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Anatomy of a catastrophe

Eskom’s countdown to catastrophe began in 2000 when it had enough coal stockpiled to last 61 days. Last month, when it shut down the country’s mines, the stockpiles were down to less than three days’ supply.

A deliberate policy began in 2000 to reduce the coal stockpile to better manage operating costs. This, coupled with a new pro-BEE policy, which favoured small and new suppliers and incentivised management to use this hierachical system of procurement, meant that for a number of years Eskom has burned more coal than it bought.

The bias towards small business also meant that road transport was favoured over rail and conveyor belt, meaning that many of the roads near the power stations are in poor repair.

Eskom seems not to have realised that small business is singularly ill-equipped to deal with moving about 120-million tons of coal a year. Supplying coal to power stations is a capital-intensive business requiring long lead times. Contracts are typically for periods of up to 30 or 40 years.

Eskom also appears not to have realised that some of its main suppliers, notably Exxaro, have excellent empowerment credentials. Exxaro, which supplies about 30% of the utility’s coal requirements, says on its website that it is the largest black-controlled, diversified mining company in South Africa.

Eskom’s problems in procuring coal and the state of the roads were highlighted in several of its annual reports, starting in 2003. The warnings were ignored by both the Eskom board and its political masters.

The problems began in 2000 when newly appointed chief executive Thulani Gcabashe implemented a new policy to reduce the stockpile to 44 days to reduce operating costs. The stockpile was reduced again the following year and a new procurement strategy came into effect in 2002 to favour small BEE companies. This was known as the “hierarchy of procurement”.

Under this directive, authorised by Gcabashe, Eskom first purchased coal from black, female-owned suppliers, then small black suppliers, then large black suppliers, then black-empowering suppliers and only then from “other South African manufacturers”. State-owned enterprises were classified as “other” under this programme.

Eskom’s buyers were required to move up this hierarchy, only sourcing from the next rung of the ladder if the first could not supply.

Because some coal suppliers were no longer selected by proximity, transport became an issue. Some coal was transported by rail, but other supplies were delivered by truck. Eskom specified that BEE transporters had to be used. It spent R20-million in 2003 fixing roads, but at least one trucker told the Mail & Guardian that he stopped supplying coal to Eskom because the roads were doing too much damage to his vehicles.

This hierarchy of procurement also meant that when Eskom needed to source additional coal it could not use its three biggest suppliers, Exxaro, Anglo Coal and BHP Billiton, despite their BEE credentials.

Gcabashe apparently favoured creating a spot market for coal purchases. Until then Eskom had relied on long-term contracts to source its supplies. It typically paid well below export prices as it used low-grade coal to fuel its power stations. Export prices of coal are about $100 a ton, while Eskom’s contract prices are a fraction of this at just R100 a ton.

Coal procurement at Eskom was so sufficiently troubled by 2003 that its annual report for the year spoke of an emergency purchases programme for the Tutuka and Majuba power stations. A source within Eskom told the M&G the programme had less-stringent requirements, but Eskom wasnot forthcoming with the details.

These emergency purchases were sourced from Eskom’s list of pre-qualified suppliers, in line with its BEE procurement strategy and to “introduce flexibility when purchasing additional coal [over and above the existing long-term contracts]”. Tenders were requested to secure coal supplies for the Tutuka and Majuba power stations.

The additional coal was transported by Spoornet and by road, with a coal transport system proposed for Majuba and Tutuka.

“Due to the poor condition of the roads in the Mpumalanga province and the lack of funds within the provincial government, Eskom spent approximately R20-million on road repairs during the year,” the 2003 annual report says.

It also warned of a looming capacity shortfall: “With regard to building new capacity, policy clarity regarding Eskom’s obligation to supply electricity is required in terms of security of supply.”

Problems with the coal supply were evident again in the 2005 annual report. “Stockpiles at a few power stations were reduced to unacceptably low levels and additional coal was sourced to meet the increased demand. Towards the latter part of 2004 the situation had stabilised and stockpiles were back in line with expectations,” the report states.

