South African Energy Update – Eskom: A Company in distress

11 April 2014

AJ KinghornShava Mining Enterprise

Tel: +27837011388e-mail: akinghorn.private@gmail.com

Zimbabwean Energy Conference

1

Coal’s Current Value Proposition

∗ The economic contribution of coal mining as follows: 19% of mineral exports by value, 7% of total merchandise exports, 21 % of liquid fuel production, and 91% of electricity generation capacity.

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Source: Dick Kruger of the Chamber of Mines of SA

Brazil - Rio de Janerio at night

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Johannesburg, South Africa at night - sorry ...... Eskom apologises

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06 March 2014 – Black Thursday for Eskom and SA∗ On March 6, the utility resorted to 14 hours of load shedding for the first

time since early 2008 to prevent a system collapse, after it lost four units, or over 3 000 MW, at Kendal, in Mpumalanga, the largest power station in its 40 000-MW-plus fleet.

∗ The disruption reportedly coincided with a shift change at the underground portion of the mine, which was supplying Kendal with coarser and drier material. Wet coal in itself is not regarded as a problem. But fine, wet coal is problematic, with Kendal typically requiring that coarse coal comprises between 60% and 70% of what it burns.

∗ When the supply of coarse coal from the underground mine stopped, Khutala reportedly supplemented it with wet, fine material from the opencast operation, without communicating the change. This slurry-like material clogged the conveyors and material-handling systems and between 1:22 and 7:58 on March 6 four units tripped, owing to empty coal bunkers. This, despite Kendal having more than 56 days of stocks, covering an area the size of four rugby fields5

Does Eskom need help to burn wet coal?

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∗ Eskom’s cents/kWh tariff has tripled from 20 c/kWh in 2003 to >60c/kwhin 2013. (compared with an average price of 212 c/kwh for IndependentPower Producers (IPP) in 2013), and this price is expected to double inthe next five years. So, not only does South Africa face a coal cliff, butalso has a cost cliff o contend with.

Eskom tariffs– the cost cliff 1

Source: Terence Creamer 23rd November 2011 7

∗ State-owned electricity producer Eskom and government are assessing ways to secure the financial resources necessary to enable the utility to resume power-saving schemes, as well as to contract with those municipalities and independent power producers (IPPs) able to supply electricity into South Africa’s power-stressed grid in the short term.

∗ Eskom controversially ended short-term purchases with a number of IPPs in December, having failed to secure funding for ongoing purchases in the third multiyear price determination, or MYPD3, which was sanctioned by the National Energy Regulator of South Africa in February 2013.

∗ Last year, Eskom contracted a total capacity of 1 135 MW from IPPs and municipalities on short- and medium-term contracts and purchased over 3 500 GWh at a total cost of R2.9-billion, which equated to 83.6c/kWh.

Eskom’s precarious financial position 1

Source: Creamer 26 Feb 20148

∗ Speaking at a state-of-the-system update in Johannesburg on Tuesday, Public Enterprises Minister Malusi Gigaba said discussions were under way between the Department of Public Enterprises, the Department of Energy, the National Treasury and Eskom, but he indicated that announcements would only be made once solutions had been found and did not provide specific timeframes.

∗ Eskom had been granted yearly increases of 8% between April 1, 2013, and March 31, 2018, as opposed to the 16% sought, which translated into allowable revenue for the period of R862-billion, rather than the nearly R1.1-trillion requested – a R225-billion financial gap

∗ Gigaba stressed that government was aware of the disruptive economic consequences of South Africa’s power constraints, which led Eskom to issue two power emergencies in late February

Eskom’s precarious financial position 2

Source: Creamer 26 Feb 20149

∗ Eskom has had to run its emergency reserves – 2426 MW of diesel powered open-cycle gas turbines (OCGTs) in the Western Cape – for extended periods. The R2-billion budgeted by Eskom for diesel fuel in the financial year ending 31 March 2014 has risen to R10-billion, resulting in a cash-flow crisis which the utility claims is affecting other necessary capital and operational expenditure.

Eskom’s precarious financial position 3

Source: Creamer 26 Feb 201410

South Africa’s electricity prices rise to high end of China and India. NB: This not including a Carbon Tax

~R0.50/kWh

~R0.75/kWh

• China and India Prices by Frost and Sullivan• RSA historic Price path Eskom• IRP Prices by DoEIRP TTT

Area of Industrial Prices China & India

Area of IRP 2010 Comparative Prices for South Africa

SA “energy gap”

Average Industrial Prices (2009 REAL)

Source: Subject concepts and issue outline, M Rossouw and R Baxter

~R0.98/kWh

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NERSA only granted Eskom an 8%

increase

The price that Eskom needs to stay in

business?

