COP21 and South Africa’s impending Coal Cliff

As the dust settles on the COP21 climate conference in Paris, it may be worthwhile to reflect what actually happened and was agreed there. One can then discern what it means for us here in South Africa. For the most part, COP21 is acknowledged to be a surprising success after small incremental progress, but also multiple failures over 21 years. For some, the turn-around happened after the failure of COP15 in Copenhagen. What happened is that Christiana Figueres took over the UN Framework Convention on Climate Change. The difference was the realisation that a comprehensive top-down deal with a global carbon price and nationally allocated carbon budgets along with a massive transfer of funds for low carbon technology from the developed world to the developing world would never be agreed upon. It was always going to be far too much.

So, what developed under Figueres instead was an understanding that the only deal on the table would be a voluntary one: A series of pledges and reviews by each country. One of the unsung heroes of reaching the global accord was none other than our own then Minister of Energy, Dipuo Peters, who, insiders say, played a big role in the long windy road to the Paris accord. Being more bottom up means that sub-national bodies like cities, civil society and business are now all part of the process and are arguably better placed than national governments to make the needed, and important, investment decisions.

The achievement of Paris is that the 2 ? Celsius limit above pre-industrial levels is the firm target. Each country is required to put forward Nationally Determined Mitigation Contributions (NMDCs) as obligations of conduct which obliges them to pursue domestic measures to achieve them and which are reviewed on a regular basis. Like other countries, South Africa went to Paris with its own commitments. Although existing NMDCs do not meet the target of keeping global warming below the 2 ? Celsius limit, much less the more aspirational 1.5 ? Celsius target, what the COP21 agreement does is to set in motion a ratcheting mechanism that combines transparency and regular disclosure together with a five-yearly demand for plans of ever-increasing ambition.

At present, the world currently produces around 50 gigatonnes of greenhouse gas emissions a year. Even if all the pledges put together by 186 nations before and during the Paris climate talks were enacted, these emissions would grow to around 55 gigatonnes of GHG emissions a year by 2030; to meet the 2° C target, the world will need to reduce those emissions to 40 gigatonnes a year by 2030. To achieve this, the world will have to reverse direction before 2020. The required reduction trajectory is to be published in 2018. This is not as impossible as it looks, recent data shows that CO2 emissions are already falling, but this can be ascribed to a poor global economy. For most of us, the first direct impact of South Africa’s own Intended Nationally Determined Contributions will be through the introduction of a carbon tax which will start to bite in 2020.

Of course, there will be considerable opposition to this measure, particularly when the country’s economy is on its knees, but the real impact will not be felt in any carbon tax; it is to be felt by the coal mining industry, an industry on which South African is heavily dependent. South Africa obtains almost 90% of its electricity and 77% of its primary energy needs from coal. Alongside electricity generation, coal is used as a raw material in the petrochemicals industry. Sasol converts large amounts into liquid fuel, a process involving substantial energy losses along the way. It is certainly the least climate-friendly way to produce liquid fuels.

Recently, we have seen Eskom in a dispute with two of its coal suppliers. One of these is with the Glencore-operated Optimum mine that feeds the Hendrina Power Station which Eskom has fined R2 billion for the delivery of substandard coal and its refusal to pay more than R150/tonne (less than what Glencore says it costs to mine the coal) for the coal delivered. The other is with the Exxaro-operated mine that supplies its Arnot plant which has supplied coal at R900/tonne, a contract which it is not renewing when it terminates at the end of December. The Optimum mine is also the subject of a potential Gupta company take-over and it is thought that the take-over is subject to a far better commercial arrangement with Eskom once the take-over is done. These disputes are simply as symptom of a far bigger problem: Eskom is what it is because of coal mining and coal mining in this country is what it is because of Eskom. Coal and lignite come from vegetation, oil and natural gas come from the remains of tiny organisms deposited on the sea floor. The graphic below sets out the time scales in which coal developed:

Source: Coal Atlas

There is no shortage of coal. It is effectively an unlimited resource. Coal reserves deposits that can be exploited economically using current technology are estimated to be 968 gigatonnes (968 billion tonnes). In 2013, humankind mined and burned 8 gigatonnes. In addition to proven, reserves the earth has vast deposits of coal that have been proven, but are currently uneconomic to exploit, amounting to 22,000 gigatonnes.

Source: Coal Atlas

As we said, Eskom is what it is because of coal, and our coal mining sector is what it is because of Eskom. Since the 1970s a symbiotic co-dependency has developed and this is now unravelling. Eskom’s legacy power stations and the type of coal that they use is set out below (Medupi and Kusile’s Calorific requirement being 20.4MJ/kg and 18.8MJ/kg respectively).

