Building New Generating Capacity: Proceed with CAUTION

Of all energy-related topics, the issue of how and what new type of energy South Africa ought to procure is the most controversial. The most authoritative document on the matter is the 2013 revised draft version of the Integrated Resource Plan (IRP). This version of the plan has come into focus again because the question of a nuclear programme is back on the agenda. Briefly, the updated IRP amends its 2010 version by pushing out the decision to procure nuclear for at least another decade. This update, and indeed the National Development Plan on the same subject, are apparently being ignored. Our government seems dead set on procuring 9,600 MW of nuclear power and does not want us to know too much about it.

It is not just nuclear power though. After Medupi and Kusile, plans are afoot to build yet another large coal fired power station known as Coal3.

Then there are plans around gas and of course, expanding the renewable energy programme.

Unfortunately, the debate on how to move forward gets stuck on different generating technologies. Most environmentalists are dead-set against coal and with some notable exceptions, are also against nuclear energy. On the other hand, many think that renewable energy is not the answer – it only provides expensive intermittent power when coal and nuclear provide base load. Many arguments, surprisingly, for an important issue like this, are based on incorrect facts. So when the Economist, a newspaper that supports efforts to reduce carbon dioxide emissions, published an article purporting to show how expensive renewable energy is, it was met with some controversy: when intermittency was included in the calculation, there were several authoritative voices in other publications that refuted the arguments.

Intermittency is a problem for renewables, but it is better to understand it as the flipside of the same problem for baseload power stations. Baseload power stations operate 24/7 and cannot vary their output much. Matching supply with demand in the day hours means overcapacity and wasting energy output at night. Both types of power source need improved storage. Happily, this is a rapidly advancing field, but commercially viable solutions are a few years away yet. Advocates for renewable energy say that they have a jump on the baseload crowd by combining intermittent renewable energy, which is getting dramatically cheaper each year with open cycle gas turbines. The debate is never-ending and, it would appear, no closer to a resolution.

Maybe it is worthwhile to look at the problem from a different point of view. The most important question is: how much generating capacity does South Africa need? That is a hard question to answer, but the best way to begin to offer an answer is to ask another question: at what price? As we have seen, when this question has not been asked, we got a massive over-investment and a wasteful mothballing of generators. Very little is known about the price elasticity of electricity but Eskom did commission a study which it included in its most recent Multi Year Price Determination (MYPD3) application to the energy regulator, Nersa. The study attempted to answer the question in the most general terms. Much more work needs to be done. The lowest projections of electricity demand in the IRP update are likely far too high.

One way of determining the appropriate generating technology is to do so first without reference to any environmental (carbon emissions, mining and water use) issues. Every now and again The International Energy Agency (IEA) puts together a projected cost of generating electricity study. They compare different technologies by using a measure called the levelised cost of electricity. Obviously, power plants are not off the shelf items and there are huge variations but in the spirit of this series of articles, one can come to some basic findings. Based on the IEA figures and excluding carbon taxes or carbon capture the splits in cost inputs are roughly as follows:

Based on the above, if our nuclear programme to build 9,600MW of capacity were to cost a trillion rand in current prices, we could have a stab at what the tariff might be as follows (the numbers are big):

• R1,000,000,000,000 (trillion) using a WACC of 8% paid over 30 years (interest capitalised monthly in arrear) requires an annual payment of  R88,051,748,865 for the capital portion;
• Add 25% for the other costs (fuel, operations & maintenance spent fuel, decommissioning etc) to get to R101,064,686,081;
• 9 600 MW with 90% uptime over 365.25 day per year generates 75,738,240GWh of electricity
• R101,064,686,081 / 75,738,240,000 = R1.45/kwh (Eskom’s average tariff is 74c/kwh).

Another way to help make decisions is to decide simply on size. In an interesting series of studies on infrastructure projects in the USA, it was found that nuclear is always over budget and subject to various delays. Another report, the 2013 World Nuclear Industry Status Report, stated that rating agencies consider nuclear investment risky and the abandoning of nuclear projects are ‘credit positive’; it reports that 67 percent of nuclear utilities assessed between 2008 and 2013 were downgraded. Given that South Africa is only just investment grade and that keeping this status is critical to retain cheap sources of funding, a nuclear build programme looks foolhardy.

But there are other factors to consider. One of the stated objectives of the government’s own 1998 white paper on energy as well as the National Development Plan is to get the private sector more involved in the energy sector. It is important that one understands what this actually means. Both Medupi and Kusile have private sector firms as suppliers of capital equipment and as contractors but this is not real private sector involvement. Private sector involvement really only happens when private capital is put at risk in the project itself. When Medupi and Kusile have budget overruns or are subject to delays, it is Eskom, or as we now see, the government (and therefore the taxpayer) at risk. When private capital is invested in the project, these risks are carried by those private sector participants who invested. However, this imposes a limitation on size. There are different views on how much private sector capital can be raised for one energy project, but it is likely a far smaller amount than is required by mega projects such as Medupi – and certainly any nuclear build.

This is no bad thing. In a recent essay, Nassim Nicholas Taleb, a former options trader and now a scholar, statistician, risk analyst and author of The Black Swan, Fooled by Randomness, and Antifragile, calls for more decentralisation, contrary to the Western illusion that that centralisation is better, more “efficient”, and that the reduction of the numbers of decision-makers is better. In support of his argument, he points to large public projects which incur disproportionately large costs overruns. While size produces visible benefits, it hides risks and increases exposure to large losses.