∗ On 28 February 2013, NERSA rejected the utility's proposed price increase, and only granted an 8% increase per annum for the next five years, leaving Eskom with a shortfall of about R190-billion to contend with, as follows:

Eskom - a company in distress

Source : Chris Yelland, EE Publishers12

Is The honourable Malusi Gigaba planning to take the price of electricity to new heights?

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Malusi Gigaba has committed to canvassingthe idea within government and to bringing “all the components together” so that the necessary funding could be secured.

Balanced State, private sector involvement in SA growth required – the problem?∗ Public Enterprises Minister Malusi Gigaba last year stated that there were no plans to privatise

Transnet and Eskom and no intention to split the companies, adding that infrastructure development was the responsibility of the State and would remain in government hands.

∗ South Africa should induce the privatisation of some of its State-owned assets to ease the financial and capacity strain on the government, while ensuring an injection of revenue into the State coffers.

∗ However, balanced State and private sector participation was required, as both had critical roles to play as the country developed and grew.

∗ Speaking at a Neotel/Mail & Guardian business breakfast on Tuesday, Industrial Development Corporation chief economist Lumkile Mondi said the debate around the privatisation of the country’s assets should be retabled – removing the government’s current stranglehold on strategic assets on the back of disappointing performances by State-owned enterprises (SoEs).

∗ “Increased revenue can only come from growth – if you can’t run it [the enterprise] efficiently, give it to someone who can,” he asserted.

∗ He cited continually delayed projects and the ever-rising costs of these projects, pointing to Eskom’s embattled energy expansion and rehabilitation plans. He also indicated that the development of South Africa’s rail system and the roll-out of new rolling stock could fair better in the hands of the private sector.

Source: Mining Weekly 05 March 2013 14

Strategy is about making choices…

“Strategy means making clear-cut choices about how

to compete”~ Jack Welsch

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Clem Sunter points to three potential courses for South Africa

none of the ducks in a rowall the ducks in a row

the failed state

To provide potential courses?

THE DOMESTIC vs EXPORT DEBATE

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Should coal be declared a strategic resource?

SA Coal Resources and Reserves

?

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Hitachi and the Chancellor House Holdings∗ Hatachi’s contract with Eskom was probed by the then public prosecutor

Lawrence Mushwana because at time Eskom’s chairman at the time, ValiMoosa, was a senior member of the ANC. Chancellor House holdings then held 25% of Hitachi Power Africa.

19 Source: Paul O’ Flaherty, Eskom's former FD

∗ The Germany-based controlling shareholder of Hitachi Power Africa (HPA) has acquired the controversial 25% stake held in HPA by the African National Congress’s (ANC's) investment arm, Chancellor House Holdings.

∗ Eskom was aware of the transactions, having been informed in September last year that the merger between Hitachi Limited and Mitsubishi would have an effect on HPA.

∗ But having a BEE shareholding remained a requirement for securing Eskom contracts and Hitachi had, therefore, requested, and had been granted, a six-month grace period to regain its empowerment position.

∗ HPA and Hitachi Power Europe (HPE) were awarded the R38.5-billion boiler contracts for the giant Medupi and Kusile coal-fired power stations, which are being built in Limpopo and Mpumalanga respectively, in 2007.

∗ Combined the contracts represented the largest awards ever made by the State-owned power utility, with about 60%, or R24-billion, of the contract value attributable directly to HPA.

HPA, the ANC, MBEKI and ZUMA

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∗ Helen Zille said that the decision to sell Hitachi shares was proof the ANC used income from state contracts to finance its election campaign. “This is Corruption, pure and Simple”

∗ “Zuma’s ANC is getting contracts from Zuma’s government - contracts that they then mess up, causing big delays and power emergencies for the whole of South Africa, which makes more people unemployed because cannot grow or even attain full production capacity, making people unemployed.”

∗ “Then Zuma’s ANC sell their shares and use the profits to get him re-elected.”

∗ While President Zuma’s government is profiting from the electricity crisis, electricity prices have risen by 300% under his leadership.”

ANC set for R50 m election windfall

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∗ It is too late for South Africa to prevent national debt reaching 44% of GDP within the next two years, finance director general Lungisa Fuzile said on Thursday.

