South Africa

South Africa

When democratic accountability fails: Eskom’s slide into darkness

If there is one thing that we can say with confidence about the state of Eskom after the “selective re-opening” of the 2013-2018 tariff application is that nobody really knows what is going on. Nobody. By DIRK DE VOS.

On Monday, The National Energy Regulator of South Africa (Nersa) turned down Eskom’s request for a 25% jump in the electricity tariff. One of the reasons it cited was that it was given very little to go on. Parliament has voted for the the Eskom Special Appropriation Bill that will inject R23 billion into the power utility and the Eskom Subordinated Loan Special Appropriation Amendment Bill that converts an existing R60 billion government loan into equity. We can be certain that those who voted for those bills don’t know whether this will halt Eskom’s slide but we can be sure that the finance minister, Nhlanhla Nene, whose ministry sponsored those appropriation bills, doesn’t really know either. One would think that acting Eskom CEO, Brian Molefe, would have some clear grip on the basic relevant facts but he just comes across as somewhat clueless even about the Nersa processes themselves.

Perhaps the hardest thing to understand about electricity utilities is the time lags between cause and effect. So, when things are going well, say, like when Eskom was supplying huge amounts of electricity at the cheapest prices anywhere in the world and funding a huge electrification programme at the same time, many thought that this was the natural order of things. No market discipline was necessary. Somehow, Eskom was different.

Only environmentalists pointing to Eskom’s coal dependence seemed unhappy. After all, hadn’t Eskom won the Power Company of the Year award at the Financial Times Global Energy Awards in 2001? An award recognising Eskom for “… providing the world’s lowest-cost electricity while at the same time making superior technological innovations, increasing transmission system reliability and developing economical, efficient and safe methods for combustion of low-grade coal”. Little did most of us know that even then, Eskom’s downward trajectory was well underway.

Actually, we’ve been here all before. Eskom, now, is in a somewhat similar position to where it was in the 1980s. An article by Dr Grové Steyn of Meridian Economics describes it well: High oil prices, uncertainty of supply from the Middle East to due growing opposition to Apartheid and the needs of the mining sector had Escom (as it was then called) embarking on a power plant building spree. Then, like now, it decided to build much bigger plants using unproven technologies than it had done before. Those new builds experienced huge cost overruns and delays and in 1981, South Africa got its first taste of widespread load-shedding. Undeterred, Escom then redoubled its efforts. By 1983, Escom had over 22 GW (more than twice Eskom’s current build programme) under construction or on order. Spiralling electricity price increases resulted in the Apartheid government setting up the De Villiers Commission to investigate. Among the findings was the problem of a looming supply surplus. Escom was building far too much generating capacity for the economy to absorb. Still, it was able to push ahead and this construction mania ended only with the enormous Majuba power station, which was eventually completed way, way over budget and years behind schedule.

Escom then still operated as a government department so the government stood behind all the debt it had accumulated through its build programme. It is widely accepted that the disinvestment campaign which really got going in the 1980s played a big part in bringing down the Apartheid government. Perhaps the single biggest blow to the Apartheid regime happened in 1985, when Citibank said it would no longer lend to South Africa. Chase Manhattan followed on with its refusal to roll over short-term credit and demanded that South Africa repay its debts in full. Other banks, like Barclays followed. These financial sanctions brought the Apartheid economy to its knees. South Africa formally defaulted in 1985. We know now that it was then that the Botha regime started discussions with Nelson Mandela and the ANC. Our electricity system and its debts had a direct impact on the Apartheid regime’s vulnerability. It’s certainly arguable that Eskom, in its previous guise, played a significant part in the demise of National Party rule.

It is not always fully appreciated how harmful over-investing in any type of infrastructure can be – especially in an economy with pressing needs and underdevelopment. Unused surplus capacity still has to be paid for. It represents lost opportunities for investing elsewhere where there are needs and investment returns. Lost opportunities are just as important as real measurable losses.

While it is true that the ANC-led democratic government in 1994 inherited a highly capable electricity utility with surplus capacity, it also inherited Apartheid’s debt. But by then a good part of Eskom’s debt had already been reduced. In a profile of Gill Marcus before she became Reserve Bank governor, Pippa Green relates how an expansive fiscal policy after 1994 to fund the Reconstruction and Development Programme was hugely constrained by Apartheid’s reckless borrowing and mismanagement of the economy. The ANC-led government knew if the debt situation was not turned around, we would soon land up in the ‘tender’ hands of the International Monetary Fund (IMF).

Eskom’s management, reading the tea leaves, knew that if it was to survive intact, would need to become indispensable in the new South Africa. In 1991, Eskom entered into a price compact where it would reduce electricity prices while simultaneously reducing its debt. After 1994, significant restructuring of the economy took place but other than corporatisation in 2001, Eskom remained essentially the same entity – one of the world’s largest electricity utilities operating as a vertically integrated monopoly. It was able to do this despite government policy to open up the energy sector, because it was able to undertake and largely self-fund the government’s electrification programme. Previously, Eskom’s core customer focus was what some describe as the ‘Minerals-Energy Complex’ based on resource extraction (mining) and capital intense minerals processing. Other customers were add-ons. The Mineral-Energy Complex describes itself as the Energy Intensive User’s Group and its 31 members represent 44% of Eskom’s total electricity output. They are also the foundation upon which the rest of the economy depends. They represent the majority of foreign exchange generated in this economy needed to finance capital investments of all types. There is a circular lock-in of sorts. Cheap electricity promotes an energy intensive mining and basic processing based economy and for this to continue, cheap and abundant electricity is needed.

