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Cablegate: South Africa: Minerals and Energy Newsletter "the Assay" -

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SUBJECT: South Africa: Minerals and Energy Newsletter "THE ASSAY" -
Issue 12-1, December-January, 2008


This cable is not for Internet distribution.

1. (SBU) Introduction: The purpose of this newsletter, initiated in
January 2004, is to highlight minerals and energy developments in
South Africa. This includes trade and investment as well as supply.
South Africa hosts world-class deposits of gold, diamonds, platinum
group metals, chromium, zinc, titanium, vanadium, iron, manganese,
antimony, vermiculite, zircon, alumino-silicates, fluorspar and
phosphate rock, and is a major exporter of steam coal. South Africa
is also a leading producer and exporter of ferroalloys of chromium,
vanadium, and manganese. The information contained in the
newsletters is based on public sources and does not reflect the
views of the United States Government. End introduction.

--------
HOT NEWS
--------

--------------------------
Energy Crisis Developments
--------------------------

2. (SBU) As of January 31, most South African mines and plants are
back in production, but Chamber of Mines Technical Advisor Dick
Kruger has told the Embassy that mines are receiving only 80 percent
of power needs. This is less than the 90 percent promised by Eskom
and is, according to Dick, likely to stay at this level for some
time. This means that mines may have to implement staggered
operations with the concomitant slowing of production. Major mines
and plants in South Africa have been at a standstill since January
25 when Eskom could no longer guarantee sufficient power to operate
and ensure workers health and safety. Estimated production losses
for the gold and platinum mines alone exceed $40 million per day.

3. (SBU) In the interests of safety, Eskom agreed to provide
sufficient power to allow maintenance crews underground to ensure
safe conditions when the mines re-opened. As power supply
stabilizes and mines ramp up to full production, they have agreed to
cut back on power demand by 10 percent. AngloGold's Mponeng mine
voluntarily reduced power consumption by 30 percent in advance of
the crisis, according to the mine's General Manager. However, as
Hernic Ferro-chrome Operations Director Jasper Pieters put it, 10
percent less electricity means 10 percent less production.

4. (SBU) Coal supply to Eskom has also been severely compromised by
the weather and stocks are at an all-time low. Major coal suppliers
are working at full throttle and have agreed to provide an
additional 5 million tons per month for the next three months to
build up stocks. The weather has also caused production problems
for open pit mines and material handling systems. The Minister of
Public Enterprises has indicated that if the coal supply situation
does not rapidly improve, the SAG may impose emergency measures to
divert some export coal to power stations. The impact of mine
closures on small mines and coal suppliers is not known, but could
be severe.

----
GOLD
----
---------------------------------
SA Still on Top but for how Long?
---------------------------------

5. (SBU) South Africa has been the world's biggest producer of gold
since 1905, reaching a peak output of 1,000 tons in 1970. According
Qsince 1905, reaching a peak output of 1,000 tons in 1970. According
to London-based Gold Fields Mineral Services (GFMS), South Africa
has produced 52,000 tons of gold from the Witwatersrand basin in the
past 122 years, which accounts for 32 percent of all gold mined in
the world to date. Since then, output has steadily declined to the
current estimated production for 2007 of 272 tons, as mines became
deeper, operating costs increased, and gold price and the
rand/dollar exchange rates showed extreme volatility.

6. (SBU) At the same time, Chinese production increased, reaching an
estimated 270.5 tons for 2007. This ranks China as the number two
producer, just short of South Africa's output. South Africa could

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add over one million extra ounces (32 tons) to annual output as
planned production from new mines and expansion projects kick in
over the next three to five years, provided that safety and
electricity disruptions are contained and the gold price continues
its upward march towards $1,000 per ounce, as is forecast by a
number of analysts and (of course) mining companies.

-----------
OIL and GAS
-----------

--------------------------------
Oil Exploration Impasse Deja Vu?
--------------------------------

7. (SBU) Exploration off South Africa's west and south coasts has,
to date, come up with only a few small producing oil and gas fields
in relatively shallow water. However, seismic surveys of deeper
areas indicate potentially favorable oil structures. BHP-Billiton,
the world's largest mining group, holds rights to two deep water
leases off the west coast, which it has attempted to bring to
account for years, but it continues to bump heads with the
government over the conversion of its exploration leases to new
order mining rights, as required by the Minerals Act of 2002.

