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Analysis: The seven urgent steps needed to save our electricity system

Analysis: The seven urgent steps needed to save our electricity system

It should be abundantly clear to anyone that Eskom, and therefore our electricity system, is fast approaching a crisis - and that it just can’t go on like this anymore. Drastic changes to how our electricity system operates are a certainty; it is merely a question of whether our government will make the necessary decisions itself, thereby influencing the outcome, or rather have fate drive the changes for us, with consequences that are impossible to determine. By DIRK DE VOS.

What we have sorely lacked for some time is proper leadership that is prepared to grasp the nettle. Just recently, Moody’s downgraded Eskom’s debt to junk. Turning all this around is going to be a painful process. It will need leadership.

On the government’s side, this job probably falls primarily in the lap of finance minister Nhlanhla Nene, and public enterprises minister Lynne Brown, who is responsible for Eskom. However, unless they are fully supported by others in the Cabinet and indeed the leadership of governing party itself, we will continue to drift.

Below are the things we need to do.

1. Let’s get real about electricity prices

The message is this. Cheap and abundant electricity is behind us and electricity will cost even more in future. How much more? A survey of our peer countries may provide a guideline. Every effort must be directed at making electricity as cheap as possible, but electricity will have to cost at least what it costs to produce on a sustainable basis.

2. Let’s understand the historical role of Eskom

It might just be that a more honest appraisal of Eskom is needed to counter the view that Eskom’s problems are only a recent phenomenon. The Eskom we now know is a product of the Apartheid government, which sought to generate cheap electricity for a power-hungry mining sector and to maintain an industrial base in a world increasingly hostile to Apartheid policies. South Africa, thankfully, is a different country now. With so much emphasis on transformation in other areas, we should look to transform our electricity system too.

What we do know from industry experts in the sector, such as Anton Eberhard, is that Eskom has, in recent history, never been particularly efficient. Medupi and Kusile are catastrophically ill-considered and badly executed projects, being well over budget and several years behind schedule – but, in a sense, this is an Eskom tradition. The most recent Eskom build, commencing in the mid 80s, namely Majuba, which has featured prominently because of a faulty silo (a design fault?) was also well over budget and very delayed. But it is not just new power stations. The truth is that Eskom, as a large electricity utility, has never been that efficient. Its cheap and abundant electricity has always been funded by the taxpayer, whether directly or indirectly. Cheap coal has helped a bit too, but not as much as generally thought.

The most serious problem with Eskom, post democracy, has been the dramatic changes in its capital structure. Professor Eberhard points out that in 2001, Eskom had both excess generating capacity and very little debt. This too was a major failing. That excess capacity was paid for by taxpayers. Besides, electricity utilities should carry a fair amount of debt because this debt is generally the cheapest debt around. Just a decade later, though, the situation has been turned on its head. From even before 1990, Eskom’s capital began a process of steady erosion, through depreciation of the plant and delayed maintenance. South Africans consumed that capital base through some of the lowest electricity tariffs in the world and an unfunded electricity rollout programme. An exploding salary overhead did not help much. Although Eskom’s management at the time pointed to the problem, our politicians delayed approval of new capacity until the 2008 black-outs hit. Right now, Eskom is severely under-capitalised and over-indebted.

3. We need to know exactly what’s going on at Eskom

Treasury under the Department of Finance is a well-functioning and even an impressive arm of government. It has kept the worst excesses of other far less functional and spendthrift departments in check by maintaining a firm grip on the nation’s cheque book. Refusing to fund out-of-budget items unless remedial action is taken is generally an effective way of imposing a semblance of discipline.

Eskom is different: Its state of health is critical to the functioning of the whole country and its economy. In this way, it has us (and Treasury) over a barrel. This can’t continue. Earlier this year, Eskom made a desperate plea for an immediate R50 billion capital injection to address its immediate funding requirements. Instead, in the medium term budget statement, there is a commitment to inject R20 billion at some undefined point and support even more borrowings. What is the real requirement? We don’t know. Minister Nene did not tell us why he came up with R20 billion and not R50 billion.

Many analysts have proposed selling off Eskom’s generators into separate companies and for Eskom to retain the grid, system operation and market functions. In truth, this should have been done long ago. Eskom, with roughly 47,000 employees and revenues of R140 billion per annum, is just too big to be managed by anyone. Breaking Eskom up has many good arguments in its favour and one of them is that it would be easier to manage its constituent parts separately.

Instead, National Treasury has to rely on Eskom’s management to accurately report on its financial and technical position. What are the incentives for Eskom’s management to do this? Countless numbers of CEOs of listed companies have been in the same position before. If you know the market can’t handle too much bad news, you drip feed little bits of bad news and hope for the best. We have only an inkling about what the extent of the bad news might be. This could include the full costs of getting generating plant availability back to acceptable levels, gridlock on coal supply agreements after 2016 and continued massive cost over-runs and further delays on Medupi and Kusile.