Since the 1991 pact, Eskom was able to pick up other important constituencies. Low income and rural voters and local government in urban areas that are dependent on the surpluses generated by the on-selling of electricity. Like the energy intensive users, they are all dependant on cheap and abundant electricity. But by doing so and even reducing electricity prices, Eskom secured political cover to continue as it had been, in an unchanged form. In addition, Eskom was able to provide large numbers of high quality and high paying jobs for the government’s deployment policies. All this meant that, while the 1991 pact remained in place, it was off-bounds from any real scrutiny.

As far as Eskom is concerned, we suffer from what Dr Steyn describes as “information asymmetry”. Its unique position as a vertically integrated state owned monopoly gives enormous discretion to management. And we should be clear about this. The interests of Eskom’s management do not align with the interests of the country as a whole. Instead of pursuing policies that would increase our country’s energy efficiency, our economy has, until recently, became more energy intense. New customers such as Aluminium smelters were found to mop up our surplus capacity on terms that locked in low prices for 20 years and the provision of electricity is also a core part of our social welfare system.

We are now several decades into an energy intensive development strategy. It was never a sustainable one. In the long run, very cheap coal is just as small part of the cost of electricity. Most of it is made up of the cost of continued capital-intensive investment. The 1991 pact priced electricity as if our capital base would never have to be replenished. These strategies always end in a cul de sac.

Although Eskom did famously warn government about impending generation capacity shortages and even accurately predicted when these would hit, when it did get the go ahead, the result was the decision to build some of the biggest and most technically advanced power stations anywhere in the world. The mistakes of the 1980s then forgotten, were repeated. The calamitous Medupi and Kusile projects can be ascribed to the misalignment of the interests of Eskom’s management and the interests of the country and it has all happened before. Huge projects provide huge rent seeking opportunities and when they don’t work out, the costs of their poor investment decisions and inadequate project management can be passed on to the rest of us.

Our interests are supposed to be looked after by Nersa, the energy regulator. But Nersa has an impossible task. It suffers from the same information asymmetry as the rest of us. Nersa is enjoined to regulate Eskom in terms of its Electricity Pricing Policy. This pricing policy is merely a guide which has to take into account several factors, including cost reflectivity, permitted returns on investment and so on but in doing so, it must assume “an efficient and prudent operator”. That is very hard to do if you don’t have anything to compare Eskom with. Think about depreciation policy for a moment. Power stations are paid for over 20 years but have an operating life of at least double that. Depreciating over the full 50 years of a power plant makes cumulative returns on capital, free cashflows and therefore the price of electricity unacceptably high over the period. Depreciate over the 20 year financing period and you have a very lumpy cost of capital going up when power plants are built and going far too low when they are all paid off’ leaving nothing in the kitty. Conventional accounting policies don’t help much here.

A paper by Rashaad Amara, an economist attached to Treasury, explains these complexities well. Essentially, for Nersa to do its job, it has to run a theoretical electricity monopoly on paper and compare this with what Eskom, a real utility with huge budgets, paying real high-priced advisors choses to tell it. Throw in political cover and Eskom can run rings around Nersa and has done so since Nersa was established. Eskom’s reporting and disclosures to Nersa are well short of what is needed to allow Nersa to make sensible decisions. Submissions to Nersa from the public or industry sectors prepared by experts often provide great insights and suggestions. But they also share a shortcoming – they are based on what can be inferred. Eskom, a monopoly operator, keeps a tight monopoly on information about itself and can keep the rest of us, including the National Treasury, guessing.

As Eskom’s performance declines, so disclosure becomes less and less .The constantly revolving door at executive level means that new management doesn’t know nearly enough either.

If the 1991 pact no longer exists and it was inevitable that it would be broken, then it is time to look at things differently. Breaking up Eskom and introducing competition, at least a generator level is not about promoting a particular economic ideology. It is about introducing a baseline and allowing the rest of us, including our regulator to figure out what is going on inside a critical part of our economy. Seen in this way, it is about democratic accountability. It would also prevent yet another repeat of loadshedding and spiralling prices for which we are ill-prepared.

South Africans should know that we are in a real jam. Getting out of it will require hard decisions. Next time Eskom comes before Nersa, it must be forced to play open cards so we can see exactly where we are and what needs to be done. Getting it wrong can have serious implications for our government. As the historical record shows. DM

Photo: Sinovuyo Bhungane (R), 9, looks on as her studies are interrupted by her cousin Yonga, as she studies using candle light during load shedding in Soweto February 3, 2015. REUTERS/Siphiwe Sibeko

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