But planned electricity supplies from Cahora Bassa did not materialise during the last few months of 2004. “This, combined with plant problems experienced at certain stations, as well as coal supply problems from Eskom’s major rail-based supplier, resulted in a dramatic reduction in the stockpile at Majuba Power Station, which necessitated additional coal purchases early in 2005.

Most of this coal, as before, was supplied by road: 16-million tons by road, compared with 3,1-million tons by rail. “Road conditions are poor and Eskom has been in constant communication with the Road Transport Authority and the Mpumalanga Province to expedite the road repairs in the area.”

The warnings sounded again in 2006. “Coal procurement was extremely difficult during the review period,” the report says. Extraordinary rainfall for the first three months of 2006 resulted in production problems at open-cast mines, it says, and additional coal supplies had to be purchased on an emergency basis as problems with Koeberg put pressure on other power stations.

“Transport of coal by rail and road remained problematic throughout the period … A number of road transporters have not performed in line with expectations. The limited capacity of rolling stock necessitated greater use of road transport to Majuba power station. These issues are now receiving urgent management attention as it is anticipated that it should be resolved early in the [then] new financial period,” the report says.

The utility is now targeting a stockpile of 20 days’ coal, says former DA researcher James Myburgh, a political analyst for Moneyweb.

The 2007 annual report is the most forthright.Coal procurement has “continued to be problematic”. This was because of “under-production at the tied collieries [coalmines linked to power stations], availability of coal of the correct quality from short-term suppliers and transportation of increased quantities of coal by road”, the report says. But “Eskom continues to support BEE coal-mining initiatives when buying coal and uses BEE haulers for the transport of coal”.

In addition, problems arose with longstanding suppliers. “Coal purchases from most of the long-term supply agreements were below target due to technical constraints and underperformance by some collieries. Purchases under short- and medium-term coal contracts were below target because of the shortage of coal suppliers caused by the delay in the issuing of mining licences,” the report says. Due to high electricity demand and low deliveries, coal stocks fell to well below target levels.

“Transport by road remained problematic,” it says. “The condition of provincial and national roads used by trucks transporting coal to Eskom power stations continued to deteriorate during the period. Where necessary Eskom has repaired damaged roads to maintain coal supplies.”

In June last year Eskom told Business Report it had about 18 days’ worth of coal in the stockpile and that it was buying 24-million tons of coal out of its annual target of 120-million tons, on the spot market rather than through fixed contracts. But this stockpile was so run down seven months later that less than three days’ supply was available.

This week Ehud Matya, head of generation for Eskom, was reshuffled. His replacement is Brian Dames, previously the head of enterprises. Matya will now look after the buying back of power from large industrial users.

Money is power

Eskom’s directors and top brass, about 30 people, paid themselves R21,8-million for the year ending March 2007, up from R18-million the previous year and a whopping R56-million for the 15-month period ending March 2005. In 2003 they raked in a collective R15,9-million.

CRISIS TWO: Lynley Donnelly reports on government’s rush to attract investors and hand over vast amounts of electricity at giveaway prices

Just one energy user, BHP Billiton, uses enough electricity to power a city the size of Johannesburg. The kicker, though, is that the resources giant gets this whacking amount of power at cost, using it to produce a profit of R6-billion.

Government’s deal with BHP Billiton and its three aluminium smelters is the subject of a confidential agreement between the company and government.

But it is thought to get its electricity at about 12c a kilowatt hour, while most of South African industry pays 16c and consumers up to 44c. One energy expert estimates Eskom’s cost of generating electricity at about 10c a kilowatt hour — about half of which is the cost of the coal.

BHP Billiton’s aluminium operations earned it $1,8-billion before tax, according to its 2007 annual report. Global operating profits for the whole group were $18,4-billion before tax. BHP Billiton could not confirm how much its local aluminium profits contributed to global profits, but last year Mining Weekly reported that BHP Billiton’s South African business represents more than half of global earnings before interest and tax.

