Problem of runaway coal bill is Eskom’s own doing
Power utility Eskom buys about 60% of SA’s coal to feed its 15 insatiable coalfired power stations, which consume 120Mt of it a year.
Now, as Eskom buckles under the weight of escalating costs, the government has called on coal suppliers to cut their ever-increasing prices. The embattled utility would do well to recognise that its hefty coal bill is largely its own doing.
Eskom’s move away from long-term coal supply contracts is at the heart of its coal price problems. In the past, cost-plus was the preferred model. Eskom would typically invest in coal mines to procure coal at cost plus an agreed margin.
In 2009, when load-shedding first hit SA, then CEO Brian Dames said Eskom needed to establish 40 new coal mines at an estimated cost of R40bn in the next 10 years to meet its coal needs. The price had risen from R60 a ton to R140 and more.
Not only did that not happen, but under former CEO Brian Molefe in 2016, Eskom moved away from the cost-plus model in favour of short-term contracts. “We shouldn’t own the bakery, we are interested in the bread,” he said at the time.
Turns out that the bread becomes more expensive that way. Eskom now pays an average of R440 a ton. Moreover, the quality became questionable as Eskom was forced to be more flexible in a scramble to meet its coal needs.
Eskom chair and acting CEO Jabu Mabuza confirmed last week that the coal procurement strategy again favours long-term coal contracts, with a preference for product that can be supplied by conveyor belt.
But Eskom faces another prominent challenge: it is a coalseller’s market and everyone knows it.
Coal production continues to dwindle while financiers move away from funding fossil fuels. The stats so far indicate coal production in 2019 is likely to be between 10Mt and 20Mt less than in 2018.
“We do not have enough money to invest in mines and so there aren’t enough new projects. The old mines are dying some of the small mines are even closing down,” Xavier Prevost, senior coal analyst at XMP Consulting, said.
It is a difficult environment in which to bargain. “The mines are going to take Eskom for a ransom. Eskom might refuse a high price. But if they don’t take that coal, where are they going to get it? Everyone knows there is a limited amount out there,” Prevost said.
Though Eskom’s return to long-term contracts is wise, Prevost says the utility is going about it the wrong way by contracting coal through public tenders.
Public tendering is generally regarded as the best way to ensure fairness, transparency, competitiveness and cost-effectiveness. It is a legal requirement for contracts of more than a certain value, though deviations are provided for.
Because Eskom dominates the domestic market, coal prices are increased when it requests coal tenders, Prevost said. With each request for proposals put out into the market, coal prices rise due to the perceived increase in demand, he says.
It was not always done this way. Eskom’s coal procurement division used to have a reputation of being shrewd and sharp. With a detailed database of coal in hand, it would approach producers directly to broker coal supply deals. If the utility reverted to this approach it stands a better chance of securing long-term coal of an acceptable quality and price, he said.
“Eskom needs to be involved directly with producers; at the moment they are keeping them at a distance. They are treating them not as friends but as opposition,” Prevost said.
Another challenge is that there is no domestic coal index or any other mechanism to assist with price discovery locally. Vuslat Bayoglu, MD and co-founder of Menar, a coalmining investment business, has long been campaigning for Eskom to adopt an index price for coal.
Prevost also said an index should be created not to dictate the price of Eskom coal but to provide a useful starting point for negotiations.
As SA’s main buyer of coal and main supplier of electricity, Eskom has some rights; but simply telling coal producers to cut their prices is not the right approach, Prevost said.
“Being so large, Eskom could control the price, but they are simply not doing it. It’s either a lack of skills or lack of understanding,” he said.
THE OLD MINES ARE DYING SOME OF THE SMALL MINES ARE EVEN CLOSING DOWN