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Let them eat coke

ESKOM has made clear its intention to grow the power supply capacity through various projects under construction.

What is less clear is exactly where all the little black nuggets are going to come from with which to feed these coal-munching beasts once operational.

To be clear, South Africa has a lot of coal running through its veins.

Supply per se isn’t an issue, what is problematic is how much some of that coal is going to cost to get out of the ground; more fundamentally, how much is it going to cost to get that coal to markets and more esoterically, who is going to supply all this coal.

The first two issues are quite dull and require drilling down into topics like stripping ratios, board and pillar mining and Transnet’s capital projects.

So in the interest of attracting more than a dozen eyeballs, we will explore the supply side of the topic in an effort to clarify the tectonic shifts taking place beneath South Africa’s coal playing fields.

Coal is a nice industry to explore because it isn’t subject to the same macroeconomic vagaries facing the shiny stuff like gold and platinum, which have not yet reached half time in their industry-wide beating.

While gold and platinum are essentially sold overseas before they come out of the ground, coal finds most of its final resting place within the country’s borders (we’ll leave emissions out of this discussion, in the hope the tree huggers don’t tweet me off).

Coal is also an interesting sector because unlike most minerals, even if companies wanted to export their goods instead of sell them locally to take advantage of rand volatility, with coal they are by and large unable to do this due to the inadequate rail infrastructure.

So the options for two-thirds of the nation’s coal producers are either sell it locally, or don’t mine the stuff in the first place.

Why this proves to be an interesting topic is that despite Eskom being jolly happy to take as much coal as it can get, it turns out that selling coal to Eskom isn’t particularly lucrative.

Coal miners have long preferred the strategy of washing as much of their coal as they can get into Richards Bay Coal Terminal for export and selling the sloppy seconds to Eskom for a third of the price.

The crunch emerges in that coal mining is experiencing the same steep input costs facing the rest of the embattled mining sector, in the form of higher energy and labour costs.

Major producers have cash cushions available to absorb these costs for the time being, but junior coal mines are increasingly choking on the disappearing profits from their endeavours.


 
The saga deepens when introducing Eskom’s preferential procurement strategy into the equation.

Simplified, Eskom intends buying more coal from junior mines; these mines will need to be black empowered mines. As it happens, there are already 33 empowered mines, which sounds like it should be enough -  but Eskom is also raising the empowerment bar from 26% to 50% plus one share.

Not surprisingly, the 33 incumbents don’t meet the 50% requirement.

Which raises the sticky question: where will Eskom buy its coal from?

The simple answer is the one forwarded by Eskom as part of its five pillars strategy, namely: “steps would be taken to consolidate smaller black-owned mining resources into larger entities”.

On the face of it, this sounds like a reasonable solution. Eskom would be silly to pay the high prices associated with junior miners on a cost plus basis or otherwise, and since it needs historically disadvantaged coal, it makes sense to use its muscle to force an industry-wide consolidation.

The problem bifurcates at this point. The first branch of the problem is that most of the smaller mines which would ideally populate these consolidated entities are unfortunately white coal. Despite white coal not being detectable in its caloric value, it is detectable in its market attractiveness to Eskom.

The second branch of our problem tree is that as premised earlier, selling coal to Eskom is marginally profitable - but factoring in country, currency and operational risk, it is not the kind of profitable which draws cash flush investors into the market.

So where is the money going to come from to transform this pigmentationally challenged coal to the Ubuntu home-grown variety?

In a business as usual, laissez-faire capitalist economy - assuming one still exists - this would result in either Eskom backtracking on its transformation goals or increasing the prices it is willing to pay for black label premium coal.

With tariffs capped and South Africa not surrendering itself to the wand held by the invisible magic hand of free markets, it is unlikely that either scenario will occur.

So what will the coal sector look like in five years’ time?

My prediction is that worried junior miners, faced with the triple whammy of labour costs, electricity costs and un-preferential procurement, will eagerly be seeking an exit strategy.

Keep an eye out in the classifieds for “White mature coal miner seeks tall, dark and empowered partner to facilitate retirement in Perth”.

 - Fin24

*Jarred Myers is a resources strategist and can be followed on Twitter on @JarredMyers. Opinions expressed are his own.


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