This is an important post. I will try and point out why Eskom's coal needs, Botswana's power needs, Botswana's coal development needs and western coast of India's coal import needs are very interconnected and will struggle to flourish without each other. All this enhances the desirability of Conti's Botswana coal assets.
Eskom is the state monopoly power producer in South Africa. Most of the domestic thermal coal supply in South Africa goes to Eskom (some goes to Sasol too). Escom is also the major power supplier to Botswana. Eskom has been struggling to maintain reliable power supplies to South Africa and Botswana and the situation has got pretty bad in recent times.
For obvious demand reasons, Eskom is a key player for the South African coal industry. Besides, pre-agreed offtake arrangements with Eskom is essential for miners to fund their capex needs - lending banks would ask for this security. The smaller the miner, the more important is this pre-agreed offtake arrangements to get finance. Eskom does these offtake arrangements because this assures them of longer term coal supplies. They can also bargain pretty hard on prices with a small coal miner who are at a relatively weak bargaining position at a pre-finance stage. To the best of of my understanding, average gross margins on offtake contracts is no higher than $7 a tonne (and could be lower). While this can assure finances and positive gross margins, this is usually not high enough to cover fixed costs, capex costs, overhead costs and so on. Miners need to sell part of their coal to the export market through RBCT (or smaller ports at Maputo or Durban)where the prices and the margins are larger (costs are larger too as the coal has to improved to export specifications). It is these higher export margins which allow the small miner to make positive net profits. You can can see why the miner would need both the Eskom offtake contracts and the export allocations to be successful.
Why does Eskom pay such low gross margins for its coal? The most important reason is that being a state owned power monopoly operating in a relatively poor country, they are restricted by the lower power charges that they can charge their power customers. Correspondingly, their input costs need to be lower.
Eskom is worried about their long term supplies in two ways. Here is a recent article talking about both these ways: http://www.bdlive.co.za/business/energy/2013/01/31/eskom-coal-supply-crisis-on-the-horizon
Firstly, they worry that the coal export market may threaten their long term supplies - sometimes they talk about asking the South African government to make coal a national strategic resource and prevent too much exports. But if you think, you will realize that Eskom cannot have it both ways: a low domestic coal price as well as a low export potential for a miner. As argued before, nobody will develop coal mines without the export potential. It is the promise of higher export prices and volumes which is why a coal miner will at all develop their resources to make profits. So, South Africa needs its export business to flourish if they want their domestic coal supplies to be secure at low domestic prices.
Secondly, the future for South African coal industry is the largely untapped resources in Waterberg region. Witbank-Mpumalanga area is really the past of South African coal industry as most of the coal has already been extracted. Of course, this makes Conti's Witbank assets even more valuable because this is where all the demand is - close by power plants, close by RBCT and good Transnet network. In fact it is the success of the Witbank area's infrastructural network which has hampered the development of the Waterberg coalfields - no good railway network, no nearby export terminals or power plants. On their own, an individual coal miner will be daunted by the cost aspects of developing Waterberg infrastructure. This is what is called a Classical free rider problem in Economics. Most importantly, a miner needs easy access to a nearby export terminal, because again, it is the attraction of the exports which will drive the domestic supplies. If RBCT is too far away, you may need build a nearer port facilities for exports. This is of course going to be very costly there with associated railway network needs- how do you make it more cost effective for an individual player?
In comes Botswana into the discussion. Botswana is a country which amazingly holds more than 60% of entire Africa's thermal coal resources. And would you believe it - it has 'ONE' working coalmine in Morupule. The coal mine supplies to a nearby small power plant. Conti has a tenement near Morupule - not entirely unattractive being next to the only working coal mine in a country - should be relatively attractive to a potential bidder too.
One problem for Botswana is that it is landlocked - it needs to build a seaport in an adjacent country and access to it. See the discussion here: http://www.miningmx.com/news/energy/India-coal-demand-to-power-Botswana.htm
Botswana coal is considered somewhat inferior to South African coal and this was considered a worry. But no longer so. India recently has shown an interest in this slightly inferior coal. Last summer, Jindal bought a tenement from CIC Canada for about $115m. Jindal wants to build power plants in Botswana and possibly export to coal India if and when an export route becomes available. See the story here: http://articles.economictimes.indiatimes.com/2012-09-06/news/33649902_1_jindal-steel-power-cic-energy-sushil-maroo If Jindal certifies the quality of the coal - you can bet the bottom dollar that it is good enough for a lot of the Indian needs. Elsewhere, I have seen Coal India expressing desire to hold Botswana coal reserves - that also must mean that the coal quality is okay. Eskom already uses coal of similar thermal calorific value in its power plants. Now the beauty of the situation for us is that a second of Conti's tenement is near Jindal's coalfields (I think the Kwaneng one with the Jorc resources of 2.2 b tonne) - this should interest a player like Coal India who along with Jindal can be a formidable financial combination to invest on common infrastructural development needs.
Lastly, geologically some of Conti's Botswana resources are contiguous to the Waterberg reserves of South Africa - some of the coal seams extend into each other. These area should be jointly developed together with support from the South African and Botswanan government. Read the port and railway discussion again on http://www.miningmx.com/news/energy/India-coal-demand-to-power-Botswana.htm It does a look a very good bet that Waterberg and Botswana's contiguous areas would be developed together.
And if they are developed together and have a common future, then some of RBCT owners (like Exxaro, Anglo Coal, Glencore, BHP) may also have interest in Conti's Botswana assets. They anyway have to refocus on Waterberg area once Witbank dies to have continuing interests in South African Coal. This leads to the possibility of second strong bidders on Conti's Botswana tenements.
India is the export play for South Africa anyway at the moment with 32% of RBCT exports and growing every year. This will continue to grow as long as the power needs of the west coast of India continue to grow - this is the part of India with highest industrial power needs. Coal India domestically cannot satisfy all the coal for these power needs.
Things are falling into place. Will Conti's management see all these links - connect the dots and organize good auctions with at least 2 strong bidders in Botswana - the pieces are all there. Do they want to? If not, why not?
CCC Price at posting:
5.8¢ Sentiment: Buy Disclosure: Held
