Captive power – An energy solution for the mining sector May 2016

By KATE COLLIER, ALESSANDRA PARDINI, GARYN RAPSON, RITA SPALDING AND MAKHOTSO LENGANE, Published in Energy Law

The mining industry is under increasing pressure to consider alternative means of power supply. The industry is faced with the effects of a growing energy deficiency as evidenced by the recent approval by NERSA of an Eskom tariff hike exceeding 9% and energy supply constraints to the mining industry and resulting losses in excess of R1.3 billion, as reported by Consultancy Africa Intelligence. Mining companies are looking inwards and exploring solutions that allow for independent electricity generation in mitigation of what EY, in its 2015 – 2016 report on business risks facing mining and metals, ranks as one of the top ten business risks in the mining industry – inadequate access to energy.

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South Africa's current installed power capacity is approximately 45 000MW and, according to Eskom, an additional 40 000MW in new generation capacity is required by 2025. The Department of Energy (DOE) announced at its media roundtable last year that, since November 2011, more than 6 327MW have been awarded in terms of its Renewable Energy Independent Power Producer Procurement Programme (REIPPPP) and a new determination has been made for an additional 6 300MW. While the success of REIPPPP is indicative of government's commitment to providing the additional capacity required, it is unclear if the DOE's procurement programmes, which include REIPPPP, will achieve the 40 000MW by 2025, and whether this estimated new generation capacity will indeed be sufficient.

In addition, the increasing affluence in developing markets translates into, amongst other things, greater demand for residential energy, creating competition for energy between society and business. It is clear that alternative avenues of power generation must be explored by mining companies seeking to avoid the rolling blackouts which have besieged the country since 2007.

The use of captive power plants provides one solution. Captive power plants operating either in grid mode with the ability to export surplus power to the local electricity distribution network or operating independently of the distribution network enable localised generation of electricity for own use.

Captive Power plants provide mining companies with the autonomy to manage their overall cost base better, and to minimise the costs of energy which represent up to 40% of a mining company's total expenditure. It further extends itself to provide security of power supply through Self-generation of power supply provides security and enables mines to avoid the ever fluctuating Eskom tariffs. In a market where we are seeing disposal of mining assets, buyers are rigorously scrutinising the expenses on the books of target companies. High energy costs and the serious safety and production implications of restrained or reduced power do not increase the “attractiveness" of a target, nor does this support the idea of reaching optimum production efficiencies of existing operations.

The opportunities afforded by localised generation of power are even more pronounced in respect of the rest of Sub-Saharan Africa. The combined installed capacity of the region clocks in just below 40 000MW, with thirty Sub-Saharan countries having installed capacity of less than 500MW.

The legal framework through which energy is generated in South Africa is governed by the Electricity Regulation Act, 2006, which stipulates that no person may operate a generation facility without a licence from the National Energy Regulator of South Africa (NERSA), save for a few exceptions which include a generation plant constructed and operated for own use. This is a useful provision for mining companies planning to explore energy generation, as it will do away with the administrative red tape of applying for a licence from NERSA.

The traditional structure of the transactions seen in REIPPPP requires a licence from NERSA to allow the independent power producer (IPP) to generate its own energy. It includes a power purchase agreement with Eskom in terms of which Eskom buys the energy produced to transmit through its distribution networks as well as an implementation agreement with the DOE which allows the DOE to “guarantee" Eskom defaults vis-à-vis the IPP.

A mining company's captive power plant, if funded without external debt, has the benefit of doing away with the limited recourse financing model of a ring-fenced special purpose vehicle such as the IPP and, therefore, the requirement to obtain a generation licence from NERSA. Mining companies that possess balance sheets healthy enough to fund a captive power plant without external debt have the benefit of a simplified transaction structure with limited participation and influence of third parties. Admittedly this is no mean feat.

Renewable energy developers that seek to assist mining companies should, however, remain cognisant of the additional environmental impacts that arise as a consequence of such plants. Depending on the technology and the electricity output of the plant, captive power plants may require environmental authorisation. In addition, cognisance must be taken of the mine's existing environmental approvals and the conditions of these approvals. Mines are highly regulated in terms of environmental law and it is essential that the captive power plant does not result in non-compliance with the mine's existing approvals.

To the extent that the mine has an existing electricity supply agreement with Eskom or a municipality, a reconciliation agreement may need to be concluded to take into account captive power generation. If connected to the municipal distribution network, the municipality may also need to conclude an amendment to its electricity supply agreement with Eskom.

In addition, occupational health and safety considerations must be taken into account.

Notwithstanding the apparent independent operation of a captive power plant vis-à-vis the mining activity to which it supplies energy, the broad statutory definitions of a mine may still mean that mining specific health and safety legislation must be applied to the plant. This will require carefully implemented integrated safety management systems and risk mitigation strategies. Non-compliance with the applicable health and safety legislation, the possible impact of accidents occurring as a direct result of mining activity, and an already under-resourced inspectorate grappling with a possibly unfamiliar environment will be some key considerations from the outset.

Sub-Saharan countries Mali, Guinea, Sierra Leone and Liberia already make notable use of self-supplied power for their mining industries. According to the World Bank, while conventional grid supply remains the dominant power-source for the mining industry in Sub-Saharan Africa, self-supply has risen from 6% before 2000 and is expected to reach 18% by 2020. Sub-Saharan Africa is home to six of the 10 fastest growing economies in the world. However, reliable power remains one of the most significant impediments to growth in the region. Inventive power solutions are required in order to bridge the poverty gap, create jobs and improve GDP. We believe that these solutions begin with the mining industry.

Collier, Pardini, Rapson and Spalding are partners and Lengane a candidate attorney with Webber Wentzel