SA coal industry in crisis

SA's coal industry is at a crossroads and unless government makes the right choices, and soon, Eskom will not be able to keep the country's lights on, a new report has shown.
The SA Coal Road Map, which was published after years of research into the state of SA's coal mining industry and its likely future, calls for, among other things, urgent improvements in SA's investment climate. Confirming Eskom's claims that it faces a looming coal supply crunch, the report warns that should government delay, or make poor decisions, there will be serious economic consequences.
The road map was established under the auspices of the Fossil Fuel Foundation and was compiled with the support of the coal producers, Eskom and the departments of energy and mineral resources.
According to a mining industry source, "that's the most important feature of the road map. Its findings and the future scenarios it has laid out have buy-in across the board. Government ignores these findings at its peril." A key issue is that the obvious providers of the huge amounts of capital required to build the new coal mines that are needed - at a cost of R10bn-R15bn each - are global resource heavyweights like Anglo American and BHP Billiton . They supported Eskom during its previous major construction programme in the mid-1970s to the mid-1980s, when they signed contracts to build mines that would supply coal on 40-year contracts to various power stations.
But there are no guarantees that they will do so again. And if they do, the commercial terms for the new supply contracts are going to be very different from those negotiated 40 years ago.
Those coal resources are now fast running out, in part because the power stations have been run at higher utilisation rates than originally planned. Repeated delays on bringing the new Medupi and Kusile stations on line mean that Eskom must keep the old power stations running, and they need new sources of coal to do so.
A crucial difference is that during the previous builds, mining groups were restricted largely to investment opportunities inside SA. Now they have global freedom. There was also a more practical working relationship then between the coal producers, Eskom, government and the country's port and rail authorities.
The road map notes: "At present investment in SA is being deterred due to the unfavourable policy and legislative environment and labour risks and better returns in other commodities and geographies. "Though some of these investors could be replaced by domestic entities, if the desirability of investing in SA coal mines declines further, this could lead to future reductions in the availability of coal for both local and export markets."
What government does about the situation could boost or cripple the coal mining industry, which is concerned about heavy-handed state intervention by means of the revised Mineral & Petroleum Resources Development Act. The big worry is that, to help Eskom, government might impose domestic coal price control or move to limit exports by either setting physical quotas or imposing financial levies.
The road map is cautious in its handling of this, clearly because of the influence of the departments of energy and mineral resources in the report, but private business sector bodies have already spoken out. Mike Rossouw, chairman of the Energy Intensive Users Group, which represents the country's biggest power consumers, says government must not introduce any policy aimed at capping coal prices or forcing the allocation of coal.
"That will have the exact opposite effect of causing prices to rise and supplies to dry up," he says. James Lorimer, DA shadow minister of mineral resources, says: "Government's hope that the [supply] gap will be filled by junior mining companies seems highly unlikely as neither the capital nor the expertise is available to mine coal in the required quantities.
"Exporting coal is where mining companies make higher profits. "Further restrictions under the proposed amendment bill, on top of an already unfriendly legislative and regulatory climate, mean that major coal mining companies are looking to other countries to make new investments, rather than building large, new mines that SA needs."
Neither Lorimer nor the road map says so, but the most obvious example is BHP Billiton, which has chopped its exposure to the SA coal industry over the past decade, selling off a string of mines and undertaking no new growth projects. Eskom's particular problem is that it needs around 4bnt of extra coal for its older power stations and, according to the road map, it has so far secured only 2bnt.
Crucially, about 800Mt of the needed 2bnt is "at risk" because there is now foreign competition for it from India, which has also embarked on a programme to build a string of new coal-fired power stations needing imports.
There was no such alternative buyer in the mid 1970s. While Eskom's power stations have been designed to burn low-grade coal - typically around 19MJ/kg (megajoules per kilogram) - a number need coal with thermal qualities in the range of 22MJ/kg-24MJ/kg.
That competes directly with the 23,5MJ/kg specification of the new lower-grade RB3 export classification for sales out of the Richards Bay Coal Terminal. The road map points out that "the possibility exists that unless the price Eskom is prepared to pay approaches a similar level to what the mines obtain from exporting this coal, or unless new players enter the industry with alternative funding or lower return expectations, producers could export a portion of the coal that is required for local use."
It all boils down to the returns the mining companies want to make out of the investments required, which will be reflected in the prices charged for the coal. The road map says: "At the heart of the deadlock between industry and Eskom over new coal projects is disagreement on the sources of this capital and the returns that are required to attract the capital... neither the state nor Eskom has publicly stated what they regard as a desired and fair rate of return."
The road map stresses that some fast decisions on tough issues critical to the future of the SA economy are required from government. The report does not say so, but bitter experience shows that making such tough decisions is a government weakness. In 2000 it opted to delay construction of Eskom's next power station. It led to the current energy crisis, which started in January 2008. Government is also running so far behind on the decisions required to implement its ambitious nuclear energy programme that the road map suggests it is already too late to build the first nuclear station by 2023 as proposed.