Africa’s red metal producer, Zambia, grapples with energy price risks given rising crude prices coupled with currency bears and electricity power generation instability given receding water levels at key water bodies as climate change risks heighten. This has not only weighed manufacturing activity in 2019 into 2020 but fuels inflation which is a bigger evil as a spiral driver of interest rate risk. For 20 years running, the power utility ZESCO ltd has been in an energy marriage with Lusaka Securities Exchange (LuSE) listed power distributor Copper Energy Corporation (CEC Plc) whose major client has been the mines. The bulk supply agreement allowed for CEC Plc to purchase power from ZESCO at special negotiated rates for onward selling to the mines to allow for smooth generation given the infrastructure CEC owns. At the end of March comes the divorce between the 2 party’s which will shape the future of Zambia’s mining. Very similar lessons to Brexit who by then would have divorced from the European Union on 31 January CEC Plc and ZESCO will have to transition for a period in the best interest of Zambia’s mining that remains the engine of growth. Mines consume 57% of the grid and any disruptions to operations could weigh copper production in an already elevated cost environment.
Vague business continuity planning breeds uncertainty: ZESCO Directorate assured the nation that it has a plan in place to supply power to the mines but the vagueness of the plan breeds uncertainty because not even the mines know how this will be achieved if the current infrastructure is owned by CEC Plc. Ceteris Paribus, the Energy Regulation Board (ERB) in November commissioned a Cost of Service Study (CSS) to run 1 year to determine not only cost reflective but optimal tariff levels which for a long time have cost Zambia energy attractiveness because it offers the lowest tariffs in the region. As such ZESCO has suffered negative jaws and runs a loss position with insufficient contribution to costs.
CDC takeover flop was the best thing ever for ZESCO:When the Commonwealth Development Corporation (CDC) group take over off CEC plc flopped on the condition around the bulk supply agreement which ZESCO was not willing to renew so as to allow for reflective pricing, this was dubbed as the smartest decision the power utility had made in the interests of ZESCO’s ailing financial posture. Long date agreements that attach fixed pricing can be price risky to the detriment of the power supplier. The CDC transaction rallied the CEC plc stock 44.5%, one of the largest jumps on the country’s illiquid bourse, overvaluing the stock which later tumbled after a stalemate blocking the takeover.
Downstream effects could be dire for the business ecosystem: The stance by ZESCO to not renew the bulk agreement is fair but when looked at from a business resilience perspective seeing that the utility doesn’t own the infrastructure raises nervousness as to the future of mining in Zambia this year. Even if ZESCO rented the infrastructure from CEC Plc, it is highly unlikely they would afford it or would build up arrears to balloon CEC Plc debtor book that would cripple its operations as it has done with IPP’s already. Could this be an opportunity for GreenCo the intermediary that the Energy Minister announced would de-risk the energy sector? The answer is yes and no. Yes from a buying perspective and no from an infrastructure perspective because the intermediary owns no transmission infrastructure. This quagmire is a sheer case of having the right reforms, underpriced tariffs with no transmission infrastructure putting the power utility at the receiving end of a hard bargain. It will also test CEC Plc’s diversification model which will also determine the future of Copperbelt in part? As analysts we do not rule out political motives but if it were, then there is little realization that the downstream effects to Zambians is graver than calculated. Employment is at risk and so is business pulse in the Copperbelt of Africa.
Mining remains the key supplier of dollars on the Zambia financial markets and tempering with its production equation could impact the foreign exchange flows, dampen growth in an already suppressed environment, increase energy costs which will weigh exploration investment capacity of the mines.
The Kwacha Arbitrageur
