South Africa

South Africa

Op-Ed: The Potemkin Village that is the IRP2016

Perhaps the best way to describe the recently released IRP2016 energy plan is a Potemkin Village. These fake settlements with their glowing fires at night were designed to give the impression of normalcy and even prosperity. By DIRK DE VOS.

There is a legend which tells the story of Grigory Potemkin, a lover of Empress Catherine II of Russia, who on the annexation of Crimea from the Ottoman Empire became the governor there and needed to make it Russian. The Empress then journeyed to the new territory in 1787 which was in a terrible state after the war and another war with the Turks was already brewing.

Desperate to impress the Empress, Potemkin came up with a plan. He had the wooden façade of a whole village constructed for him. Then as the Empress inspected the new territory from a barge on the Dnieper River, Potemkin’s men, dressed as peasants, would populate the villages. Once the barge left, the village was quickly disassembled, then rebuilt downstream overnight. These fake settlements with their glowing fires at night were designed to give the impression of normalcy and even prosperity. There is no evidence that any of this happened, but a Potemkin Village is now used to describe any pretentious façade intended to mask or divert attention from an embarrassing or shabby fact or condition.

Perhaps the best way to describe the recently released IRP2016 energy plan is a Potemkin Village. The best analysis available in the public domain on the plan is that done by Chris Yelland. It is hard to offer any further comment on the document itself. Besides being lightweight, the document contains several large errors in calculating the costs of different technologies and missing annexures. Yelland also points out that there is more than one version of the document – the one published in the Government Gazette on 25 November 2016 that refers to the annexures and a different one, with all references to annexures removed, on the Department of Energy website. One does not have to be a genius in critical analysis to know that the original research used to put the document together has been dumped in favour of some pre-determined outcome. In this case, keeping nuclear in the mix.

It is therefore pretty disrespectful to say that any public engagement, the next step, can usefully take place. Public participation workshops are supposed to take place between December 7-15 at venues in the major metro areas at venues still to be announced. The public participation process then closes in February 2017. On the basis of the above, the whole process must be reviewable by a court and one can be sure that an affidavit in support of an application to do just that is being drafted somewhere as you read this.

This rather grubby façade that is the draft IRP2016 doesn’t hide how electricity planning really takes place in this country. The value of long-term planning for any country’s electricity sector has merit and our IRP processes are supposed to inform a ministerial determination as to what new generating capacity should be built by when. But our electricity system is wholly owned and operated by our vertically integrated monopoly, Eskom. As such, one can pretty much ignore what any IRP says and look instead to what Eskom is thinking. Quite what Eskom’s management thinks is hard to discern but they do disclose the outlines of their capital expenditure programme as well as how they understand the role of Independent Power Producers (IPP) in the mix.

After the departure of Brian Molefe as CEO, Eskom’s board has appointed the former head of generation, Matshele Koko, as its acting CEO. Other than lying on national broadcast television, Mr Koko has developed a reputation for defying national energy policy by refusing to sign up further shovel-ready IPP projects. It is hard to think of a more inappropriate person to head up our electricity supply sector. Early next year, another set of IPPs, the so-called baseload coal IPPs, will be looking to get their generation licences and start construction. Environmental groups will oppose them to the end but it is perhaps Eskom, sitting with its own surplus capacity, who will be happy to sink the process as well. Then there is the gas IPP. It also looks doubtful from here. Eskom’s strategy seems to be to hope that the investors in any kind of IPP project will also come around to the view that whatever our IRP-informed electricity policy might be, it is Eskom that decides these things.

When the increasingly competitive renewables beat out coal, nuclear or other fossil fuel options on a like-for-like basis, Eskom, often through Mr Koko, simply changes the premise. What he does is to introduce a concept called “sunk cost”. So, when Medupi and more especially Kusile look like pure folly on an all-in basis, we are told that leaving “sunk costs” aside, the power that Eskom will get from these generators is much cheaper than anything IPPs can do for Eskom. Of course, the “sunk costs” don’t disappear – Eskom’s regulated asset base tariff mechanism allows it to make a profit from its customers based on these very same “sunk costs”.

While South Africa’s renewable energy programme has drawn praise by how it has attracted perhaps R160-billion in private sector investment since it started from nothing in 2010, Eskom has been spending between R50-billion to R60-billion per annum and has a capital expenditure programme that plans to lift this to beyond R60-billion/annum level. But when you examine Eskom’s capital expenditure plans, there is very little or nothing about any IRP or about efforts to align them with national energy policy. Eskom doesn’t even bother to pretend that it pays any attention to any IRP or official national energy policy. When the draft IRP2016 gets published and is drafted in such a way that it leaves the door open for nuclear by 2037, what does Eskom do? It says it is proceeding with its nuclear procurement anyway despite no Treasury support for it.