8. (SBU) A key obstacle is understood to relate to the Department of
Minerals and Energy's (DME) insistence that local courts arbitrate
in disputes while BHP wants the International Court of Arbitration
to resolve commercial disputes - consistent with many oil-producing
countries. The government has also blocked stabilization provisions
that would protect BHP from any future changes in the law. BHP's
old-order sub-leases are believed to include access to international
arbitration and "stability clauses" and the government appears to be
using the conversion requirement to remove these rights.

9. (SBU) The BHP/DME dispute over rights dates back to 2005 when, in
partnership with Occidental Oil (U.S.), BHP planned to begin
drilling a deep well at a cost of about $50 million. The drilling
program would have given South Africa its first deep-water oil
exploration well, but was postponed because of a number of
uncertainties in the new mining legislation. These concern issues
related to production-sharing, conversion of mineral rights, taxes
and royalties, and the decision-making power given to the Minister
of Minerals and Energy. This followed a decision in November 2005
by the board of the oil and gas licensing authority (Petroleum
Agency of SA known as PASA) to reject an application for a permit
for two lease blocks off the country's east coast by Global Offshore
Oil Exploration (a U.S. company) on the grounds that it was "not
happy about the applications process" - Global was one of BHP's
partners in the deep-water venture. The postponement has delayed the
drilling for two years and may delay it again unless the impasse
with the DME is resolved, and provided a drilling rig is available.

--------
DIAMONDS
--------

--------------------------------
De Beers Retains Rights to Dumps
--------------------------------

10. (SBU) More than 130 years of diamond mining has created huge
waste dumps of discarded material around mining areas. Early
Qwaste dumps of discarded material around mining areas. Early
recovery processes were inefficient and large quantities of diamonds
landed on the dumps. The majority of stones are in the smaller
categories but larger stones have been recovered from dump
re-treatment operations. It is now recognized that these dumps
constitute a valuable resource of diamonds and they are being
processed together with mined kimberlite or as a stand-alone
operation. Many have been acquired by small black empowerment
companies. It has always been assumed that the dumps belonged to
the mine operators and represented an integral part of the mining
right. However, this right was challenged when the Department of
Minerals and Energy (DME) granted a prospecting right to Ataqua
Mining for dumps at De Beers' Jagersfontein mine in the Free State
Province, where mining operations ceased in 1971. De Beers

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immediately took the case to court.

11. (SBU) The High Court ruled in favor of De Beers and set aside
the granting of that right by the DME, stating that South Africa's
new mining legislation did not apply to the treatment of old
tailings dumps. The judgment has far-reaching implications in that
it means mining companies recovering minerals such as gold, diamonds
and platinum from tailings dumps do not have to apply for a mining
right in terms of the Minerals and Petroleum Resources Development
Act (MPRDA), which came into effect from 2004. This, in turn, means
the tenets of the Mining Charter and social and labor plans do not
apply to dump recovery operations. A specialist on mining issues
says that the significance of this judgment is huge and means that
every dump in South Africa can be mined without having to apply for
a mining right if ownership can be proved.

-----------
ELECTRICITY
-----------

----------------------------------
Pouring Water on the Energy Crisis
----------------------------------

12. (SBU) The very wet rainy season that South Africa is "enjoying"
has poured cold water on power utility Eskom's attempts to maintain
a semblance of reliability to its power supply. With a 3 percent to
8 percent nominal reserve capacity and demand frequently exceeding
supply (due to planned and unplanned maintenance), scheduled and
(mainly) unscheduled outages have occurred daily and now the heavy
rains have added another dimension to Eskom's (and the country's)
woes. Open cast coal mines have reduced output because of flooding,
coal handling from mine mouth to power station by either road or
conveyor belt has been impeded, coal stockpiles at plants have been
flooded, and wet coal has caused feeding and efficiency problems in
the boilers. Added to this is the fact that the price of export
coal is fetching well over $100 per ton (some seven times the
domestic price), and more of the higher quality coal is being
diverted to this market, leaving Eskom with an even lower quality of
coal than it is used to. As a result, power station stocks are down
to four days supply and one mega-station is feeding directly from
mine delivery.

