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South Africa's Eskom: power of the powerless

LONDON, Dec 23, 2009 (Commodity Online)

A report from BNP Paribas Fortis Metals Monthly says how South Africa's Eskom, the monopoly electricity utility in the world's main source of platinum group metals is caught between the devil and the deep blue sea.

Eskom needs a vast amount of fresh investment - and rather swiftly - if it is to avoid a repeat of the January 2008 fiasco, when the country was crippled by several days of power cuts. One way it might start to get itself out of its financial mess would be to jack up tariff charges - but Eskom is so heavily subject to political interference that route is looking increasingly thorny. But without some decisive action in 2010 a fresh - and possibly more serious - power failure is almost inevitable at some point.

Here comes the World Cup! From June 2010 the world's attention will be more than usually turned towards South Africa, the host country for the premier international football event. According to FIFA, the International Football Federation, the cumulative television audience was more than 26bn for the 2006 World Cup, and the same number is expected this time round. The country's government will be hoping that next year's winter - between May-July - will be warmer than usual, not because it wants the world's football stars to have easier playing conditions, but to guarantee that the country's creaking electricity network does not collapse under the strain during what is traditionally the peak period of demand.

Within South Africa, Eskom has become a byword for inefficiency, synonymous with power failure rather than power supply. And this power failure is not just its inability to cost-effectively deliver sufficient electricity; it's become in the last month a metaphorical power failure, as the company has drifted into a leadership vacuum that extends far beyond the corridors of Eskom and into government itself. On 11th November Eskom's CEO, Jacob Maroga, was physically locked out of his office, according to local South African reports. Two days before that, the company's chairman, Bobby Godsell, handed in his resignation.

This boardroom fallout reflects the structural mess that Eskom now finds itself in. Interestingly enough, the government later asked Godsell to reconsider his resignation, but Maroga remains out in the cold. Godsell declined the offer, which is a bad sign - if an experienced old hand like Godsell does not want any more of this poisoned chalice, many other equally talented managers will be deterred from considering it.

Godsell, a hard-nosed businessman who used to run AngloGold Ashanti, had demonstrated an unwillingness to disguise the fact that Eskom needed - needs - a clear and determined managerial overhaul. That can only be achieved by permitting the utility to escape the clutches of various political factions now seeking to assert their voice in running the country, all vying for the attention of President Jacob Zuma, who so far has been unwilling to involve himself too directly in the affairs of the troubled company.

The ruling ANC government's militant wing, the Youth League, called for Godsell to resign, as did the Black Management Forum, which describes itself as a "non-racial thought leadership organisation."

The Forum went so far as to accuse Godsell of adopting a "baas/boy" mentality towards Maroga, in other words accusing Godsell of being a racist.2 Godsell is a big enough player to defend himself against such a slur - what's important in all this is the extent to which the ANC government is permitting one of the most serious structural failures now facing the country to be distorted into a mud-slinging matter, diverting attention from the underlying reality - which is that South Africa faces a medium-term electricity supply crisis, one that could cripple supply of around 70% of the world's production of platinum group metals.

That may not matter so much when the world is in a recession, and new car sales are in a slump - but what might happen when the recession is over? Both platinum and palladium prices have recovered strongly this year, up almost 70% and more than 100% since the start of 2009, without any real prospect of a massive surge in new car sales in the major markets in 2010. Both metals are vital ingredients in autocatalysts; if and when new car sales do pick up, they will be in much greater demand than today and the prices of both are likely to rise much higher than they are currently. The world needs South Africa's PGMs; South Africa's PGM's producers need electricity; and Eskom needs to deliver without interruption.

Massive investment needed

This on-going crisis first emerged in January 2008. On 25th January that year Anglo Platinum and AngloGold Ashanti, among others, said they had been forced to completely shut down their mines, as Eskom could not guarantee security of power supply. South Africa accounts for some 80% of global platinum supply and more than 40% of palladium. In the weeks succeeding the shutdown Eskom managed to get supply up and running again, albeit still today at just 95% of capacity - but that did not prevent the platinum price from soaring to a new record of $2,200/oz.

