THESE SHOULD BE GOOD TIMES FOR SOUTH AFRICA’S COAL INDUSTRY, ONE OF THE WORLD’S LARGEST; INSTEAD, THE BIG PLAYERS ARE SCRAMBLING TO REDUCE EXPOSURE TO THE TROUBLED SECTOR

By Gavin du Venage, South African Editor

South Africa’s coal fields lost US$2 billion in lost export revenue last year, even as volume was up. (Photo credit: Anglo American)

On the surface South Africa’s coal sector should be thriving. It produces around 255 million metric tons year (mtpy), making it the fifth largest coal mining state in the world; customs data show that last year 74.4 million mt of bituminous thermal coal was exported, which reflects a steady increase in output; in 2013, already a record breaking year, 70 million mt were sent abroad. The country’s single biggest external customer is India, taking delivery of more than 30 million mt in 2014. The Netherlands was the next largest recipient, taking nearly 10 million mt.

About half of the remainder feeds Eskom, the local electricity utility, which consumes around 125 million mtpy. Coal accounts for about 95% of the country’s energy needs and in spite of efforts to dilute this with renewable and nuclear sources, overall consumption is likely to grow as new coal generation plants come online.

Another significant coal consumer is Sasol, the world’s largest coal-to-liquids plant which provides around a third of South Africa’s petroleum needs made from up to 60 million mtpy. The company is expanding the capacity of its synthetic fuels production plant in Mpumalanga, which will ultimately convert an additional 25 million mtpy when it reaches commercial production.

Future prospects appear pretty good too, at least at face value. Eskom predicts it needs to find new supplies amounting to 60 million mtpy by 2020 to replace coal from declining mines, and feed new committed build projects. Combined with other potential mines being developed, South Africa’s coal exports could peak at around 90 million mtpy between 2020 and 2025.

So all in all, these should be good times for South Africa’s coal producers. Dig a little though and fundamental problems become apparent, explaining why industry executives are increasingly long-faced.

Anglo American's Isibonelo Colliery supplies coal to Sasol. (Photo credit: Anglo American)
Anglo American’s Isibonelo Colliery supplies coal to Sasol. (Photo credit: Anglo American)

The Problems Facing South Africa
The first problem is one the miners themselves can do little about: the decline of the coal price. This has cost the country $2 billion in lost export revenue last year, even as volume was up, South Africa’s Mineral Resources Minister Ngoako Ramatlhodi disclosed at this years’s Mining Indaba in Cape Town. The drop in revenue has put the squeeze on both producers and the country’s national treasury.“We are concerned about the extreme volatility in the coal price, which has a direct effect on the profitability of companies, contributing to fiscal issues, as well as implications for employment,” Ramatlhodi said.

Faced with a global oversupply the price of coal exported from Richards Bay, the world’s single-largest facility for the fuel, has dropped almost 50% since the start of 2011. Further price declines are expected as the surplus in the seaborne variety of the commodity is poised to triple this year, according to Deutsche Bank AG.

The decline in available capital is especially worrying. South Africa has more than 66 billion mt of coal that can currently be extracted economically. This will take a minimum investment of $10 billion for mining, infrastructure and logistics, Ramathlodi noted.

A decline in coal revenue is more than a bump in the road for a country heavily dependent on mining. Coal is, according to the Chamber of Mines, by far the most important South African mining segment. In 2012, coal accounted for 46% of domestic mining commodity sales, as well as 19% of total mining export sales of nearly $30 billion.

Coal mining directly employs close to 90,000 people and paid almost $1.5 billion in wages in 2014, the Chamber’s figures show. Coal is the single largest export earner for the country and total sales revenue of $7.5 billion last year left gold trailing in second place at $6.1 billion. Platinum group metals are third at $5.5 billion and iron ore is fourth at $4.1 billion.

A dragline moves overburdan at the Greenside Colliery. (Photo credit: Anglo American)
A dragline moves overburdan at the Greenside Colliery. (Photo credit: Anglo American)

Majors Look for an Exit Startegy
Lack of investment can only be aggravated by the fact that some of the biggest operators appear ready to hitch their skirts and make a run for it. Glencore, BHP Billiton and Anglo American are restructuring their South African businesses in a way that suggests they see the country as less of a revenue priority.

