Eskom prepayment contracts are for business needs and the benefit of its customers
Saturday, 17 September 2016: A lot has been said in the media space regarding Eskom’s use of the prepayment method in order to secure coal supplies, with most commentators having a misguided perception that this practice is wrong. Nothing is further from the truth. Prepayment is a common commercial practice that is used widely and not unique to Eskom contracts. Over the years, contracts were put in place due to a genuine business need, concluded on commercial terms, and yielded benefit to Eskom and its customers.
Eskom procured coal from Tegeta and Umsimbithi, who were the only companies able to deliver the additional tonnage of the required coal, to mitigate the risk of load shedding during winter.
During the 2008 electricity supply emergency, the Eskom Board approved advance payments to the value of R400 million to enable suppliers to undertake projects needed to supply coal.
Specific cases that can be cited are: (i) a prepayment in the form of a loan was provided to Liketh Investments and this loan was recovered in 12 consecutive instalments; (ii) Eskom has historically invested in the Khutala Colliery with a structured loan agreement to assist Rand Mines for the commissioning of the mine; (iii) In cost-plus mine contracts, Eskom invested (future fuel)/pre-paid in the mines to start up the mining operations. It subsequently pays for the operating costs and a management fee. In return Eskom receives security of supply at the right qualities and volumes. This contracting methodology also reduces Eskom’s cost of coal to the extent of the upfront investment made. The cost plus contract counterparties are Anglo, Exxaro and South 32 (formerly BHP Billiton); and (iv) Recently, in October 2015, Exxaro requested full funding of its Matla cost-plus operation capital requirement. The estimated cost requested by Exxaro is R1.8bn for the establishment of a new mining shaft.
Eskom obtained independent intelligence of a potential protest action at Rietkuil and surrounding areas in December 2015, which increased the security of supply risk, prompting a declaration of an emergency. Continued monitoring of the security of supply risk from January to March revealed that Eskom needed to build up its coal stock requirements. Umsimbithi experienced strike action around this same time, which placed a further strain on stock levels prompting an immediate need for additional coal.
Subsequently initiatives were pursued which resulted with eight (8) companies supplying coal to Arnot Power Station in January 2016. However, this was a temporary and sub-optimal measure as the coal was not all of the required coal quality for Arnot Power Station. This meant a deficit of 2.1 million tons remained for the station’s winter supply plan. Hence an alternative solution was needed to source the required coal quality due to the adverse effect on generation plant performance and maintenance as well as to mitigate the risk of load shedding.
In April 2016, Umsimbithi and Tegeta, were approached to increase supply to mitigate the shortfall. Both suppliers were able to meet Eskom’s requirements for additional coal quantities at the required coal quality which resulted in approval for the extension of both contracts.
Tegeta indicated that the required coal quality can only be sourced if they divert their export quality coal to supply Eskom. In addition, there was an indication that additional equipment was needed to reach the required tempo of coal delivery to Eskom that would mitigate the shortfall. Tegeta mentioned these as the factors that led the company to request a prepayment from Eskom.
Umsimbithi indicated that they were able to supply additional coal with no additional resource requirements.
Eskom concluded a contract with Tegeta to supply 1 250 000 tons of coal from April to September 2016 and obtained approval to extend the contract with Umsimbithi to supply 540 000 tons from June to September 2016. These two contracts in our view sufficiently addressed the winter shortfall and security of supply risk relating to coal procurement.
The Tegeta prepayment request was considered on its merits, which were the current security of supply risk circumstance and previous transactions of a similar nature which is outlined above.
Additional conditions relating to the prepayment included a 3.5% prepayment discount on the coal price and sufficient security guarantees. The coal CV requirement was increased due to the prepayment request. In addition penalties would be applicable in the event that Tegeta does not provide the contracted qualities.
We can confirm that the full amount of the prepayment to Tegeta has been recovered via coal delivered to Eskom by the end August 2016. During this period of time Eskom had sufficient security in place to cover any potential default by Tegeta.
These transactions have enabled Eskom to commit to no load shedding during the winter peak period which is a significant commitment to the country.
An internal audit review has been conducted and concluded that the process followed for the procurement and prepayment complied with the Public Finance Management Act and National Treasury regulations.
To ensure long term security of supply to the Arnot Power Station the current RFP process is in the contract negotiation stage and is projected to be concluded this month. It is noteworthy that Tegeta is not one of the respondents to this RFP that has been issued to the market.
Statement issued by Eskom, 17 September 2016
