Read the case study below and answer ALL the questions that follow.

THE COAL CONUNDRUM

Coal is one of the largest and most affordable sources of energy, responsible for $38\%$ of electricity generation globally. In

South Africa, coal provides $83\%$ of the power generated by Eskom, as well as being used as a heat producer in industrial

processes such as in the manufacturing of cement, paper and steel. It is also turned into liquids and gases, used as fuel,

or processed into chemicals to make other products. We unpack the dynamics of the South African coal mining sector.

South Africa is endowed with an estimated $30$ billion tonnes of coal, making up $3\mathrm{.}5\%$ of the world$$s coal resources. SA

miners make up $3\mathrm{.}7\%$ of global annual coal production. The $253$ million tonnes of coal that SA produced in $2018$ were

used as follows $120$ million tonnes in the generation of power by Eskom$$ roughly $40$ million tonnes in the creation of gas,

liquid and chemical products by Sasol$70$ million tonnes were exported$$ and other domestic industrial processes used

the remaining $23$ million tonnes.

Eskom$$s procurement picture.

Eskom currently has $13$ operational coal$-$fired power stations and a further two under construction. More than $80\%$ of coal

produced in the country is mined in Mpumalanga with the rest mined in Limpopo, KwaZulu$-$Natal and the Free State. $11$ of

Eskom$$s stations are based in Mpumalanga, within close proximity to coal mines, thereby minimising costs for coal

transportation. The domestic price of coal is mainly determined by Eskom $($given its dominance in this market$)$ who

utilises three different contract structures and pricing mechanisms in purchasing coal. $33\%$ of coal volumes are sourced

via cost$-$plus coal contracts, $25\%$ from fixed price coal contracts and $42\%$ from short$-$term contracts.

Cost$-$plus contracts $($currently with Exxaro, Seriti Resources and South $32)$ are typically very long$-$term in nature,

effectively holding Eskom responsible for ensuring the sustainability of the coal mine. Eskom pays for the cost of running

the operation and the capital required, with a margin paid to the coal miner for operation and management. These mines

are directly linked to the power stations, with some having conveyor belts running between mine and station to ensure a

more optimal cost outcome. Fixed price, long$-$term contracts are based on an agreed fixed or commercial price for coal

and ensure the delivery of agreed volumes to Eskom. Here, the costs to run the operation are borne by the mine owner,

as well as the capital needed. Eskom compensates the miner for the coal, with a margin that should compensate them for

the operational and capital cost, however, there is pricing risk borne by the miner. Short$-$term contracts were created to

enable the government$$s ambition for transformation, whereby the state was seeking to procure coal from majority blackowned

miners. These contracts are similar to fixed price contracts but tend to be short$-$term in nature.

Eskom$$s cost problem.

Eskom reports that $52\%$ of coal costs are made up of short$-$term contracts, contributing $42\%$ of volumes. These contracts

are much more costly for Eskom than the alternatives. Higher logistical costs are one of the predominant reasons. Mines

belonging to new entrants in the industry are generally located further away from power stations that utilise their coal, with

significantly increased transportation and logistical costs as a result. Eskom is currently discussing reverting back to a

lower cost option $$ where the bulk of volumes are sourced via long$-$term coal contracts $$ with a preference for coal

delivered by conveyor. It is$,$ however, not clear what will become of the new entrants that have been incentivised to enter

the coal sector over the last while and may not be sustainable under such new arrangements.

Eskom requires an additional $1\mathrm{.}3$ billion tonnes of coal to cover all coal$-$fired power stations for a period of roughly $10$

years. This is not catered for via the current contracts, which have reportedly secured sufficient coal supply until $2021.$

Eskom will need to recapitalise its cost$-$plus mines to ensure the security of coal supply at an optimal cost. With Eskom

facing a mounting debt burden, capital spend on coal mines has been reduced over the last number of years to meet

debt servicing costs. Yet, as mining is a capital$-$intensive sector, any underspend on capital means that significant catchup

will be required to meet power station demands soon.

Climate change and future

Thermal coal used in energy production has a major shortcoming in that this process is responsible for a third of global

carbon dioxide emissions.