American Society of Civil Engineers awarded a grade of "D" to the country’s roads, dams,
sewers and other structures, and estimated it would take $1.6 trillion in spending over five
years to raise the grade to "B." I argued that remediating America’s infrastructure was
necessary to continue as a prosperous, First World nation.
when you let neglect go on too long. Their government announced a "national emergency" on
January 25, 2008 as the instability in the power grid threatened collapse of the network1. The
government owned utility Eskom ordered the largest mines to close and cut power to millions
of homes and businesses, an emergency tactic they call "load shedding." The mines had to
stop work for five days, and then agree to cut back 10% of their usual power demands2. This
crisis is playing out like a chapter from Ayn Rand’s novel, Atlas Shrugged.
While coal and aluminum companies were impacted, the gold and platinum miners suffered
more as their mines are very deep – over a mile below the surface. It’s not safe to send
workers down shafts unless at least 90% power is guaranteed. One large company, Harmony
Gold estimated that the production halt prevented them from mining over 25,000 ounces of
gold3. The miner laid off 5,000 workers in February in order to return to profitability4. Uranium
production may drop as well, since many companies like AngloGold produce uranium as a by-
product of gold.
Other commodities are affected by the electricity instability as well. Last month, Xstrata
declared force majeure in contracts with vanadium and ferrochrome customers as it feared it
would be unable to deliver adequate amounts of these inputs to steel production5.
ArcelorMittal faced a similar situation, and may have to import steel to supply customers at a
higher cost6. Analysts expect a global short term steel shortage as well.
Sadly, this power problem was not new. South Africa had experienced electricity disruptions
several times over the past three years, often caused by technical problems at the nuclear
plant Koeberg7. Earlier in January, terrified tourists at Table Mountain were trapped in cable
cars in mid-air for hours due to a power outage at the plant8. Eskom warned the South
African government a decade ago that unless more power plants were built, the country could
suffer a supply deficit by 20079. Despite the growth trends, temporary excess capacity was
mothballed and maintenance was sorely neglected.
Alec Erwin, the South African Minister of Public Enterprises claims the government is the
victim of its own success in growing the economy so rapidly and connecting black townships
to the grid. However, the boom in the economy was necessary to decrease the high
unemployment rate of 25.5%10.
Now traffic crawls to a standstill when the stoplights go out, and restaurants have to close
since they can’t cook. Some industries are looking at generators or alternative sources of
power, but the price may be too high for small firms11. These companies may have to move
offshore where they can get steady electricity or shut down. A company that makes plastic
milk bottles claims it’s losing 4 million Rand per week due to the power fluctuations
(approximately USD $500,000). Complaints by CEOs of the economic damage have been
belittled by the government, as Trevor Manuel, the Minister of Finance referred to loss
estimates as "overcooked and utter garbage"12 .
As South Africa’s electricity market is dominated by Eskom, a public company, no one knows
what the real cost of electricity is. For years electricity was ample and cheaper than other
developed countries, probably due to taxpayer subsidies13. This encouraged waste by
consumers and high use by industry.
There is evidence that some large industrial customers like BHP Billiton pay less than a third
what consumers pay per kilowatt14. In 2004 when the government decided to open bidding
on new electricity generation, the private sector passed on the opportunity due to Eskom’s
control of 70% of the market.
In addition to growing demand, another problem is loss of generating capacity. During the
crisis, Eskom had an unexpected drop of 9,000 megawatts, enough power to run
Johannesburg three times over. South Africa depends primarily on coal for electricity, and the
country has a shortfall of 20 milliontons15. In addition, the Department of Minerals and
Energy has dragged its feet on issuing more mining rights so that Eskom can source more
coal.
Ironically, in 2000 Eskom had a healthy 61 day supply of coal, so they started a policy to
reduce the stockpile. It dwindled to less than three days supply in January during the height of
the crisis. Without sufficient quantities of coal, the fires aren’t large enough to generate
enough steam for efficient electricity production.
