South32 sees opportunity to work with Eskom on further coal supply

24th August 2015

By: Martin Creamer

Creamer Media Editor

  

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JOHANNESBURG (miningweekly.com) – New diversified mining company South32, which on Monday reported 56%-higher underlying earnings of $1-billion, sees an opportunity to work with Eskom on additional coal supply.
 
The demerged BHP Billiton entity, which is fast-tracking the implementation of its regional operating model in South Africa, currently has three primary contracts in place to supply coal to the State electricity utility.

“Our relationship with Eskom is strong, not only on the coal supply side, but equally as important on the Hillside aluminium smelter side and how we are managing our way through the load-shedding that’s currently going on in South Africa,” South32 CEO Graham Kerr told the media in a global conference call in which Creamer Media’s Mining Weekly Online took part.

South32 COO Africa Mike Fraser revealed that the company – which pleased analysts on reducing its net debt level to $402-million and thus supporting its BBB+/Baa1 credit ratings from Standards & Poor’s and Moody’s – was currently in discussion with Eskom on the recapitalisation of the Khutala coal mine in Mpumalanga, where there were options to extend the underground operation, sink new shafts or move into opencast mode.

“That’s all going to require capital and the conversation with Eskom at the moment is do we take this on South32 risk and enter into a fixed-term coal supply contract, or do we continue with the current cost-plus arrangement,” said Fraser.

Although there were still five years to go before that investment decision needed to be made, the dialogue was already under way.

Eskom’s current preference, as enunciated by acting CEO Brian Molefe, is to move away from cost-plus arrangements and to invite tenders for coal supply as Eskom’s balance sheet provides little leeway for the utility to continue to mine upstream coal assets when its primary draw on capital is for investment in generation capacity and power distribution.

South32, in contrast, has a large coal resource and sees opportunities to participate further in the domestic market.

Of the ASX-, London- and JSE-listed company’s three primary contracts with Eskom, only Khutala is a cost-plus mine. At Duvha and for other short-term contracts, South32 supplies coal to Eskom on fixed-price contract.

With regard to Eskom’s current policy position of requiring coal to be supplied by companies that are black controlled in a 50%-plus-one share arrangement, Fraser said that while South32 was absolutely committed to meeting Eskom’s requirements and while the company was fully empowered in terms of South Africa’s Mining Charter as well as this country’s black economic empowerment (BEE) code, there was an emerging realisation that Eskom was unlikely to meet all its volume requirements with that expectation.

“If you talk to Eskom and you talk to certain members of the African National Congress, I think there’s a recognition that … to meet volume requirements, Eskom is going to have to have some flexibility on how it thinks through that. But we’re absolutely committed to meeting their requirements and we’re fully empowered in terms of the charter as well as the BEE code,” Fraser added.

Kerr said that any investment decision South32 made on its Khutala and Klipspruit collieries would require board decisions from mid- to late 2017, when the company would require both regulatory and commercial certainty from Eskom, which was already providing the right indications.

“We see an opportunity to work together,” Kerr added.

The forecast drop of 15% in domestic coal production over the next two years reflected the cessation of operations in Khutala’s openpits as well mining taking place further and further from the shaft.

“What we’ll do over the next three to five years is come to the right answer, with Eskom, on the correct position at Khutala; and there is a lot of upside for Eskom if we can get it right, because it’s right next to Kendal power station, which is one of the more modern forms of generation capacity and we can supply a lot more of the coal that Kendal needs if we move into a much bigger operation. But that’s in the conversation and it’s a live debate with Eskom at the moment,” Fraser explained.

On the risk of Eskom imposing penalties on coal specifications not being met, he said the company did not face that risk as it was strongly incentivised to meet quality requirements.

MANGANESE ANGST

On the current state of South32’s manganese operations, Kerr said that a review was under way of both the manganese alloy business and also its manganese mining business following last year’s closure of three of the four furnaces at Metalloys, which at full production required 800 000 t of manganese ore a year supplied from South32’s Wessels and Mamatwan manganese mines in the Northern Cape.

“We have to make a decision on the optimal ore production out of the Kalahari because the market is such that it is unlikely to be able to take another 800 000 t of ore, which is why the review flows all the way back to our ore business,” Fraser explained.

ISIZINDA ALUMINIUM

Kerr said in response to Mining Weekly Online that the acquisition of South32’s Bayside aluminium casthouse in Richards Bay by South Africa’s black-controlled  Isizinda Aluminium had been concluded on June 30, and the agreed 96 000 t/y of liquid aluminium was being supplied to Isizinda, in which the 100% black-owned Bingelela Capital has a 60% shareholding and the JSE-listed Hulamin 40%.

Isizinda has concluded a R10-billion, five-year aluminium slab supply agreement with Hulamin for 96 000 t/y.

"It’s a good working example of the manner in which our aluminium smelter is still adding value to South Africa in terms of job creation and further downstream processing,” Kerr added.

Isizinda, together with South32 and the Richards Bay industrial development zone, are evaluating further phases of development to expand the casthouse to beyond 96 000 t/y of slab with other value-added products that could include extrusion billet, rod, wire, rim alloy, slugs and a dross plant to support downstream aluminium growth.

In the next three years, South32 is seeking to reduce controllable costs by at least $350-million a year with CFO Brendan Harris commenting that the cash generating capacity of the company’s asset portfolio and strong balance sheet were key points of differentiation for the company, which intends distributing a minimum 40% of underlying earnings as dividends to shareholders in each six-month reporting period.

It is also seeking to reduce sustaining capital expenditure (capex) by 9% to $650-million in the 2016 financial year, with this rate of expenditure expected to be maintained on average over the company’s planning horizon.

The company has designed a strategy that is intentionally simple and enabled by the regional operating model, which includes reducing layers of management, aggregating functional support at the regional head offices, fostering stronger relationships with stakeholders and optimising the procurement function.

On a proforma basis, cash generated from continuing operations increased by 35% to $1.84-billion in the 12 months to June 30, up on the $1.36-billion in the corresponding period last year.

Proforma capex of $768-million included stay-in-business capex of $578-million and major project capex of $51-million t the Appin Area 9 underground extension at Illawarra metallurgical coal in Australia, which is coming in ahead of schedule and 20% under budget.

Capex associated with the premium concentrate ore project at Gemco manganese in Australia and the second phase of the central block project at the Wessels mine in South Africa is included in South32’s share of capex associated with equity accounted investments of $139-million.

Edited by Creamer Media Reporter

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