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22 May 2024

Navigating ESG Complexities in the Real World — South Africa's Looming Gas Crisis

After Eskom, Sasol is South Africa’s second-biggest polluter of greenhouse gases. The petrochemical giant faces mounting Environmental, Social and Governance (ESG) pressures to improve its greenhouse gas emissions. Equity Analyst Dylan Griffiths writes how near-term ESG wins for Sasol have alarming real-world consequences for other South African corporates.

Sasol’s Secunda synthetic fuels plant is often described as the single-biggest emissions site in the world. At 53.8 million tonnes of greenhouse gases a year, Secunda’s emissions exceed the individual totals of more than 100 countries — including Norway and Portugal — according to the Global Carbon Atlas.

Sasol rightly faces massive shareholder, climate activist and regulatory pressures to improve its emissions scores. It has committed to achieving net-zero emissions by 2050. Its transition includes inter alia turning to low or lower carbon energy sources. In the near term, substituting dirty coal for cleaner gas is low hanging fruit for Sasol.

Sasol has long stood as the custodian of the South African gas market. It supplies local industrial users with low-cost gas sourced from the Pande and Temane fields in northern Mozambique. Sasol bears all the risks along the value-chain — from exploration, to production, to distribution. But this model is set to change, and alarmingly soon.

Sasol has traditionally on-sold approximately 25% of its Mozambican gas to local industrial users. Because of depleting gas resources, in August 2023 Sasol affirmed its commitment to fully internalise this gas supply by 2027. This good-news decision for Sasol has some alarming consequences for other industrial gas users in South Africa.

Sasol has now placed its gas customers on rolling short-term contracts through to 2027. It is encouraging them to secure alternative supply agreements thereafter. Due to historical gas pricing regulations, these new alternative supply agreements are likely to be concluded at significantly higher prices. Higher production costs will become an existential threat to most gas-dependent businesses — putting thousands of jobs at risk.

One such business is Italtile Limited, a long-term holding in the Foord Equity Fund. Italtile’s subsidiary Ceramic Industries uses natural gas sourced from Sasol to power the kilns which fire its tiles. Natural gas accounts for approximately 70% of Italtile’s total energy requirement.

There is no imminent quick-fix solution to this looming gas supply crisis. At present, the most shovel-ready of the alternative solutions is a Floating Storage and Regasification Unit (FSRU) located at the Matola port in Mozambique. Initial estimates suggest FSRU gas costs could be double those currently paid. However, the project is at a standstill, as securing an anchor offtake partner remains a key feasibility hurdle.

One proposal is for Eskom to come to the fore with an offtake commitment for about 50% of the FSRU gas for use in a 1.2GW gas-fired power station to be built close to the port. To date, Eskom has made no such commitment. Given the tight deadline, financing and construction time required for these projects, final investment decisions are needed urgently.

For Italtile, managing this looming gas crisis will require its own ESG balancing act. It must weigh the social impact of production cuts in its ceramics division against emissions regressions associated with substituting coal for natural gas as an energy input. Yet, for Sasol, the internalisation of its gas supply presents as an essential stepping stone towards repositioning the business for a sustainable future.

The uncertainty surrounding Southern Africa’s long-term gas supply highlights material investment risks. It not only represents a national energy security risk, but also highlights the complexities and interconnectedness inherent in managing ESG risks, where decisions can have far-reaching consequences.

Understanding the risks and externalities of the gas supply cliff has been a focus for our investment team over the last year. We have adjusted our positioning where we think it poses a material risk to companies in our portfolios. Outside of investment returns, we think this issue poses material risks to the lives of many South Africans and should be receiving more urgent attention from government and other stakeholders.

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