In January Glencore said it was looking at cutting output from its Optimum coal mine by at least 5 million mt a year. The operation had been acquired only a year previously from BHP, so the news came as a surprise, particularly as Optimum accounts for more than 10% of South Africa’s exports.

The affected areas included the mine’s open-cast operations, as well as large portions of the coal processing plants and support services. The 17-year-life Optimum complex has 3,700 employees, 1,070 of whom would be affected. This cut followed “a detailed review” as a result of “ongoing financial hardship at Optimum,” the company said in a statement.

Glencore also supplies 20 million mt of thermal coal a year to Eskom from four South African mining complexes, which produce 47.3 million mtpy, plus three mid-tier operations that produce 20.7 million mtpy.

BHP meanwhile is spinning off a portfolio of operations in Australia, South Africa and South America into the jauntily named South32. The new entity will begin its life with about $2.2 billion of balance sheet items.

The chop falls most heavily on Australia, which makes up nearly 60% of the portfolio, with South Africa coming in at just under 30%. It will be a diverse mix of alumina, zinc, silver and a few other minerals, with coal making up a shade less than 20% of the total basket.

Four South African mines and, especially significant, the company’s export capacity entitlement of 17 million mtpy from Richards Bay Coal Terminal are included. All four mines–Wolvekrans, Middelburg, Khutala and Klipspruit–are located in the Witbank coalfield in Mpumalanga province east of Johannesburg.

Between them the mines and attendant infrastructure employ about 10,000 people, BHP said in its presentation explaining the new structure. With the mines will go two long term coal supply agreements with Eskom that will expire 2033 and 2034 respectively.

Also heading for the door is Anglo American, which is putting more than half of its Australian coal production up for sale but also looking to divest South African coal assets as part of a strategic shift to focus on the most profitable compartments of its portfolio. In South Africa, the company is said to be looking to sell the Kriel, New Denmark and New Vaal mines, which principally serve Eskom’s power stations. “We have talked to Eskom and various government agencies about what we can do to reduce our investment in the South African domestic business,” Seamus French, CEO of Coal Business at Anglo American told an investor briefing in December, while remaining sketchy on the details.

The export component was he said a “fantastic business” with “great quality coal,” but that it came in at the top half of the cost curve when compared to Australian mines.

“The challenge in South Africa is that 7% mining inflation,” French said, adding that this made South Africa one of the costliest producers in Anglo’s global portfolio. Low productivity driven by lack of skills and some technical issues were the main contributors to cost inflation. However Anglo hoped to raise productivity by 30% over the next three years and keep costs in local currency the rand to what they were in 2014, French said.

Crucially, Anglo will be looking to finalize its giant New Largo project in the north of the country. This is the proposed mine intended to supply Eskom’s under construction 4,800MW Kusile power station with some 5 million mtpy of coal at full production by 2019. However, there’s been little sign of urgency as Eskom and Anglo haggle over terms, particularly on a stipulation that the projected $1 billion facility be majority black owned.

The back and forth between Eskom and Anglo illustrate the struggle that the industry is having to navigate conflicting legal requirements. Anglo argues that it meets the requirements of the Mineral & Petroleum Resources Development Act, which requires all mining companies have 26% black ownership; Anglo claims to meet this target through its partner the Inyozi consortium, which has a 27% stake in New Largo.

Eskom though sets its empowerment target of 50% plus one share to any new supplier to its power stations, answering to separate legislation set out by the country’s Department of Trade & Industry. Which set of requirements is set to trump the other is as yet unclear but Anglo has argued that it can’t build a billion dollar mine while holding an effective minority stake.

Currently the mine is in the final feasibility stage and French noted that an agreement signed last year indicated that the parties were closer to reaching a settlement. In all likelihood, Eskom will have to blink first as it clings by its fingernails from a coal supply cliff.

The reality is that only a handful of majors have the financial clout to build a facility such as New Largo, while the junior sector, black owned or not, will struggle to find bankers who will finance such large projects.

A stacker/reclaimer at BHP Billiton's Klipspruit colliery; the mine is one of the assets being spun off into a new company.(Photo credit: BHP Billiton)
A stacker/reclaimer at BHP Billiton’s Klipspruit colliery; the mine is one of the assets being spun off into a new company.(Photo credit: BHP Billiton)

Parastatal Taking Fire
Eskom’s troubles have also affected Exxaro, South Africa’s largest black owned coal company and one of the few with the financial muscle to take on big projects. It is developing the $1 billion Grootgeluk colliery, intended to supply Medupi power station, a 4,800-MW plant that is now three years behind schedule.

