Moneyweb News

Shooting from the hip

Author: Ryk van Niekerk|

17 September 2012 08:29

BHP Billiton power skeletons rattle again

Article tools

Print
Send
Subscribe to newsletters
Feeds

New revelations of below cost electricity tariffs will reignite debate.

JOHANNESBURG - BHP Billiton’s (JSE:BIL) electricity skeletons are staring to rattle again. New revelations show that the multinational only pays around a 10th of the price of electricity for its Richards Bay aluminium smelters, than normal consumers do.

It also suggest that BHP Billiton pays even less for electricity than two years ago and that the price it pays is significantly lower than it costs Eskom to generate and distribute it.

The allegation comes from the DA’s Pieter van Dalen. He contends that BHP Billiton pays between 8.8c/kWh-10c/kWh for electricity, while normal consumers pay as much as 120/ kWh. If it is true, consumers are subsidising the production of aluminium for one of the largest companies in the world with minimal benefit to the local economy.

The fact is that the smelters use a lot of electricity. They use approximately 5.7% of the production capacity of Eskom, or enough power to supply a large city. It is also equivalent to 60% of the electricity generated by a large power station.

Unfortunately, the generation and distribution of this electricity to the smelters is a lot more expensive. In 2010 Eskom’s acting Chairman Mpho Makwana said in parliament that the cost price was around 42c/kWh. Even at this price, it suggests that BHP Billiton only pays for around 25% of the generation and distribution costs.

The reality therefore is that not only does the smelters hog a large chunk of Eskom’s generation capacity, it also reduces the generators profitability and financial position. It is a massive liability.

The situation is however very complicated, as the contracts for the supply of electricity was signed in the 1990s and early 2000s. Although conditions were different then and Eskom had an abundance of electricity to sell, Eskom clearly did not do its homework. The contracts used foreign derivatives to calculate the price BHP Billiton pays for electricity, while it was for 25 years. Apparently there is no contingencies build into the contract, and no escape clause should Eskom run into supply problems.

The period of 25 years is also extremely unusual. The international standard for aluminium contracts range from two to five years.

As national editor of Sake24 before I moved to Moneyweb last year, I was closely involved with Jan de Lange’s Public Access to Information Act (PAIA) application to Eskom. Jan is a seasoned investigative journalist and he did excellent work to unravel the details of the contracts.

His research led to a PAIA application that asked three simple questions:

1. What were the duration periods of the contracts?

2. What formula was used to calculate the price BHP Billiton should pay for electricity?

3. Who signed the contracts on behalf Gencor (the predecessor to BHP Billiton) and Eskom?

In PAIA terms, it is a very straightforward and simple application. It was submitted in 2009 and despite an affirmative High Court judgement, and a denial for leave to appeal, smart legal footwork from BHP Billiton has resulted in the case being referred to the Supreme Court of Appeal in Bloemfontein.

Although very disappointing, the three-year delay has made the simple PAIA application virtually irrelevant, as sufficient information emerged in the public domain to answer Jan’s questions.

The answers to the first two PAIA questions are:

1. BHP Billiton currently pays between 8.8c/kWh and 12c/kWh. The source of this information is an Eskom management report that was leaked to Van Dalen and the media two years ago. Van Dalen’s latest claim of around 10c/kWh concurs with this ballpark.

2. The dates of inception and termination of the contracts appear in the table below. The Department of Public Enterprises revealed these periods last year in response to a parliamentary question from Van Dalen.

Name of smelters

Start Date

End Date

Bayside

August 1995

July 2020

Hillside Potlines 1&2

August 1995

July 2020

Mozal

April 2001

Mar 2026

Hillside Potline 3

July 2003

June 2028

3. The answer to the third question as to who signed the contracts, is slightly more complicated. From the starting dates of the first two contracts (Bayside and Hillside 1&2), the assumption can be made that the actual contracts were signed between 1992 and 1993. The construction of such a smelter takes approximately two years, and the start of the construction work would be dependent on a signed contract. Interestingly, the current Xstrata CEO Mick Davis was the Eskom financial director at the time. He would have been closely involved with the negotiations and it may even be possible that he signed the contracts on Eskom’s behalf.

4. This is where it really becomes interesting. Davis resigned from Eskom in August 1993. Two weeks later, on September 1 1993, Gencor announced that Davis would be appointed to its board early in 1994. In a related development, Flip Rademeyer, who was later the FD of Sanlam (JSE:SLM) and who was destined to become the Eskom FD immediately resigned, as Davis was effectively appointed above him.

This in itself does not prove any misconduct, but raises the question why BHP Billiton is defending the PAIA application with such aggression.

It also does not explain who signed the contracts for the Mozal and the Hillside Potline 3 in 2001 and 2003, which is believed to be very similar to the first two contracts.

The current situation is exacerbated by an apparent deadlock between Eskom and BHP Billiton, as the companies have not been able to renegotiate the supply agreement for the Richards Bay smelters. In 2010 the companies quickly renegotiated the supply contract to the Mozal plant in Mozambique, but two years later the parties have not been able to do the same for the Richards Bay operations.

The key questions remains: Were the contracts signed in good faith? Can the deadlock be resolved amicably? Will the authorities handle this mess properly?

Topics: BHP Billiton, Richards Bay aluminium smelters, Eskom,



Site comments powered by Disqus

Similar articles

Articles with the same people

Articles with the same company

JSE Today
All Share
Daily indicators
Winners & Losers
All share

Editors' Picks

Special Investigations

SuraPure owes R41m

More than 98 000 members.

Investment Insights

How many Top40 shares are ‘buys’?

Consensus views have their limitations.

NEXT ON MONEYWEB X