Giant merger puts wind up Eskom

The multibillion-dollar merger between Xstrata and Glencore has sailed smoothly through the competition regulators in most countries where the two commodity companies operate, but it is facing a headwind in South Africa following a dramatic, last-minute objection by Eskom, which wants price and supply restrictions placed on the merger.

After an investigation of the merger, the Competition Com­mis­sion recommended to the Comp­etition Tribunal that the $33-billion deal be approved in South Africa but that retrenchments should be kept to a minimum. That prompted Eskom to ask for permission to intervene, leading to the hearing on the matter being postponed until January 18 instead of going ahead at the end of 2012. Unusually, Eskom's submission is confidential.

But the parastatal said in a statement that it is not opposed to the merger but wants certain conditions imposed on the deal, including measures to ensure that the ratio of exports to domestic coal supply is kept constant after the merger and that the merging parties agree to negotiate in good faith on long-term contracts as they expire.

Xstrata is one of the world's largest exporters of thermal coal used to generate electricity and one of the largest producers of coal used to make steel. Glencore is the largest shareholder in Xstrata with an interest of 33.65% and acts as a trader of Xstrata coal. The merged entity would account for approximately 15% of Eskom's coal supply and it would also be one of the largest traders of coal in the market. Coal is Eskom's biggest single cost overall and is projected to grow by 10% on average a year for the next few years.

In its tariff application to the national energy regulator of South Africa, the state-owned enterprise stated its coal costs for the 2012-2013 year would be more than R35-billion, which suggests that the 15% supplied by Xstrata could cost about R5-billion.

Average Eskom electricity prices have risen by more than 200% during the past five years and the parastatal has applied to the regulator for a further 16% increase each year for the next five years.

Pricing trends
In its investigation, the commission considered the impact of the merger on local supplies and pricing and found that price increases in recent years were due to several factors, including the increased attractiveness of exports because of greater exporting capacity and rising demand for coal by India, and an increase in short-term purchases by Eskom.

Xstrata's annual reports show that its operating profit from thermal coal in South Africa grew from $111-million in 2009 to $160-million in 2011. And in just the first half of 2012, this figure was $155-million.

But the commission concluded the merger had little to do with the problems Eskom was experiencing. "While the pricing trends have been cause for concern, the factors underlying them are not related to the merger," the commission said.

The IndustriALL Global Union, which represents 50-million workers in 140 countries, published an article on its website that reported that Eskom's submission is highly critical of Glencore establishing itself as the gatekeeper of South Africa's coal exports and that it has little interest in developing and maintaining the South African domestic market.

"It claims that Glencore's philosophy is diametrically opposed to that of Eskom and the public interest; Eskom perceives Glencore's endgame to be the introduction of an export-market related price factor for coal," the article said.

Eskom did not comment on the report but said in a statement that its concern centred on "effects that the proposed merger would have on Eskom's ability to obtain a timely, sufficient and competitively priced source of coal for its power stations".

Eskom's interim report for the six months ending September 30 2012 noted that the long-term coal supply is threatened by international competition for South Africa's coal reserves, which influences the coal price. And even the national development plan, released in 2011, indicates that coal-mining companies are unwilling to sign new long-term contracts with Eskom because they can get higher returns by exporting coal.

But the commission drew attention to existing and proposed measures that could address these concerns.

"These include regulatory instruments in the mining rights regime that allow the government to impose conditions relating to the pricing and supply of mineral resources, if necessary, and protect local buyers from being discriminated against or subject to uncompetitive pricing," the commission said.

Furthermore, legislation enabled the minister of mineral resources to initiate or prescribe measures to create incentives for the beneficiation of minerals in South Africa.

According to the national development plan, a national coal policy is urgently required and it says that formal structures could foster collaboration by the government, Eskom, Transnet, Sasol, independent power producers and the coal industry to  optimise domestic coal use and maximise coal exports. The plan suggests that detailed planning should be done and that measures such as conditions attached to mining licences and export permits for particular grades of coal should be introduced.

Ted Blom, a partner of Mining and Energy Advisers International, said Eskom's intervention in the merger was an attempt to cover up its own lack of action in getting coal producers to supply Eskom.

Eskom's chief executive, Brian Dames, stated in a 2009 interview that South Africa needed at least 40 new coal mines to prevent shortages in the long term. Dames was head of Eskom operations at the time.

Balance of payments deficit
Blom said the replacement coal needed was about 100-million tonnes a year from 2015 onwards. But to date only one contract had been agreed on, although not yet signed, for a small to medium supplier, Vele Colliery, Blom said.

The only region that could replace the depleted Witbank and Middle­burg coalfields was the Waterberg coalfield, which had about 400-billion tonnes of coal – enough for more than 100 years, Blom said. But the area lacked infrastructure such as railways for transporting the coal and water for mining.

Transnet will spend billions to increase its ability to move coal from the Waterberg coalfield to ports for export and to Eskom's Mpumalanga power stations. But until the rail line is completed, Eskom will have to move the coal by truck.

Blom said Eskom would run out of coal in the Middleburg area, where its major power stations are, between 2015 and 2020, and transport costs would weigh heavily on it.

Leon Louw, the executive director at Free Market Foundation, said that the country was suffering from a massive balance of payments deficit, so it was "ludicrous" to have a giant conglomerate upset about two of its suppliers' business arrangements and potentially trying to restrict exports. "Everyone in South Africa wants to promote exports except Eskom."

Louw said it had no right to ask for special conditions. "That Eskom can even be taken seriously shows how serious the problem is."

The National Union of Mine­workers and the National Union of Metalworkers of South Africa also raised concerns about retrenchments and the increased risk to coal supplies and prices.

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