Central Energy Fund and PetroSA Annual Reports: briefings; Diamond Value Addition: Nedlac briefing

Meeting report

MINERALS AND ENERGY PORTFOLIO COMMITTEE
14 September 2005
CENTRAL ENERGY FUND AND PETRO SA ANNUAL REPORTS: BRIEFINGS; DIAMOND VALUE ADDITION: NEDLAC BRIEFING

Chairperson: Mr E Mthethwa (ANC)

Documents handed out:
Central Energy Fund briefing on Annual Report and budget
PetroSA briefing on Annual Report and budget
Fridge South African Diamond Value-Addition Project
Nedlac briefing on SA diamond industry
Draft Input into the Fridge Diamond Study

SUMMARY
The Central Energy Fund (CEF) and PetroSA first briefed the Committee on their Annual Reports and financial statements for 2004/2005. The importance of PetroSA within the CEF group was shown by its contribution of R1.7 billion to the total R1.9 billion profit for the group. The gas supply to PetroSA’s manufacturing plant would be depleted by 2007.

The Committee were concerned with CEF’s commitment to investigating alternative energy sources given its dependence on PetroSA’s profits. Members asked a number of questions relating to the advance payment between PetroSA and Imvume Management, a matter previously discussed by the Standing Committee on Public Accounts (SCOPA). PetroSA was participating in deep-water exploratory projects to mitigate the depletion of gas reserves by 2007.

The National Economic Development and Labour Council (Nedlac) then briefed the Committee on South Africa’s diamond industry in a global context. South Africa’s cutting and polishing industry was the fifth largest worldwide, but was being marginalised by cutting centres like India and China that used cheap labour. Discussion focussed on the effect of the Diamond Amendment Bill on job losses and export duties. Members were frustrated that Nedlac made no specific recommendations regarding the Diamond Amendment Bill.

MINUTES

Central Energy Fund briefing
Mr M Damane (CEF Chief Executive Officer) briefed the Committee on the Annual Report and financial statements of the CEF group of companies for 2004/2005. The importance of PetroSA within the CEF group was shown by its contribution of R1.7 billion to the total R1.9 billion profit for the group. A number of the subsidiary companies were operating at a loss. Oil Pollution Control SA (OPCSA) recorded a deficit in 2004/2005, and the CEF Group only continued to manage OPSCA as a result of a directive from the former Minister. iGAS was not currently trading, and the Strategic Fuel Fund (SFF), as a Section 21 company, was difficult to close down, even though a new ministerial directive had made the trading of crude oil stock impossible.

The Energy Development Division of CEF was investigating alternative energy forms, and in 2005/2006 would begin the construction of a wind farm in Darling and a hydroelectric plant in Bethlehem. This division was conducting research into the replacement of paraffin with Gel fuel, and also completing pilot testing for low smoke fuel production, which involved the extraction of ‘volatiles’ from coal in order to prevent respiratory diseases. In a joint project with the United Nations, the CEF was pilot testing solar water heaters. At the suggestion of the Department, the CEF was currently testing the value chain for Liquefied Petroleum Gas (LPG), as marketing costs were making LPG too expensive.

In 2005/2006, iGAS planned to develop the Liquefied Natural Gas to Power project in the Eastern Cape. iGAS was also examining the possibility of increasing the gas flow along the pipeline from Mozambique. SFF was no longer commercially viable, yet government required SFF to keep strategic stock. Environmental liabilities were an ongoing problem for SFF.

PetroSA briefing
Mr S Mkhize (PetroSA CEO) presented to the Committee PetroSA’s shareholder objectives and financial performance for 2004/2005. PetroSA was established in 2002 through the merger of Soekor and Mossgas, and was owned by the government through CEF. PetroSA produced 27 000 barrels of crude oil per day, and was also involved in local Gas to Liquid (GTL) manufacturing, as well as trading a variety of chemicals on international markets.

PetroSA’s shareholder objectives were, first, to make the refinery viable even though there was a lack of fuel reserves in SA. Second, to operate according to international standards on safety, health, environment, and quality. Third, to contribute to the macro-economic objectives of the country. PetroSA had shown a revenue growth of 19% in the last financial year, and should be able to expand its operations by borrowing. PetroSA’s operating profit for 2004/2005 was R1.7 billion.

In the area of Black Economic Empowerment (BEE), PetroSA had not achieved its target of 50% spending on BEE suppliers (it achieved 34%). Its Centre of Excellence produced over 300 graduates in various trades such as welding, rigging, fitting, and the PetroSA Development Trust was investing R55 million in education and training, health, and the empowerment of women.