∗ "We are too close to 2016," he said after a Treasury briefing to Parliament's finance committees, a day after Minister Pravin Gordhan tabled the 2014/15 budget.

∗ National debt had risen from a low of 27.3% of GDP in 2008/09 to 41.8% in 2012/13.

Too late to avert 44% debt – Treasury

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∗ Public Enterprises Minister Malusi Gigaba later provided a more detailed explanation of the causes, including:

∗ The depletion of dry coal stockpiles at some plants, which resulted in lower power output as a result of wet and poor quality coal;

∗ The loss of three units at the Kendal power station, in Mpumalanga, as well as reduced output from Duvha, where conveyor belts were being reconstructed following a fire in December;

∗ Low dam levels at the Drakensberg and Palmiet pumped storage power stations;

∗ And, a loss of imports through the Zimbabwe Electricity Supply Authority

The primary culprit?

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∗ Energy Minister Dikobe Ben Martins said in early February 2014 that the DoE planned to initiate the long-awaited procurement processes for new baseload and cogeneration IPP projects by the end of March.

∗ The bidding processes would be pursued in line with the determinations issued on December 19, 2012. Under the baseload determination, 2 500 MW had been allocated for coal-fired IPP projects, 2 652 MW for baseload or mid-merit natural gas capacity and 2 609 MW for domestic and imported hydro-electricity prospects.

The energy minister also needs to be held accountable!

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∗ “As Eskom we need to really apologise to all South Africans for the inconvenience caused by what has happened,” Dames said.

An apology from Eskom, but what about the government?

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Additional Shadows of Discontent –Environmental Question 1∗ State-owned power utility Eskom has applied to postpone the date by

which sixteen of its power stations have to comply with the National Environmental Management: Air Quality Act (AQA) minimum emission standards, the Department of Environmental Affairs (DEA) confirmed on Tuesday.

∗ The DEA explained that while Section 59 of the AQA provided for any person to apply for exemptions to provisions of the Act, it was clear that no exemptions could be granted from a provision of Section 22, which pertained to the Atmospheric Emission Licence, among others.

∗ Eskom's power stations currently had to meet existing plant standards by April 1, 2015.

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Additional Shadows of Discontent –Environmental Question 2∗ The recent controversial Kriel debacle has forced Eskom and the

government to allow security of coal supply to override environmentalissues. Currently the Kriel power station, in Mpumalanga, is operating inbreach of its Atmospheric Emission Licence conditions.

∗ While Eskom indicated that it had been able to find solutions to ensure thatthe Duvha and Matla power stations, which are also located inMpumalanga, were compliant with the requirements of the MinimumEmission Standards of the Air Quality Act, it said Kriel could only be madecompliant through fabric filter plant retrofits, which were currentlyscheduled for between 2017 and 2022.

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Landmark ruling∗ Since January 31 2014, in a landmark judgment sentencing a company

director to a prison term for breaking environmental laws, pressure hasincreased on South African corporates to comply more fully with the law. Acourt in Limpopo imposed a prison sentence on Matome Maponya, themanaging director of Blue Platinum Ventures, for causing environmentaldegradation. It was the first time in South African history such a ruling hasbeen made. Maponya was sentenced to five years, suspended on conditionhe rehabilitate the damage, estimated at a cost of R6.8 million, within threemonths.

∗ What are the legal implications for Eskom, given their flagrant disregard forenvironmental concerns?

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The coal cliff

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∗ South Africa is facing a dramatic power crisis, exacerbated largely by the looming coal cliff. The size of the coal cliff ranges from 60 – 120Mt and is expected to impact on the country between 2013 and 2019.

∗ This cliff refers to either an overhang (over supply of coal but no power station to use it) or underhang (under supply of coal with power station empty). Of the four billion tonnes of coal that Eskom needs over the next 40 years, two billion tonnes will have to come from new sources (coal mines).

∗ At this stage we are only considering the coal cliff from a volume perspective. However, if coal qualities are included as another parameter, the size of the cliff increases.