The rumour mill, citing various Eskom senior managers’ off-the-record views, is now revolving quite quickly. Professor Eberhard has suggested establishing a commission of inquiry. This is a good idea but it is likely that Eskom’s problems need to be addressed before any such commission of inquiry with suitable terms of reference can make useful findings.

However, formally splitting Eskom up is not the task it might once have been. As Eskom became more indebted, it would have committed to several security covenants on its assets in favour of its bond holders and creditors. Any restructuring would therefore involve arduous re-negotiation and possibly further state underwriting of its debt holder obligations.

Still, despite this, Ministers Nene and Brown could still insist that Eskom operate and report as if it were restructured along the lines described above. Instead of reporting on a consolidated basis, each generator should report on a stand-alone basis after each of them is allocated that share of the Eskom debt for which it would have been reasonably responsible. The balance of the debt remains with the grid and (slimmed down) headquarters. Each generator would then have its own power purchase agreement with the grid side using arms’ length contractual terms.

Doing this would allow Treasury to understand what it is really in for and why. It may well be that most of Eskom’s problems can be fixed easily, but if it is the disastrous Medupi and Kusile projects that are dragging the whole thing down, then National Treasury should know exactly the scope and size of the problem and move to some sort of direct re-capitalisation or remedial action for these projects. The rest of Eskom would have different problems to be solved with different interventions.

4. Make subsidies and developmental objectives explicit

The business of generating and supplying electricity as cheaply as possible should be the only objective of our electricity system. Eskom has been tasked with all sorts of unfunded developmental objectives. This should stop. Things like providing a limited amount of free electricity might be necessary but this cannot be funded by Eskom. The government must set aside the costs of this in the social welfare budget.

More importantly, local government will need to wean itself off using the huge margins over cheap Eskom supplied electricity to fund all sorts of things unrelated to electricity. Local government taxes, like developmental objectives, need to become explicit. We cannot be serious about building energy-efficient cities and towns if the revenue model at local government depends on consuming electricity. Local municipalities absolutely have to pay their electricity bills as they fall due. Eskom can’t shoulder this debt as well.

The private sector, too, will need to change the way that it does things. In particular, we need to look to the Energy Intensive User’s Group, a collection of 32 large companies that, collectively, represent 27% of our GDP but almost half of all electricity consumed in our country. The electricity price that many of these users pay is not sustainable and is another hidden subsidy borne by the rest of the economy. Some sectors will not manage a fair price (like aluminium smelting) and will have to close down, but others with high labour absorption rates like gold mining might need direct subsidies. Perhaps that can be justified but then we ought to make the costs of the subsidy transparent.

5. Do no more harm

The current 2013 version of the Independent Resource Plan (IRP 2013) is a good document. If any changes need to be made to it, it will be on how electricity demand will continue on a downward trajectory as it has in response to the price increases. South Africa, one of the most energy intensive economies in the world, will have to look more like other peer countries as electricity prices edge closer to those seen in peer countries.

What we can’t afford is completely fanciful and unaffordable nuclear programmes. In fact, as Dr Grové Steyn, a specialist in infrastructure, regulatory and applied economics, points out, we should absolutely avoid any mega-projects and rather build our generating capacity incrementally, as well as projects in which the private sector can participate and have them shoulder the risk of delays and cost over-runs. The renewable energy programme shows how this could be done. The lessons learnt there should be extended to new conventional base load energy as well.

For conventional energy, building a gas infrastructure, as pointed out by the IRP 2013, is where our focus should lie, and getting our long-awaited Gas Master Plan out cannot happen soon enough.

6. Let’s solve this as a region

Finally, let us understand that energy provides a basis for us to re-engage in the southern African region. The development of the region is directly in our interest, as our fates as separate countries are increasingly intertwined. Cheap electricity from South Africa has prevented our neighbours from developing their own capacity, but this should now change. Mozambique sits on huge proven natural gas reserves; Botswana has coal. Several moribund hydropower projects should be revitalised. Let us rebalance our terms of trade with counter-parties that, for the first time, can sell us something that we actually need.

7. A last word

South Africa’s electricity system has emerged as a big risk for our future prosperity. It has been a poorly functioning sector for much longer than is generally accepted. But it can’t continue. We should now take the bold decisions needed to change things before a breakdown of the system forces us to do so. We should accept that in Eskom as presently structured, we have adopted the wrong model and have invested heavily in it. Providing emergency stop-gap funding, especially in the amounts that Eskom regularly requires, without addressing the root causes, is no solution.

If you’re in a hole, stop digging – or so they say. DM

Photo: Arnot Power Station near Middelburg in Mpumalanga (Wikimedia Commons)


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