The gas supply to PetroSA’s manufacturing plant would be depleted by 2007. As the escalating crude oil and gas prices would make it difficult to secure a long-term feedstock supply to the manufacturing plant, PetroSA would need to streamline internal processes so that internal costs were not added to feedstock. Through the South Coast Gas Development Project, PetroSA should be able to provide gas for its manufacturing plant until 2013. However, if this failed, it would have to feed crude oil into its supply.

Discussion
Advocate H Schmidt (DA) noted that CEF was ‘heavily dependant’ on PetroSA’s profits from Liquid to Gas (GTL) manufacturing. He enquired whether CEF was making a concerted effort to research alternative energy sources, given its ‘vested interest’ in PetroSA’s commercial production of oil. Mr A Mjekula (CEF: Chairperson) responded that CEF had generated a profit of R55 million without dividends from PetroSA. However, this profit was generated from interest, and there was a need to generate a profit from activities located within CEF.

Mr N Gumede (Department Chief Director: Hydrocarbons and Energy Planning) added that CEF’s ‘vested interest’ in PetroSA was negated by its responsibility to two authorities. CEF was answerable both to the Department and to the South African National Energy Research Institute (SANERI). Renewable energy sources were first investigated as a means of providing electricity to unelectrified areas, but were found to be expensive. Renewable energy sources would not replace standard energy sources, and should be used on the basis of diversity rather than cost. Hydroelectric power, for example, should be supplied to upper income groups that could afford to pay for it.

Advocate Schmidt asked whether the documents detailing PetroSA’s relationship to Imvume Management were delivered to the Standing Committee on Public Accounts (SCOPA). He enquired whether the official policy agreement between the two companies allowed for advanced payment from PetroSA to Imvume Management, and whether the amount advanced was the first such payment. He also asked whether PetroSA requested an explanation from Imvume Management about a possible payment made to Glencore. Did the contract stipulate that Imvume Management should make payment direct to Glencore?

Mr Mkhize replied that Paragraph 7(2)(1) of the contract between PetroSA and Imvume Management allowed for an advanced payment. The advanced payment in question was the first such payment. PetroSA had not officially asked Imvume Management whether it made a payment to Glencor, and Imvume Management had signed its own agreement with Glencore.

Mr W Spies (FFP) enquired whether PetroSA was satisfied that the R18 million owed to them by Imvume Management could be collected. Mr Mkhize replied that, to date, Imvume Management had repaid R7 million. If the money were not repaid, PetroSA would have to recover it through Imvume Resources.

Mr Spies contended that the profit margin recorded in PetroSA’s financial statements was questionable. PetroSA recorded a profit of R1.7 billion for 2004/2005 and a profit of only R400 million in the previous financial year. PetroSA’s under-performance in 2003/2004 led to the closure of a plant, for which the insurance payout was R700 million. As the insurance payout was made in 2004/2005, this figure could be deducted from the profit, thereby decreasing it. PetroSA’s financial performance would then compare unfavourably with that of SASOL, which had managed to increase its profits by 34%. Mr Mkhize answered that the figures for ‘gross revenue’ and ‘operating profit’ in the PetroSA financial statements did not include the insurance payout.

Mr E Ngcobo (ANC) asked what the status of SANERI was as a research institute located within CEF that investigated alternative energy forms. He queried whether CEF had implemented the recommendations of a workshop on alternative energy forms held in May 2001. Mr Damane replied that SANERI was not a primary research institution, but managed research as part of CEF’s Energy Development Division. Nevertheless, SANERI was carrying out primary research into geothermal energy systems. It was also managing research projects on the use of Hydrogen as an energy source, and on the use of solar water heaters.

Mr Ngcobo enquired whether PetroSA’s corporate social development programme was improving the mobility of technical skills from institutions to industry. Mr Mkhize explained that PetroSA was working closely with Sector Education and Training Authorities (SETAs), and, as part of the training programmes, it had established an international database to help create employment opportunities for trainees. PetroSA had asked the University of Cape Town to open a department for geophysics and petroleum engineering. It was sending students to Houston, Imperial College, London, and the University of Strathclyde, and also sponsoring skills development programmes at Cape College.

Mr C Kekana (ANC) suggested that PetroSA should be seeking an ‘African solution’ to harnessing solar energy rather than letting Western countries take the lead in such research. Mr Damane pointed out that the University of Johannesburg had secured an international patent on the use of a flexible polymer as a replacement for silicon on solar panels. This was a ‘major breakthrough’, and Japanese investors had bought into the patent.

Mr C Molefe (ANC) queried whether CEF were considering the introduction of ethanol as an alternative fuel. Mr Gumede explained that ethanol had two possible uses: as a fuel for motor vehicles, and as a replacement fuel for paraffin in low-income areas. As local ethanol resources were insufficient to meet even half of the total demand for paraffin, ethanol would have to be imported if used as a household fuel. It was still being debated whether ethanol should be used for motor vehicles or in homes.