Immediate actions required

Source: SA Coal Roadmap 201330

Domestic demand increasing

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Eskom’s Infrastructure Programme

Source: Eskom Mining Indaba 201332

∗ Eskom’s Medupi Power station was due to be commissioned in 2011.However, due to the delay in construction of Medupi, the first set ofMedupi boilers is only due to come on line late this year (2014) at a“guestimated” cost of nearly R200 billion (B) - against an original targetof R50 B. This particular cliff has had three negative impacts. Firstly,Eskom was not able to meet its supply requirements which has led to“load shedding” in the smelter sector. Secondly, there is an R8 B buy-back option which was rejected by NERSA. Thirdly, and most damaging,with demand significantly exceeding supply, Eskom is avoidinguncontrolled black-outs only by running its diesel-driven open-cycle gasturbines (OCGTs) flat-out at enormous cost, while simultaneouslyengaging in demand management and controlled load-shedding byexercising its interruptible contracts to large customers such as BHPBilliton, paying large energy-intensive industrial users such asferrochrome smelters to shut down, and urging consumers to switch offeverything possible.

Eskom capital expenditure – the cost cliff 2

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∗ In August 2013, Trade and Industry Minister, Rob Davies, announcedcabinet approval of the building of a third coal-fired power station byEskom, although timelines, schedules and costs have yet to beapproved. This decision was taken based on Eskom spendingapproximately R240 B on the Medupi and Kusile power stations — thelion’s share of a R300 B budget to expand its generation capacity overten years. The construction of both stations has already been delayed bythree years (and counting). If the more accepted guestimate of a cost ofR400 B for the two power stations proves to be correct, where will theadditional R160 B needed for the completion of the two power stationsstation come from?

Eskom capital expenditure – the cost cliff 3

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∗ Another critical issue facing Eskom, and one that is often glossed overwhen discussing Medupi and future power sources, is that of funding.Other demand/supply management options have been identified butthese require funding (how much?). Eskom personnel have engagedwith their shareholders and the regulator intensively over the past fewmonths and, hopefully, the funding will come through. The residentialmass roll-out programme was a significant contributor to managingsupply and demand and Eskom wanted to get started on the secondphase of the project as soon as possible. Once the required funding hasbeen received, this would go forward. Perhaps a commercial roll-outprogramme is also needed? The extended summer peak period wouldalso impact on how often and for how long Eskom would have to run itsgas turbines. The turbines would be used to a large extent during thesummer months.

Piggybank Scenarios – From Whence the funds?

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∗ Eskom is a State-Owned Enterprise (SOE) and, as such, is governed bythe ruling political party. Public Enterprises Minister, Malusi Gigaba, lastyear stated that there were no plans to privatise either Transnet orEskom and no intention to split them, adding that infrastructuredevelopment was the responsibility of the state and, accordingly, wouldremain in government hands. He also said in the Department of PrivateEnterprise’s May 2013 Budget Vote that initiatives adding momentum toa “comprehensive industrialisation and transformation programme”,linked to the multibillion-rand investment programmes of SOEs such asEskom and Transnet, would be unveiled. He noted that there was an“unyielding political will” to ensure that black industrialists, miners andprofessionals were developed and nurtured through the procurementpolicies and programmes of the various SOEs falling under his authority.

Status Quo and the foxes approach?

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∗ How long will Eskom continue being an albatross around the taxpayers’necks? When will the public, faced with ever increasing electricity costs,blackouts, and clear examples of management ineptitude, finally say‘enough is enough’? Clarity and transparency is urgently needed fromPublic Enterprises Minister Malusi Gigaba as to his strategy goingforward.

∗ With the government and its SOEs being so closely intertwined, it isdifficult to point fingers solely at either party. Will the government laythe blame at Eskom’s door, echoing the words of Sport and RecreationMinister Fikile Mbalula, when he lambasted Bafana Bafana for their poorsoccer showing? Will South Africans ever hear Minister Gigaba admit“We indeed have a crisis of monumental proportions, that Eskom’sperformance to date has proved. The mediocrity we have seen isdisgraceful. We must never wake up to this situation ever again. Eskomstaff are a useless bunch of losers that have disgraced the country.”

The Albatross 1

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∗ Or does the Minister have the appetite to confront President Zuma withthe unsavoury facts that the six million jobs recently promised in pre-election mode are now at risk, both from a supply a cost perspective?And will Minister Gigaba recognise that government strategies withinEskom have proved to be a disastrous failure, crippling not only Eskombut hampering the entire country. Unfortunately this second scenarioseems unlikely as Gigaba has said that the creation of new cost-plusmines to supply Eskom was an opportunity to secure “high levels ofownership and the progressive building of black operating capacity andenterprises throughout the mining value chain at a large scale”. Hereaffirmed government’s intention to ensure that, by 2018, Eskomprocured over half of its coal from black coal miners, “which would be astrategic act of transformation”. In order to benefit both Eskom ANDthe country, coal should be purchased at the lowest price possible. Inmy opinion, these are yet further examples of government strategieswithin Eskom that do not make sense financially and may well prove tobe a disastrous failure, and that will cost the country dearly.