The company’s 2007 report puts South Africa’s contribution to profit by location of assets at $1,15-billion or R8-billion. If Billiton’s South African aluminium interests contribute to about half of the aluminium sector’s global profits, it amounts to about $900-million or R6,3-billon.

Government policy has been to attract energy-intensive industry but, as Eskom’s excess capacity has run out and become a deficit, it finds itself contractually bound to industries that keep running while the rest of the country experiences blackouts and the associated traffic chaos and loss of business.

But government also finds itself facing a huge bill to build new capacity to keep the lights on. It will cost tens of billions of rands to build the equivalent capacity being used by BHP Billiton’s smelters.

One critic, Richard Young, an arms deal whistleblower, estimates that BHP Billiton’s Hillside operation puts R5-billion into the economy annually, of which R1-billion is in tax. Young also estimates that Bayside earns BHP R8,9-billion gross profit and Mozal R5,3-billion. This fattens the company’s profit margins, while consuming South Africa’s energy.

Young estimates brown phase two load-shedding costs the economy R2-billion a day — R600-billion a year. He called for the shutdown of BHP Billiton’s aluminium smelters until there is a sufficient supply and safety margin or they can supply their own power.

“Even if Billiton had to be compensated for its losses by the government using taxpayers’ money, this would be far better than allowing the damage caused by load-shedding to continue,” he says.

Minerals and Energy Minister Buyelwa Sonjica announced on Wednesday that government’s development electricity pricing programme (Depp) will continue, despite the need for a review of how to allocate local energy resources. The Depp aims to attract energy-intensive foreign investment through Eskom’s “competitively priced” electricity offering.

T-Sec’s Mike Schussler told Inet Bridge that South Africa’s neighbouring countries receive rates of 11c a kilowatt.

According to its half-year results published this week, BHP Billiton’s global aluminium production over six months amounted to 675 000 tons, making annual production about 1,3-million tons. Oddly, its website puts the combined output of its three South African smelters at1,4-million tons a year.

Last week the Mail & Guardian reported that BHP Billiton pays an estimated 12c/kWh for electricity at its smelters — well below what domestic users pay (about 40c/kWh). The combined power usage of BHP Billiton’s three smelters is 2 400MW. The Rio Tinto/Alcan smelter brings the total to 3 750 MW. To produce new capacity of about 4 000MW will cost South Africa nearly R80-billion — or the total cost of the Medupi power station.

But the South African aluminium industry does not appear to benefit from local aluminium production. The price of primary aluminium on the London Metals Exchange is about $2 500 a ton (about R17 000). In the past local buyers paid a 5% “regional premium” on that price.

According to the department of trade and industry, although aluminium was being sold at something “approximate to import parity prices”, discussions with BHP Billiton took place regarding the company’s pricing regime. Nimrod Zalk, chief director of industrial policy at the department, said “a subsequent review of pricing regimes has seen the removal of [South African] regional premiums”.

“With respect to aluminium we are much less concerned than we have been in terms of other markets, such as carbon steel, for instance,” he said.

Zalk admitted that, given South Africa’s “energy crunch”, government needs to be “more strategic about energy allocation”.

“One of the mistakes in terms of government policy in the past is granting lots of concessions without conditions beneficiating products in the South African market,” said Zalk.

He said that one of the new conditions was to ensure that in the case of smelters, such as Alcan, at least 40 000 tons of aluminium is made available to the local market at export parity prices.

Analysts balked at the idea of shutting down energy-hungry smelters, but for South Africa to remain a desirable foreign investment destination the country must be seen to honour its contractual obligations. To shut down the smelters is not a simple process, said one analyst. Government would be paying the cost of effects all through BHP Billition’s aluminium value chain — its aluminium refineries and bauxite ore mines in Australia for one.

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