Mr Molefe asked what PetroSA was doing to mitigate the depletion of gas reserves by 2007. Mr Mkhize answered that PetroSA was participating in deep-water exploratory projects along the eastern coast. However, there were a number of problems with deep-water drilling, including the lack of drill rigs for deep waters, the sharp continental shelf along the SA coastline, and the instability created during drilling by strong currents.

Mr Molefe commented that PetroSA was seen to be dependant on SASOL, and asked whether there were licensing agreements between the two companies. Mr Damane replied that CEF was engaging SASOL on the matter of licenses and would report back to the Committee. It was important that PetroSA could continue to sell its products locally. PetroSA also aimed to sell products internationally, yet this was a sensitive matter, as a commitment to international clients may affect PetroSA’s ability to supply products locally.

The Chairperson commented that the Committee looked forward to the outcome of negotiations between PetroSA and SASOL. There was insufficient time to address some issues in their entirety. These included: the sustainability of fuel reserves, the strategic stock being maintained by SFF, and international regulations on health and safety. Once the relevant documents on the transaction between PetroSA and Imvume Management were delivered to the Committee, it would not be necessary for the Committee to deal with this matter again.

National Economic Development and Labour Council briefing
Ms M Da Silva (Nedlac) briefed the Committee on the SA diamond industry in a global context. SA was active in all aspects of the diamond value chain, and its cutting and polishing industry was estimated to be the fifth largest by value after India, Israel, the United States, and China. However, most of the global cutting and polishing industry had moved to lower-cost cutting centres such as India and China (together constituting 66.1% of the industry value). As a consequence, 92% of local diamond production by volume (49% by value) was not economically cuttable in SA.

The SA jewellery industry was small in scale when compared with the jewellery manufacturing industries in Europe, the United States, and India. The domestic market in SA was small, and the distance from major consuming markets was an inhibitor to growth. The cost of intervening in areas of the downstream diamond industry, like jewellery manufacturing, was high, as a result of capital intensity, barriers to entry, risks, and global competition. Even if the SA diamond industry successfully intervened in downstream manufacturing markets, growth could not be guaranteed because of the rapid progress being made in emerging competitor hubs, such as China and Vietnam.

Discussion
Mr Molefe asked what effect the Diamond Amendment Bill would have on job losses, the imminent closure of some diamond mines, and export duties. How were Southern African countries co-operating to address these issues? Mr H Mkhize (Executive Director: Nedlac) answered that Nedlac was reviewing the policy on export duties through discussion of the Diamond Amendment Bill. Nedlac and its social partners were aware that the Bill should facilitate the creation of jobs, and to this end were developing inter-sectoral partnerships.

Ms Da Silva added that the closure of some diamond mines was caused by the exhaustion of diamond deposits. The export duty on diamonds not beneficiated in SA was 15%, and De Beers was currently re-importing 162% of the category one diamonds that it exported. Other Southern African countries were competitors with SA in the diamond industry, and therefore co-operation in the region may be ‘double-edged’.

Mr Kekana argued that the Committee would be left in an ambiguous position if Nedlac presented research relating to the Diamond Amendment Bill without making specific recommendations. Mr Mkhize replied that Nedlac was not able to offer recommendations, but was informing Members of the issues relating to the Bill.

Mr Kekana observed that India cut 95% of the diamonds produced in SA. India could cut diamonds cheaply through the use of cheap labour, but how could China, as a socialist state, cut diamonds profitably? Ms Da Silva clarified that 95% of small diamonds produced in SA were cut in China, but this figure was 54% if aggregated with bigger diamonds. The cost of manufacturing diamonds in SA was $55-$100 per carat, and $1.50-$12 per carat in China. SA was able to polish the bigger diamonds.

Advocate Schmidt enquired why the research report was produced for Nedlac by consultants, and whether Nedlac accepted the findings of the report. Mr Mkhize replied that when Nedlac commissioned the research report, it sought an independent viewpoint on the diamond industry, and therefore had made use of consultants. Nedlac accepted the report, which was now in the public domain.

Mr Kekana commented that there should be an inquiry into the allegation that De Beers took diamonds out of SA before 1994. Nedlac’s research should not emphasize global competition at the expense of the benefits of the diamond industry to ordinary people.

The Chairperson commented that the research report would be helpful for the public hearings on the Diamond Amendment Bill. However, Members would have expected that Nedlac would put forward specific recommendations on amendments to the Bill. Research on the diamond industry should emphasise both the upstream and downstream sections of the industry. As SA possessed the fifth largest cutting and polishing industry, the profits should benefit the majority of citizens.

The meeting was adjourned.