Eskom to buy $3.7B rand annually worth of exportable coal

Unloading coal at the port of Nakhodka, Russia.

South Africa’s Eskom has coal market observers scratching their heads after the public utility announced plans to purchase expensive, export-quality coal from Glencore’s (LON:GLEN) Optimum Coal.

The move comes amid concerns that Eskom, which has been criticized for its policy of “load shedding” (rolling blackouts) during peak power periods in order to provide enough electricity for its user base, will not be able to source enough coal from existing contracts.

Eskom needs between 22 million and 40 million tonnes of coal a year from new suppliers over the next decade. However, with big coal producers like Anglo American (LON:AAL) and BHP Billiton (NYSE:BHP) trying to exit the domestic market, “Eskom might have to enter into very expensive agreements for export-quality coal – as is now being contemplated with Glencore,” the Sunday Times reported.

The deal to buy 5 million tons of coal a year from Optimum Coal is worth R3.7 billion ($318.5 million). The company, of which Glencore owns a stake, produces about 10 million tonnes a year of coal a year from its underground and open-pit mines, with about half purchased domestically by Eskom, and the other half exported.

However the coal that Eskom would be buying from Optimum is unsuitable for use in South Africa’s power stations, meaning it will need to be blended down, at considerable cost, The Sunday Times cites an industry expert as saying. “I think it is the most crazy thing … in the past century,” said the expert, who could not be named due to sensitive contracts with the parties.

In January Optimum Coal announced it was considering closing several of its South African mines in order to reduce production by at least 5 million tonnes. The decision followed a review showing that the company’s operations have been running at a loss for the last two years due to slumping coal prices.

Meanwhile Eskom, which is struggling to build power plants to keep up with electricity demand and end its controversial load-shedding program, will reportedly be bailed out by the government. The Times reports that the company will receive 10-billion rand by June, another R10 billion in December, and possibly another R3 billion next year. The government expects to find the money by selling state assets, including a stake in mobile phone company Vodcom, a unit of Vodafone, Fin24 reported in February.