13. (SBU) Two years ago, an electricity outage (blackout) was an
extremely rare event in South Africa. Then, in December 2006 one of
the two generating units at Koeberg (900 megawatt capacity each),
the country's only nuclear power station, was severely damaged when
a loose bolt got into the rotor. This set off a series of
blackouts, mainly in the Western Cape, which lasted until a new
rotor was installed in about May-June of 2007.

14. (SBU) From then on, outages became increasingly frequent until,
with the advent of summer (September), they have become an almost
daily occurrence culminating on January 25 with the closure of most
mining operations throughout the country because Eskom could not
guarantee supply. This is likely to cost the mines and the country
billions of rand in lost revenues and foreign exchange and in
potential investment in energy-intensive ventures. The SAG has
Qpotential investment in energy-intensive ventures. The SAG has
declared the power outages a national emergency that must be treated
with urgent actions, including a hike in electricity prices and
mandatory quotas with penalty and incentive systems. The next week
will tell whether the situation has improved.


15. (SBU) Comment. The energy crisis has resulted in the inevitable
apportioning of blame and making of excuses by major players in the
industry. These include policy interventions by government, poor
planning and management by Eskom, the mining industry's failure to
produce sufficient coal, transport contractor's inability to deliver
coal to the power stations, and the high rainfall over the early
summer months. However, the primary causes of the crisis are:
government's failure to do anything when it was clear as early as
1997/8 that a power shortage was pending; at the same time
state-owned utility Eskom was forbidden from building new capacity
as government wanted the private sector to do this; government
continued to procrastinate until 2004 when it was obvious that the

PRETORIA 00000217 004 OF 005


private sector was not coming to the party; failure of heavy users
of power to make adequate provision to protect themselves against
power shortages; and government and Eskom's black empowerment
policies (transformation) which saw skilled and experienced
employees and contractors replaced by inexperienced people. End
Comment.

-----------------------------------------
First Greenfield IPP to be Online in 2010
-----------------------------------------

16. (SBU) South Africa's energy and skills crises have inspired the
SAG to offer 30 percent of planned new energy projects to the
private sector (IPPs or independent power producers) in an attempt
to speed up the building of new generation capacity. The AES-Khanya
consortium has been designated as preferred bidder to build two 500
megawatt open-cycle gas-turbine (OCGT) power stations (probably
fueled by diesel to start with). Start of construction has been
delayed, but the Department of Minerals and Energy's (DME) Chief
Director for Electricity said that the stations could still come on
line by the end of 2009. The two power plants will together add
1,000 megawatts to the national grid and will be located in
KwaZulu-Natal and Coega (site of Rio Tinto's proposed 725,000 ton
aluminum plant) in the Eastern Cape. DME estimated the cost of the
two plants at $750 million, of which $120 million would be foreign
direct investment. The AES-Khanya project represents the first IPP
involved in a significant greenfield project. The consortium is led
by U.S.-based AES and incorporates three local black economic
empowerment partners.

--------------------------------------
Gas Turbines the Way to Go in a Crisis
--------------------------------------

17. (SBU) The Managing Director of Eskom's Enterprises Division said
that gas turbines are the only way to beat power cuts faster. If
this option were not taken, frequent power cuts would continue for
many years until new base load plants were completed from 2015. He
said that a gas turbine plant was quick to build and had a
relatively low capital cost but that fuel would be expensive and
would require millions of liters of diesel. State power supplier
Eskom has already completed two 500-megawatt peak-demand gas
turbines on the west and south coast, respectively. These plants
were completed in 18 months and designed for a load factor of 6
percent but were now running at 50 percent to meet regular demand.
A further two turbine plants with a combined 1,000 megawatts are
being built, but would only be completed next year after Eskom had
to wait six months for the decision on the environmental impact
study. Eskom is considering converting these plants to closed
cycle, which would make them more fuel efficient and produce more
power.