Eskom is today caught between a rock and a hard place. According to Eskom's own plans, to meet future demand growth for electricity supply it needs to invest some Rand 385bn ($52.5bn) and it has yet to secure around 20% of that. Earlier this year it proposed to put up its tariffs by 45% a year over the next three years, starting in 2010. That was greeted with howls of outrage by all sectors of society, from trade unions through to mining companies.

At the start of December Eskom backed-down a little - and claimed that it could squeeze by with putting up tariffs by 35%/year for the next three years. Even this is too much for the Congress of South African Trade Unions (Cosatu), which said in response it " would still be too high." The ruling ANC government, which is in a tripartite alliance with the South African Communist Party and Cosatu - inevitably backs Cosatu. In a statement the government said: "We see the Eskom proposal to NERSA [the National Energy Regulator of South Africa] not assisting South Africa's economic growth." It's both an energy mess and a political nightmare - many South Africans are understandably asking themselves, if Eskom can really make do with 35% increases then why did it ask for 45% in the first place? It looks like bending to political pressure - and a very thin end of a long, fat wedge.

Coal v. solar power

Nor do Eskom's problems end there. For in the new era of carbon-consciousness Eskom scores very poorly. According to South Africa's 2009 Carbon Disclosure Project report, published by the government, Eskom is currently one of the world's three biggest emitters of carbon dioxide, at 220 Mt/year, helping make South Africa the world's 12th biggest polluting nation. The company hopes to reduce its reliance on coal burning by more investment in solar energy, but weaning itself off coal will be extremely difficult and also costly. Currently Eskom depends on coal burning for 80% of its power generation.

According to the company, about 26 GW of extra electricity generating capacity will be required by 2030 over and above what Eskom currently plans to invest and build between now and then as far as conventional power generation is concerned. This is going to lead to a massive electricity-generating shortfall that, Eskom hopes, can be filled by solar generation. Yet the cost of developing a pilot solar plant, generating just 100 MW- is put by the company at 6bn-7bn rand, equivalent to between $800m-$940m; it's evident that Eskom as of today does not know where the sort of investment it needs for its solar energy plans is going to come from. 26 GW is 26,000 MW , so if the costing for the new pilot solar plant were to be replicated for all 26 GW of the generating 'gap' Eskom would need at a minimum another 1,560bn rand, or about $209bn. Raising that kind of financing in the next two decades will be impossible - meaning that the country will still be almost entirely reliant on coal-burning. Yet if only it were

that simple. Again, according to Eskom, substantial investments will be needed in coal mining, just to keep pace with growing electricity demand. In September this year the now-departed CEO of Eskom forecast that as much as 110bn rand ($10.5bn) would be needed to build at least 40 new coalmines within the country by 2020 to ensure sufficient supply. By that date it's estimated that Eskom will be burning as much as 200 Mt of coal/year, against some 130 Mt today.

Very uncertain outlook

In August this year Eskom reported a full year (and record) loss of 9.7bn rand (to the end of March 2009) v. a loss of 168m rand for the previous year. Its spare generating capacity remains much lower than the 15% it says would be appropriate. It has twice raised its tariffs since the crisis of January 2008, by an average 59%. Its five-year expansion plan, with a targeted investment of 385bn rand ($49bn) got a shot in the arm recently, when at the start of December the World Bank said it had agreed in principle to lend Eskom up to $5bn towards this expansion plan, but back in August Eskom's credit rating was downgraded from A1 to Baa2, making the cost of borrowing - if it can be obtained - that much higher. The African Development Bank has agreed a $500m 20-year loan for Eskom. And it will get another 60bn from the South African government.

But what the government gives with one hand it takes away with the other - the Department of Trade and Industry is reportedly seeking a repayment from Eskom of 300m rand ($40m) that was used to build power lines to the Coega Industrial Development Zone, following a decision by Rio Tinto-Alcan to abandon its intention of building a new aluminium smelter in the zone. With awful irony, Rio Tinto-Alcan abandoned the plan because Eskom could not give it the kind of long-term reassurances over power supplies and tariffs it needed.

President Jacob Zuma is a big football fan and has high hopes for Bafana Bafana, the South African national team, at next year's World Cup. We don't expect the lights will go out next June-July. But we also do not expect them to shine very brightly thereafter. Watch out for fresh record PGM prices, if not in 2010, then shortly thereafter.

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