Much of the problem has arisen from Eskom’s rigid interpretation of South Africa’s affirmative
action program, black economic empowerment or BEE16. While there was much oppression
under the former apartheid system, the pendulum seems to have swung too far in the other
direction. The company notonly favored black owned vendors, but moved in 2002 to a strict
"hierarchy of procurement" in purchasing coal. Eskom started by sourcing coal from black
female suppliers, then small black owned companies, then large black firms, then companies
with pro-black practices, and then other suppliers. Only if the first supplier couldn’t
accommodate would Eskom move down the chain to lower priority vendors.
However, it’s the quality of the coal is also a problem. The government blames wet coal,
although coal burns better wet than when dry. In actuality, Eskom purposely sources coal of
such poor quality it can’t be exported. The utility can demand a steep discount from local
suppliers17. Frequently, it’s full of rocks and is so fine it turns into mud in the rain18. Although
even the lowest grade coal has increased in price, the power company refuses to pay more
for its contracts.
Coal companies could no longer be chosen by proximity, so supplies often were trucked in
long distances by haulers chosen in the same BEE hierarchy. In addition, the hauling
companies did not necessarily have experience, they were hired due to their BEE status. One
contractor was allegedly a former interior designer. Eskom continued their penny pinching
ways, paying below market rates for hauling – especially considering the equipment
breakdowns from inadequate roads. Many of these firms went bankrupt, exacerbating the
supply crunch.
While small companies became insolvent, Eskom was very profitable. In 2006, the utility
netted R6.45 billion (about USD $840 million). Over the past three years, the directors
received R57 million in bonuses (equivalent to USD $7.44 million) while the electric grid
disintegrated.
During the crisis, Eskom continued to export electricity despite government statements to the
contrary. Over 1,500 megawatts were delivered to neighboring countries while South African
cities were suffering rolling blackouts.
Eskom has also stumbled due to lack of qualified personnel. Bowing to political pressures, the
skill shortage a union warned Eskom about was ignored in favor of racial and gender quotas.
The utility’s workforce was cut in half over the past 15 years, as technically competent whites
were denied employment. Eskom’s HR department sent out a memo in January 2008 right
before the crisis stating, "No white male appointments for the rest of the financial year."19
South Africa is suffering a "brain drain" as skilled workers – including former Eskom engineers
– continue to emigrate to countries like New Zealand and Australia. Approximately one million
whites left the nation between 1995 and 200520. Most of those whom emigrated due to high
crime and limited economic opportunity were productive workers between the ages of 20 and
40. As the core of the workforce continues to seek jobs elsewhere, the nation suffers as a
result. A South African entrepreneur explained, "Racism in any form, when introduced into the
economy, can only yield what we are now reaping. Economic chaos and failure."21
Instead of addressing the issues that suffocated supply, Minister Erwin stated that the
government will respond to the crisis by squelching demand. Eskom will be ordered to enact
large rate increases, fines, penalties and even disconnection if power use is deemed
excessive. Only a state owned utility would attempt to discourage purchasing their product.
In fact, Eskom’s Finance Director, Bongani Nqwababa told the government to deter
investment in South Africa until 2013 due to the inability to generate more power. Rio Tinto
has apparently taken the utility at their word and has announced they are rethinking the
aluminum smelter in Coega planned for 201122. Incredibly, the government claims there will
be no problems hosting the soccer World Cup in 2010.
Platinum was $1605 when the crisis started. Since South Africa produces 80% of the world’s
platinum supply, the price shot up 43% by early March to nearly $2,300 per ounce. Palladium
is often a by-product of platinum mining and can be substituted for its sister metal, so it was
trading at $600 at one point. Gold did not move up as much as platinum, less than 10%.
In addition, the ratio between gold and platinum is very skewed. It has a 15 year average of
1.52 but it reached a near record 2.379 before moderating to 2.1.
