Eskom’s coal standoff with Glencore unpacked

Johannesburg - The standoff between power supplier Eskom and commodity trading and mining group Glencore [JSE:GLN] has long been coming.

In 2012, just as the Competition Tribunal was mulling over the merger between Glencore and Xstrata, Eskom entered the fray as a so-called intervening party.

Eskom was concerned about the influence the merged entity would have on coal prices.

At the time, Eskom was already grappling with soaring primary energy costs and coal was a major contributor to the rising energy costs. In the year ended March 2015, Eskom paid R83.4bn for primary energy.

While Eskom did not oppose the merger, the utility recommended that it be approved subject to conditions regulating supply of coal to Eskom and so submitted a few conditions for the merger.

Among these conditions, Eskom insisted that the merged entity negotiate in good faith on long-term contracts.

Eskom also wanted Glencore to rule out the application of export parity pricing “whether during initial determination thereof or by way of any price adjustment mechanism in so far as such pricing would exceed pricing based on the cost of production together with fair return”.

A touchy subject for Eskom

Coal is a touchy subject for Eskom, but this has not always been the case. When it built its power stations, the utility concluded long-term contracts with coal miners. The mines, located adjacent to the power stations, would supply coal to Eskom for the duration of the mine’s life. This way, the coal miners were guaranteed of a steady income, especially for low grade coal.

This worked well when there was sufficient electricity capacity, but since the electricity crisis erupted, the wheels have come off.

Eskom has accused the mines of under performing, thus forcing the utility to resort to expensive short-term coal contracts. At the company’s recent results presentation, acting CEO Brian Molefe announced that Eskom was seeking a R2bn penalty from Glencore for supplying it poor quality coal, an allegation denied by Glencore.

Fighting for survival

The penalty must be the least of Glencore’s concerns right now. Faced with financial hardship because of difficult market conditions, Glencore’s Optimum Coal is fighting for survival. The multinational, itself on a cash preservation mode because of a drop in commodity prices, has reportedly spent R3.4bn while it renegotiated a deal with Eskom.

With Eskom unwilling to renegotiate its standing contract, Glencore has opted for business rescue. Glencore has been desperate to renegotiate the contract it signed in 1993. In terms of the contract, the Optimum mine supplies Eskom’s Hendrina power station with 5.5 tonnes of coal a year.

In anticipation of questions about the coal supplies, Eskom insists that the recent developments at Optimum will not jeopardise operations at the power station.

“We have about 40 days of coal stockpiles at Hendrina and therefore the operations of the power station will not be affected in the short-term, we would truck in coal from other suppliers whilst exploring our legal options on the matter,” Eskom said in a statement.

Trucking coal will come at an additional cost for Eskom.