, and asked to R2bn in contract penalties. Glencore said it could not survive at R150/t and sold the mine to a Gupta-controlled Tegeta. Eskom has just announced it is paying Tegeta R473/t in advance. And if the delivered coal srtill isn't up to standard?

In the present climate, no-one else is particularly keen to invest in the coal business. It does not help that export prices are at a low ebb. 2015 was the first year for a long time that export revenues were lower than local sales, even in the face of a weak rand. To add to coal’s woes, there are environmental ambitions to reduce greenhouse gas emissions, and coal is a primary emitter. We* call them “ambitions”, because coal is over 90% of the source of our electrical energy. Replacing that 90% with some other source would demand far more capital than we can raise over the next 20 years. We are stuck with an ongoing need for coal for at least a generation.

We have a need for coal, but there seems to be a blindness about where, in only a few years time, that coal is going to come from. The supply from the existing mines is drying up.  There has been plenty of exploration, and new reserves have been identified, but we need investment now if we are to continue to generate power post 2020.

One plan that appears well advanced is to fuel the Mpumalanga power stations with coal from the Waterberg. There are several small miners waiting in the wings, while Exxaro’s Grootegeluk mine could readily create more capacity than that needed for Medupi.  Transnet has done extensive design work on a line from Lephalale to Emalahleni, but it will take at least five years to construct. Coal could be supplied from the Waterberg early in the 2020’s, so work needs to start now. However, the costs of transport will be significant.

Investment in the industry will only follow if coal prices increase.  They have been increasing, but too slowly to attract the needed investment. Even these relatively modest price increases have worried some in Government.  There has recently been a proposal by the National Energy Regulator, NERSA, to change its methodology for determining multi-year electricity pricing. If NERSA has its way, Eskom will have to account for the coal purchases by each power station. It will have to show that it is using the coal efficiently and that it is properly controlling the quality of coal supplied. NERSA intends to set different pricing structures for the cost-plus mines, for coal purchased in terms of fixed price contracts and for short-term contracts.

To add to the challenge, the Energy Minister announced, in her recent budget speech, her intent to start a super-regulator to check NERSA’s decisions. So Eskom’s management’s decisions will be second-guessed by NERSA, whose decisions will be second-guessed by a new super-regulator. As a recipe for disaster, it has few equals.

The last time there was this sort of interference with market mechanisms in the energy supply industry, NERSA’s predecessor, the National Electricity Regulator, fought the good fight against inflation by controlling Eskom’s price increases below the CPI. For a few years, the cheapest power in the world got even cheaper. Then the bubble burst and we suffered blackouts, as well as huge price increases.

We have still not recovered from the damage to our economy. The cost when we first lost power was about R75 per kWh . As we adjusted to the lack of supply, the cost dropped. People installed their own generators and took other steps to mitigate the disaster. Today the cost of lost power is of the order of R7 per kWh.  That is twice what it costs Eskom to run their diesel-fired gas turbines, but it keeps the lifts working and the supermarket fridges cold.

What it does not do is to allow the unrestricted growth of industry. Since 2008, we estimate that about 60 major projects that could have created over 100 000 jobs have been cancelled because the power needed to run them was not available. There is a thesis that the growth in the economy and the supply of energy are no longer linked.  Any study of global economies soon shows that this thesis is flawed, to put it politely. Our own growth and our energy supply were in lockstep for 50 years. China’s economy and its power generation have similarly been linked for 25 years.

We need power to restore growth. Our past investment in coal-fired generation means that we are locked into coal for the foreseeable future. It is critically important that we recognize that the coal industry needs investment, and that investment will not happen while Government talks about introducing price controls and worse, actually does so. Eskom’s procurement policies, requiring all coal suppliers to have more than 50% BEE ownership, is making the challenge all the more challenging.

Where, oh where, is our coal going to come from?

* We? My friend Xavier Prevost, helped to write this, most of which appeared in Business Day yesterday

1 comment:

Chris Reay said...

Getting the Waterberg infrastucture established is the first of the 18 Strategic Infrastructure Projects of the NDP. The initiative, management and the money seem to be missing. We spent a lot of effort to get a hold onto the scarce skills problem but that gathers dust with all the other reports.