It’s true that South Africa doesn’t dominate gold production any more, as it dropped to the
second largest supplier last year at 11.1% of the market23. However, with increasing demand
from the Chinese and the Indians getting back into the market (per Le Metropole Cafe), the
price should have jumped more.
At the G-7 meeting in early February, the IMF once again threatened to sell tons of gold,
despite the fact that the U.S. Congress has repeatedly blocked past attempts24. As I
mentioned in earlier writings, central banks including the Federal Reserve have colluded to
suppress the price of gold which makes their fiat paper currencies look stronger in
comparison 25.
As I discussed last month, infrastructure development and rebuilding is a key trend in today’s
world. Not only can you invest in this area profitably, countries that fail to maintain their
infrastructure deserve
your attention. Even if a country has good mining laws and is politically stable, it has to
ensure that industry can work efficiently and move its products to market.
Last year, the South Africa was ranked the 18th most popular destination for foreign direct
investment by corporate executives. This was a major improvement over 2006, besting
Mexico and South Korea26. That opinion is likely to change sharply. I expect South Africa to
fall out of the top 25 nations in 2008 due to continued uncertainty over power generation,
despite government promises of additional electricity.
1.
http://uk.reuters.com/article/oilRpt/idUKL3193446320080131?pageNumber=2&virtualBrandC
hannel=0
2. http://www.ft.com/cms/s/0/253b5a24-ce8d-11dc-877a-000077b07658,dwp_uuid=4f00dc36-
aef2-11dc-880f-0000779fd2ac.html?nclick_check=1
3. http://www.stratfor.com/analysis/southern_africa_recurring_regional_power_shortages
4. http://www.miningweekly.co.za/article.php?a_id=127103
5.
http://www.reuters.com/article/rbssIndustryMaterialsUtilitiesNews/idUSL0177028720080201
6. http://www.engineeringnews.co.za/article.php?a_id=125554
7. http://www.eskom.co.za/annreport06/info_westerncape.htm
8. http://www.telegraph.co.uk/news/main.jhtml?xml=/news/2008/01/23/wcape123.xml
9. http://www.guardian.co.uk/world/2008/jan/25/southafrica.business
10. http://www.nytimes.com/2008/01/31/world/africa/31safrica.html
11. http://www.mnet.co.za/Mnet/Shows/carteblanche/story.asp?Id=3444
12.
http://www.int.iol.co.za/index.php?(click_id=13&art_id=vn20070128093211290C122218&set_i
d=
13. http://www.moneyweb.co.za/mw/view/mw/en/page662?oid=188775&sn=Detail
14.
http://www.mg.co.za/articlePage.aspx?articleid=331969&area=/insight/insight__economy__b
usiness/
15. http://www.miningweekly.co.za/article.php?a_id=125940
16. http://www.southafrica.info/doing_business/trends/empowerment/bee.htm
17. http://www.miningmx.com/energy/905300.htm
18. http://www.moneyweb.co.za/mw/view/mw/en/page38?oid=190463&sn=Detail
19. http://www.mnet.co.za/Mnet/Shows/carteblanche/story.asp?Id=3444
20. http://www.fin24.com/articles/default/display_article.aspx?ArticleId=1518-25_2003186
21. http://www.evancarmichael.com/African-Accounts/1492/SMEs–The-impact-of-the-current-
power-crisis-in-South-Africa.html
22. http://www.ft.com/cms/s/0/1c872d20-ce0d-11dc-9e4e-
000077b07658,dwp_uuid=4f00dc36-aef2-11dc-880f-0000779fd2ac.html
23. http://www.goldsheetlinks.com/production.htm
24. http://www.businessday.co.za/articles/topstories.aspx?ID=BD4A703147
25. http://www.lonestarsilver.com/news_8-31-04.html
26. http://www.atkearney.com/res/shared/FDICI_2007.pdf