Vote shedding?

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∗ Will Minister Gigaba commit to a new revised date of the revised datefor the commissioning of the first set at Khusile and provide an updatefor the Coal Supply Agreement to Khusile? Will he commit to a newrevised date of the revised date for the commissioning of the first set atMedupi and give the public an indication of the risk severity of Medupi(a coal fired power plant) never being fully commissioned like manynuclear power stations scattered around the world?

∗ The Bataan Nuclear Power Station in the Philippines is an example of thedangers of political interference in national power requirements. Thebuilding of the Bataan Nuclear power station commenced in 1976 andmore than thirty years later, at an incredible cost, the project wasmothballed and turned into a tourist attraction.

The Albatross 2

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Ten years to fix∗ Eskom CEO Brian Dames said South Africa was still feeling the

repercussions of the ANC government's decision not to build new plantswhen asked by the utility to do so in 1998. Construction of Medupi onlystarted in 2007 and has been plagued by delays related to design flawsand labour unrest.

∗ "It will take 10 years to fix the 1998 problem," said Dames, who stepsdown at the end of this month.

∗ Dames said the supply and demand relief measures had been identifiedand were well known, but that key decisions were now needed toliberate the financial resources required for implementation.

∗ And after the 2008 debacle, the government realises it could pay aheavy price if it does not decide in time on the next phase of powerconstruction when Medupi and Kusile are complete.

∗ "We are working around the clock to arrive at decisions quickly," PublicEnterprises Minister Malusi Gigaba said.

40 March 2014

Problems and solutions?∗ "I don't think there is nearly enough attention being given to the supply

of coal for Eskom. That's an area government needs to do more workon," said Mike Rossouw, chairman of the Energy Intensive Users Group,which represents heavy power users such as mines and factories.

∗ Eskom's coal stockpiles are mostly kept in the open, in part because ofthe high cost of storage, and so are prone to damage from heavy rain.Storage bunkers are available but not enough to protect all the coal andthe problem is compounded by most of Eskom's supply coming fromexposed open-pit mines.

∗ "The industry is by far not deregulated enough. We need to have moreparticipants in base-load generation in South Africa," said Cornelis vander Waal, an energy analyst at consultancy Frost & Sullivan.

41 Reuters March 2014

∗ Eskom’s credibility with operational time frames has been tested andfound wanting, and the way forward remains clouded in uncertainty,half-truths and indecision. Until government accepts accountability forEskom’s failure to provide the country with an adequate, and cost-effective, power supply, and long-term viable solutions are proposedand put into practice, South Africa will stagnate.

∗ Bad planning, a lack of transparency, poor management, unrealisticeconomic solutions and a lack of political will surrounding our nationalenergy planning can only serve to worsen the looming power crisis,throwing Clem Sunter’s scenarios into stark relief.

Summary

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Balanced State, private sector involvement in SA growth required – the solution?∗ South Africa should induce the privatisation of some of its State-owned assets to ease the

financial and capacity strain on the government, while ensuring an injection of revenue into the State coffers.

∗ However, balanced State and private sector participation was required, as both had critical roles to play as the country developed and grew.

∗ Speaking at a Neotel/Mail & Guardian business breakfast on Tuesday, Industrial Development Corporation chief economist Lumkile Mondi said the debate around the privatisation of the country’s assets should be retabled – removing the government’s current stranglehold on strategic assets on the back of disappointing performances by State-owned enterprises (SoEs).

∗ “Increased revenue can only come from growth – if you can’t run it [the enterprise] efficiently, give it to someone who can,” he asserted.

∗ He cited continually delayed projects and the ever-rising costs of these projects, pointing to Eskom’s embattled energy expansion and rehabilitation plans. He also indicated that the development of South Africa’s rail system and the roll-out of new rolling stock could fair better in the hands of the private sector.

∗ Public Enterprises Minister Malusi Gigaba last year stated that there were no plans to privatise Transnet and Eskom and no intention to split the companies, adding that infrastructure development was the responsibility of the State and would remain in government hands.

Source: Mining Weekly 05 March 2013 43