----------------------------
Power Hike of 14.2 percent for 2008
----------------------------

18. (SBU) South Africa produces the lowest cost electricity in the
world and has used this advantage to attract heavy energy users,
such as metal smelters, refiners and fabricators, to set up shop in
Qsuch as metal smelters, refiners and fabricators, to set up shop in
the country. The developing energy generation shortfall has
resulted in scheduled and unscheduled electricity cuts that have
already caused production losses to large and small businesses
amounting to hundreds of millions of dollars. Eskom has budgeted
some $50 billion over the next five years and expects to spend $150
billion by 2025 to double its generating capacity to 80 gigawatts.


19. (SBU) Financing is likely to come from local and international
money markets, from the SAG as owner, and from Eskom's own cash
flows. Eskom maintained that the current tariffs were significantly
less than the 5.5 US cents it would cost to build 1 kilowatt-hour
(kWh) of new capacity and that its cash flow was insufficient to
fund the expansions. It approached the National Energy Regulator
(NERSA) for approval to hike rates by 18.7 percent in 2008, 17
percent in 2009 and 11 percent in 2010. The Regulator agreed to
allow Eskom to increase tariffs to customers, excluding

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municipalities, but by 14.2 percent (up to 3.5 US cents per
kilowatt-hour) in 2008. The 184 municipalities that distribute
electricity are also set to raise tariffs by 12 percent from
mid-2008.

20. (SBU) Business has not taken the increases lightly and states
that these are likely to worsen the already high inflation rate of
8.6 percent. They believe that more creative ways can be found to
finance Eskom's needs that do not rely so heavily on tariff rises.
The Technical Advisor to the Chamber of Mines said the hike would
cause increases in working costs of at least 1.4 percent at gold
mines, more than 1.4 percent at platinum mines, and 1.1 percent at
collieries. However, he said that the mining industry was not
surprised at the hike, especially due to the increase in the cost of
coal. NERSA calculated that the hike would add 0.5 percent to
annual inflation. While they took note of concerns that the hike
would hurt the economy, particularly the poor, they believe that the
long-term benefits far outweighed the short-term fears and that
there had to be a trade-off between industry sustainability and
other socioeconomic goals. NERSA's Chief Executive said the
increase would encourage more independent power producers to enter
the local market.

------
MINING
------

--------------------------------------------
Mining Boosts South Africa's Export Revenues
--------------------------------------------

21. (SBU) Record prices have been received for nearly all the
commodities produced by South African mines during 2007 and these
have carried over into 2008. Critical commodities breached key
psychological barriers and revenues for platinum, rhodium, palladium
and gold are expected to earn $26 billion in 2008 compared with $16
billion in 2006. In the year to February 2007, the mining sector
tax revenue exceeded the original estimate by nearly $4 billion.
The Chief Economist of the Efficiency Group pointed out that
traditionally 1 percent of state revenue came from the mining
sector, but this is likely to increase to 3 percent in 2007.


22. (SBU) Given adequate power and a continuation of the global
commodities boom, South Africa's mining industry seems set to
increase its foreign exchange earnings from both current operations
and a number of new mining projects due to start or reach full
production over the next few years. The major supply expansion
projects are in the hands of the private sector while the
concomitant infrastructure expansions are state-owned and subject to
government and environmental approvals, all of which tend to delay
projects and increase costs.

23. (SBU) Most of South Africa's mineral exports have experienced
dramatic price increases. Export steam coal hit $100 per ton in
November and has since touched $130 per ton on the spot market.
This is seven times the price paid for domestic coal, admittedly of
inferior quality for power generation. Gold crossed $900 per ounce
and is forecast to hit $1,000 per ounce in early 2008. Of the PGMs,
platinum breached $1,700 per ounce, rhodium $7,000 per ounce and the
Qplatinum breached $1,700 per ounce, rhodium $7,000 per ounce and the
demand and prices for palladium and ruthenium increased
substantially.

24. (SBU) Uranium prices increased by a factor of ten to some $200
per pound in mid 2007 but have since come back to about $60, which
is still well above the $20 per pound of a few years ago. Prices
for iron ore and steel and for base metals such as copper, nickel,
cobalt, lead, and zinc have doubled and tripled over the past two
years and other commodities are at or near record levels. Chinese
demand continues to be the driving factor, while worries about the
United States economy and the environment raise uncertainty, which
is good for gold and platinum. South African mining companies have
benefited from higher commodity prices but are struggling to control
higher costs and increase production.

BOST

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