In my February newsletter, I discussed the deteriorating state of infrastructure in the U.S. The 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 .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.
As I was finishing that essay, South Africa showed me a textbook example of what happens 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 network. 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 demands. 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 gold. The miner laid off 5,000 workers in February in order to return to profitability. 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 production. ArcelorMittal faced a similar situation, and may have to import steel to supply customers at a higher cost. 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 Koeberg. 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 plant. Eskom warned the South African government a decade ago that unless more power plants were built, the country could suffer a supply deficit by 2007. 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%.
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 firms. These companies may have to move offshore where they can get steady electricity or shut down. A company that makes plastic milk bottles claims its losing 4 million Rand per week due to the power fluctuations (approximately USD 0,000). 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".
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 subsidies. 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 kilowatt. 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 milliontons. 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 BEE. 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 suppliers. Frequently, it's full of rocks and is so fine it turns into mud in the rain. 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.'
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 2005. 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.'
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 2011. 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 market. 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 attempts. 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.
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 Korea. 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.
Copyright © 2008 Jennifer Barry