Station	Location	Nominal Capacity (MW)	Age in 2014(Design life 30 years)	Expected Calorific Value of Coal (MJ/kg)
Arnot	Middleburg, MP	2 232	38	23.8
Camden	Ermelo	1 480	42	24.2
Duhva	Witbank	3 450	34	21.9
Grootvlei	Balfour	1 090	44	21.4
Hendrina	MP	1 865	43	22.2
Kendal	Witbank	3 840	25	19.2
Komati	Middelburg MP	791	52	21.0
Kriel	Bethal	2 850	34	23.1 (units 1-3)20.5 (units 4-6)
Lethabo	Viljoensdrif	3 558	28	16.0
Majuba	Volksrust	3 843	17	21.4
Matimba	Lephalale	3 690	27	20.4
Matla	Bethal	3 450	34	20.5
Tutuka	Standerton	3 510	28	22.5

Eskom historically contracted with coal companies to build mine-mouth plants to utilise low-grade, cheap coal that is transported to Eskom’s power plants via a conveyer belt. Domestic coal supply contracts have been long-term on either a cost-plus basis or at fixed price contracts. According to the IEA, in 2012, the cost of coal represented 27% of Eskom’s total operating costs reflecting Eskom’s relatively low fuel costs. Higher grade coal has been exported. This is critical, because the ability to export provides the required investment returns. Sales to Eskom of low grade coal at low prices get balanced by export of high quality coal on international markets where about 20% of the world’s hard coal output is traded. Eskom hasn’t had to compete on price for its own grades of coal.

More recently, India has emerged as a new market and it too has built its power stations to a low grade coal specification. India has its own vast coal resources but is unable to keep up with demand. Until 25 years ago, nearly all the coal used in India was produced locally, it now imports a quarter of its demand from Indonesia, Australia and South Africa. For the first time, Eskom has had competition for product that only it could use. Further, new techniques in beneficiation of low grade coal (via washing) allows for an increase in the calorific content to export quality, making Eskom’s prices for the unwashed coal less attractive. What remains after washing of low-ish grades is coal that is even lower than Eskom’s minimum requirements.

At the same time, the Central Basin coal reserves in Mpumalanga, where South Africa has sourced most of its coal, are depleting and remaining reserves are a poorer quality to that which has been mined. Contracted supplies from cost-plus mines such as the Optimum mine, are beginning to fall short of Eskom’s quality or quantity requirements and these older coal mines with declining grades of coal are becoming uneconomic. Eskom itself say that its cost plus mines’ production rapidly deteriorated since 2007 and, every year since, they have performed below their own budgets. In response, Eskom has had to move to other types of contracting, based on spot prices but replacing coal transported from the mouth of a mine via conveyer belts with coal means that potentially lower prices are off-set by rail and road transport charges. The graphic below shows the changing mix of Eskom’s coal supply contracting terms as well as the means that it is delivered.

One option is to source more coal from the Waterberg region in Limpopo (where Medupi is being constructed). Other potential coal resources exist but are not technically or economically viable. However, for the Waterberg to become a viable source of coal supply to Eskom’s power stations in Mpumalanga, substantial investment in the rail infrastructure is needed. An overview of the existing position is set out below:

If Transnet is to make the investment needed to increase rail capacity to the Waterberg, then it would have to include infrastructure for coal destined for the export markets via the Richard’s Bay terminal (an under-utilised facility). This then puts Eskom in direct competition for supply with export markets. It is understood that supplies from the Waterberg will come with an increase in coal costs beyond the R350/t budgeted in the Integrated Resource Plan 2013 update. While production costs for Waterberg coal are much cheaper, according to a study done by Macquarie Bank in 2013 transport and beneficiation costs push delivered costs of coal from the Waterberg, to R410/ton.

There have been calls to address the problem of competition from export markets by declaring coal a “strategic resource” but this does not solve the problem. Doing so would undermine the commercial basis for Transnet to expand the rail infrastructure to the Waterberg. In any event, there has been a substantial under-investment in the coal mining sector. Other than Sasol’s own endeavours to secure its coal supply for its Secunda synfuel plant, very few new coal mining developments have been brought online for more than a decade.

This is where the COP21 agreement now comes into play. New investments in coal mining in a context of over-supply and declining prices don’t make any sense. The falling price of coal on international markets and a glut of supply makes the coal sector a relatively risky proposition. Any funding going into new coal mines is likely to become increasingly contested, cutting off funding that might otherwise have been available. Some describe what is going on as “The War on Coal”. Certainly, the risks of a much needed new investment (from Eskom’s point of view) in coal mines is much higher than ever. All this undermines the commercial basis to expand the rail infrastructure to the Waterberg. What this means is that the move away from coal, bolstered by COP21 does some of the same things that declaring coal a strategic resource – it undermines the case for new investments in coal. Eskom describes the coming coal shortages as follows:

A 40 Mtpa requirement translates into about 10 new mines that need to be opened up in SA for Eskom’s requirements alone. Eskom estimated in 2013 that the capital expenditure to meet this requirement amounted to R100 billion alone. Little has been invested and this then describes our impending coal cliff. It also makes Eskom’s efforts to transform the coal mining industry by procuring 64% of its coal supply from emerging miners a very tricky process. How does one secure financial viable BEE owned mines while keeping the cost of that supply as low as possible? COP21 has just made it even more difficult.

Perhaps the only option is for the government itself to put up the upfront costs of building mines by reallocating this type of construction as an investment into “infrastructure”. While Eskom and the coal industry, particularly the new BEE entrants might urge such a step, the real question is whether this will make any financial sense. Investing in the supply of coal that world leaders in Paris just agreed to buy a lot less of looks increasingly like a decision that taxpayers will have to fund. Some very tough decisions await us all. What is entirely unacceptable is any view that suggests that, in a post-COP21 world, Eskom can secure its future through ever-increasing tariff charges or that it can continue as it did before. DM

Photo: Coal is loaded onto a truck at the Woestalleen colliery near Middleburg in Mpumalanga province, September 8, 2015. REUTERS/Siphiwe Sibeko