Mr Yelland, in his article, records that a substantive criticism of the IRP2016 is that it broke the basic rules of planning which is to start with an unconstrained, least-cost, base-case scenario, using up-to-date technology costs, to establish the associated least-cost, unconstrained base-case and then develop it further by running several other scenarios using various imposed constraints, whatever these might be, and establish the costs of these constraints. For example, a CSIR study by Dr Tobias Bischof-Niemz, Jarrad Wright, Joanne Calitz and Crescent Mushwana showed a perfectly viable and costed plan that is heavily orientated towards renewables. Even with the dodgy pricing assumptions used by the IRP2016, the CSIR, running an identical model with the same assumptions but on an unconstrained basis, points to a renewables-dominant future.

A decision to go the route of least-cost renewables is not just a question of generation. The grid has to be reorientated and become less centralised so that flexible and variable renewables can work most effectively. However, it is Eskom that decides what investments in the grid will be made, not any IRP process.

Subcontracting our electricity planning to Eskom is a bad idea but it is even worse when Eskom itself is in the poor financial state it is. The extent of the deep problems were analysed by Stephen Labson. While the country managed to stave off a credit rating downgrade and keep its investment grade, Eskom’s credit rating is already junk. The Moody’s September update makes for sobering reading. Eskom’s Ba1 rating (let’s call it respectable junk status) relies solely upon the support that would be provided by the government of South Africa. On a stand-alone basis, its credit rating would be much worse. The report notes existing government support via a R350-billion Guarantee Framework Agreement and is reflected in a R60-billion loan, converted into equity in 2015, and the R23-billion equity injection provided by the sale of the government’s stake in Vodacom.

More worryingly, Moody’s points to the fact that Eskom has been unable to deliver its projects, notably Medupi, Kusile and Ingula, anywhere near on budget or on time. Eskom’s cashflows are dwarfed by its capital expansion programme that is funded by yet more borrowing. Interest payments that can’t be met by its operations just grow (or are capitalised) and Eskom’s debt pile just grows without a clear idea how it will ever be repaid.

The danger is that energy policy, already divorced from the IRP Potemkin Village, becomes subject to the country’s larger macroprudential problems. Treasury is not just on the hook for guarantees it issues to lenders, according to the most recent Quarterly Reserve Bank Report, a big chunk of pension fund money is invested in Eskom’s unsecured debt. The Reserve Bank does not split out investments across different State-Owned Enterprises (SOEs) but it does show that the PIC which manages the government employees’ pension fund was the largest investor with R180-billion invested in this debt. As with the guarantees, Eskom would represent the largest portion of all this debt. That R180-billion represents about 10% of the PIC’s total investments. Other private pension funds hold 4% of their investments in the debt of SOEs. The government employees’ pension fund managed by the PIC is a defined benefit scheme. Any shortfall must be met by Treasury and therefore the taxpayer. Eskom is a significant systemic risk to the country’s financial stability. In this way, energy policy is whatever shores up Eskom’s financial position.

One recalls an old joke that has some hopelessly lost tourists somewhere in Ireland. They draw up to a pedestrian on the side of the road and ask directions to Dublin. The pedestrian replies, “If I were going to Dublin, I wouldn’t be starting from ‘ere”. Realising the full extent of the huge challenges South Africa faces is a start to figuring out what to do about it. Obviously, the electricity sector needs to be restructured, something which has been delayed since 1998, but like building a nuclear power plant, restructuring the sector will take much longer than anyone thinks, has uncertain outcomes and can be far more expensive than initially thought. Here are some suggestions for the short term:

  1. Place Eskom directly under National Treasury in acknowledgement of its macroprudential risk and have the Minister of Finance appoint the board and senior management of Eskom. Anyone who even thinks that a problem can be ignored because it is a “sunk cost” should be fired immediately;
  2. The board and management need to be tasked with four things: (1) ensure plant availability over a period of a year remains at 80%; (2) produce detailed financials for each generator including its coal supply agreements, the grid and each local distribution grid it owns – full transparency; (3) improve Eskom’s credit rating; and (4) align the capex programme with a future IRP and national energy policy – including grid readiness for connecting increasingly cheap renewable energy and the back-up that it needs.
  3. Restart the IRP processes and ensure that these are independent and free of political interference and one that includes investments, not just in generating capacity but in energy efficiency and demand response mechanisms – make this more than the Potemkin Village that it has become.

These suggestions don’t solve the problems but they put us on the path to solving them. We are likely to see big funding gaps open but at least they will be there for everyone to see – which is better than the funding gaps that are presently metastasising out of sight. And is that not, after all, what democratic accountability is all about? DM

Photo by Gavin Fordham via Flickr.

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