Centralisation on a technical level has its own costs. Consider this. Cape Town’s and the Western Cape’s electricity supply is only half met by Koeberg. Peak capacity for the province is around 3,500MW, while Koeberg can supply 1,800MW if both units are up. Transmission losses from electricity generated upcountry amount to 200MW, around 10% of the power delivered. If any unit at Koeberg is out of service, as one will be in February, these losses increase to 500MW. The same issue is at play for all South Africa’s coastal provinces.

Doing things on a smaller scale, it’s been suggested in a debate on nuclear energy that we avoid the technology debate and instead devise a strategy for allocating scarce capital resources, in the face of uncertainty to meet our power supply objectives. This requires selecting projects that the returns (benefits) they generate over time are likely to be greater than their costs over time accounting for opportunity costs of the options not chosen. Here, the argument points to a systemic inability on the part of all of us to comprehend the nature, scope and scale of uncertainty. The problem with big infrastructure projects is that all the risk is borne, eventually, by the taxpayer. This has been the case for Medupi and Kusile. It will certainly be the case for any nuclear programme. It’s pertinent, then, to attempt a different way of making decisions. If we know that our forecasts will be wrong and that in 15 – 20 years from now, the world is likely to be a very different place in ways that we cannot yet imagine, so shouldn’t we face up to the realities of the limits of planning and think differently about strategies for going into the future?

Dr Steyn suggests something known as “Incrementalism” or the science of muddling through. What this means is avoiding any attempt at large-scale rational comprehensive planning in favour of modest approaches and favouring technologies with lower complexity, shorter lead times, smaller unit sizes, lower dependence on dedicated infrastructure and higher substitutability of inputs. He also points out that diversity in a system promotes beneficial forms of innovation and growth, it hedges against exposure to uncertainty and ignorance, it mitigates the adverse effects of institutional ‘momentum’ and ‘lock-in’ in technological trajectories and accommodates disparate interests.

What is valuable where there is a large degree of uncertainty is options. We all know this intuitively in our own lives and actively build in options in our own decision-making. Parents generally advise their children on subject choices at school, or even their children’s love interests, to “keep their options open” because we know that options have value. The choice of large and inflexible technologies with long lead times and large scale dedicated infrastructure displaces other options.

Leaving aside environmental issues around coal for a moment, then, the recent coal baseload IPP tender with a 1,600 MW to be made up of projects smaller than 600 MW, each to be operational by 2021, is a far better way of moving forward. Of interest is that the price cap for electricity supplied to the grid by these coal-fired generators is 82c/kwh (average onshore wind tariff in round three was 74c/kwh and average solar PV in the same round was 99c/kwh). Of particular interest is that Nersa estimated in 2012 that Medupi, with 4,800MW, would have a levelised cost of electricity (or a tariff on a stand-alone basis) of 97c/kwh. It has certainly gone up since then and Kusile, of similar size, will supply electricity at an even higher rate.

What South Africa’s renewable energy procurement programme has demonstrated, if nothing else, is that when one sets up a competitive bidding process and provides institutional certainty, a large amount of private capital, both direct investments and debt can be motivated to take all construction risk and supply electricity to the grid at low cost.

On the other hand, you can reliably take a bet that large infrastructure projects will be over budget and subject to extended delays? Why, then, would you want to be the counter-party to this wager? If it is a government funded project, you are the counter-party and it will cost you.

Discussion Points:

• Given Eskom’s historical record, its credit rating and its high overhead, should it be part of any procurement of new generating capacity?
• For the present, Eskom is the only buyer of independently produced electricity but it is now in deep financial distress. This poses a risk for future development of an independent electricity sector. Furthermore, as we have seen, Eskom’s transmission infrastructure is incapable of synchronising with new generation projects. This cannot continue.
• The only independent power procurement done at any significant scale in South Africa is the Renewable Energy Independent Power Producer Procurement Programme (REIPPP) by an entity drawing skilled staff from Treasury’s Public-Private Partnership (PPP) Unit. It functions outside formal departmental structures of national government or indeed national legislation. It is able to do so via a rather dodgy legal definition that Eskom, the buyer, is not a public entity and therefore not subject to public procurement rules. Surely this ad hoc arrangement needs to be formalised if we are to procure more energy?
• If credit worthiness is a key factor in energy procurement, itself a capital intensive sector, then should we not open up opportunities for metros to undertake the job of procuring generating capacity themselves? The current legislative framework, namely the Municipal Systems Act 2000 (MSA); the Municipal Finance Management Act 2003 (MFMA); the Preferential Procurement Policy Framework Act 2000 (PPPFA) and Treasury’s Supply Chain Management Guide for Accounting Officers of Municipalities and Municipal Entities 2005 does not lend itself to anything like this. Which metros would have the technical capability of procuring their own power?
• Perhaps we should go further than separating generation from the grid, as the long delayed Independent System and Market Operator Bill seeks to do, and look to breaking up the grid into three or four independent but linked grids. Maybe a grid for the north and central parts of the country and two coastal grids would work. Over time, the objective would be to procure all or most of the electricity being fed into a grid by generators within the geographical area of the relevant grid. DM

Photo: Medupi Power Station near Lephalale in Limpopo as seen during a media visit on Thursday, 11 April 2013. When completed, the power station is to have six boilers each powering an 800 MW turbine, producing 4800 MW of power. Picture: Werner Beukes/SAPA