Given its majority black shareholder structure Exxaro should have the inside track on supplying Eskom. However the delays have played havoc with Grootgeluk’s ramp-up schedule and mine plan. So it’s no surprise that Exxaro executives have, in recent months, made it clear they want no further exposure to the utility above what they are already contracted to deliver.

Exxaro can take some comfort though in the $100 million or so Eskom is obliged to fork out to the company this year in payment and penalties related to the 8.9 million mt which was destined for the unfinished Medupi.

Eskom is not the only parastatal taking fire from business. Glencore is in a dispute over its refusal to sign a take-or-pay agreement with Transnet, the state-owned railway utility. A take-or-pay agreement obliges collieries to produce a minimum volume of coal for transport. Failing to do so will trigger a $15/mt levy.

Transnet argues that it needs the levy to oblige companies to meet their obligations so that the parastatal can pay for the enormous amount of capital it is sinking into infrastructure, particularly on the coal line. Take-or-pay is common in other coal mining jurisdictions such as Australia, where, incidentally, it is blamed as the cause of oversupply in the market and contributing to coal’s price decline.

Glencore says such a deal would interfere with its ability to respond to market forces, by selling coal when demand is low. It could even threaten the ability of mines to deliver to Eskom, Glencore CEO Ivan Glasenberg said in a telecast briefing from London. Mines may be obliged to reduce sales to Eskom in order to meet their take-or-pay commitments.

“The government has got to be a little concerned on these take-or-pay (contracts). If Eskom needs more tonnage and everyone is locked into the take-or-pays to Richards Bay, it’s going to be hard to divert tonnage into the Eskom market,” Glasenberg said.

Around 36 collieries are served by the coal line, which can carry 77 million mtpy to the RBCT. Transnet has pledged to spend more than $3 billion to increase capacity to 81 million mtpy.

South African thermal coal exports from Glencore sold for $68/mt last year, an 11% drop on 2013, while its sale to Eskom fell 12% to $23/mt. It sold about 23 million mt into each market, Glasenberg added.

The spat over take-or-pay is another indication of how the industry is squeezed between competing state interests; as Transnet wants to hold companies to meet minimum export quotas, Eskom is pushing equally hard for coal to be designated a ‘strategic resource’ and therefore liable for export restrictions should local supplies be threatened by exports.

The utility will need at least 4 billion mt of coal over the next 10 years, of which more than half — at least 2.17 billion mt — has not been secured. As such, Eskom is eager to limit the ability of companies choosing who they sell to. Coal producers will therefore be faced with penalties for exports not delivered to one state company, because another insists they must serve local demand as a priority.

If and when coal does get designated is a matter of fierce debate, but until it is conclusively decided it is yet another uncertainty factor with which industry has to contend.

Eskom’s troubles are having another unintended consequence for coal operators too; fed up with the increased power outages Eskom has forced on them, countries across South Africa’s borders are seeking to build up their own generation capacity.

Botswana, Malawi, Mozambique, Zambia, Zimbabwe and Tanzania are all in the process of putting together agreements with independent contractors to build coal-fuelled thermal electric plants. A typical project is that being put together by Tanzania-focused Kibo Mining, which aims to build a mine with a 300Mw coal plant on site.

“Tanzania needs about 2,000 MW, but is producing only about 1,000 MW,” Kibo CEO Louis Coetzee said in an interview. “Tanzania has a policy view to increase energy generation, based on a mix of 30% gas, 30% hydro and 30% coal.”

Demand, he noted, was driven in part by the flourishing mining industry in a region that needed electricity, particularly across the border in the Democratic Republic of Congo. “We see scope for electricity exports, but our priority will be to feed the local grid in Tanzania.”

Mine-mouth projects throughout the region he said were particularly attractive because they offered a quicker route to monetization than exports. It also meant that coal deposits far from existing transport nodes would became viable, as there was no need for costly rail and port infrastructure.

“There’s also the whole beneficiation debate that has everyone talking,” Coetzee said, “electricity is a very good way to beneficiate coal.”