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28 March 2017 15:51 (South Africa)
South Africa

Eskom: Nersa, you have the power to tame the Beast

  • Dirk de Vos
    dirk-de-vos.jpg
    Dirk de Vos

    Dirk runs a corporate finance and advisory firm, QED Solutions (qedsolutions.co.za) out of Cape Town.

  • South Africa
Photo by StormSignal.

Eskom’s lack of transparency is one of the most powerful weapons it has had to counter any efforts to reform itself or the electricity sector. It’s time to change that. By DIRK DE VOS.

Eskom has moved away from a full reliance of the legacy generator-tied mines that delivered coal directly on conveyor belts to more short-term supply agreements with collieries who deliver by truck on roads not designed for this type of traffic.

The new procurement policy comes at a greater cost in terms of the price that Eskom pays for coal and the management of this type of supply. It also comes at the cost of deteriorating roads and pollution (which it does not pay for). What it does do is to open up procurement to new entrants, both coal miners and truck drivers. A third of Eskom’s coal supply – or around 40-million tonnes of coal per annum – is now delivered by road.

Through this policy Eskom has created a whole new sector of the economy made up of largely black entrepreneurs who have had to invest in expensive trucks but who are entirely dependent on Eskom as their only customer.

But it’s an unsustainable sector and, but for Eskom’s procurement policies, a good part of it would not have existed in the first place. As electricity demand continues to fall, Eskom has to confront mothballing some of its generation capacity once again. And Given Eskom’s own severe and growing financial problems, the most expensive generators supplied by the most expensive coal get taken out of service first. It is the generators supplied by the truck-delivered coal that are pushed out first.

Eskom seeks to pin the blame for the predicament of the coal truck drivers on the renewable energy generators and lets it be known that if further renewables are connected, as Eskom is legally bound to do, the situation could get worse for Eskom’s road deliveries.

On the other side is the renewable energy sector that has 37 projects that Eskom refuses to sign up and connect. It appears that this matter will eventually land up in court but the renewables are not financed in a way that allows for protracted and expensive litigation. There is now a real threat that that the utility-scale renewables sector in South Africa will collapse and with it a loss of investments, particularly in manufacturing, jobs and rural development.

South Africa will bear additional losses. REIPPPP, the procurement programme for renewables, was developed at great expense and is widely regarded as one of the best of its kind in the world but it is only now, and in respect of the projects that are still to be connected – with their very low tariffs – that South Africa is able to get the returns on the massive investment it made in REIPPPP. The first bidding rounds were always going to result in high tariffs. To use an analogy, imagine that all work on Medupi, except for its Unit 6, stopped. If that happened, then Unit 6 without Units 1-5 would probably be the most expensive operating coal-fired generator ever to have been built.

Many observers and the renewables sector demand that Eskom implements government policy on renewables. How can Eskom, an organ of state, remain in defiance of its own government’s policy? Even the president said the renewable programme will proceed, in his recent State of the Nation Address, didn’t he?

But Eskom has been in more-or-less defiance of government policy on electricity for almost 20 years now. In 1998, the then government adopted a white paper on electricity – it required the use of market mechanisms, choice and private sector involvement. Eskom’s management was able to prevent any changes by supplying very cheap electricity and undertaking an enormous electrification programme using its own resources. Who would want to break up something that delivered in such abundance?

Legislation such as the Independent System and Market Operator (ISMO) Bill, a requirement of the 1998 policy that would have separated generation from transmission, went nowhere. Various efforts to revive a watered-down ISMO (requiring just accounting separation) have produced nothing.

After several bouts of load shedding, revelations on how Eskom has been managed and tariffs that have gone up by a factor of three (in real terms) we now know that Eskom has been on an unsustainable trajectory. We are stuck with a failing utility that is piling on unsustainable debt to complete a capital investment programme that is out of control in terms of budgets and completion timelines. The investments needed to take us to a different and cleaner technology path are not being made, even as these are making huge progress elsewhere in the world.

The mistake we make is to view Eskom and the electricity sector through the lens of policy-making and various supporting processes such as the Integrated Development Plans. After 20 years of policy-making and new legislation governing the sector, very little progress has been made. It’s time for a rethink.

More than anything else, we are stuck with a principal-agent problem. This problem has received a lot of attention in economics and the theory of the firm. In theory, managers of a company (the agents) who are empowered to make decisions should have their interests aligned with the owners of the company, the shareholders (the principal). Very often though, this is not the case. Managers’ incentives can be quite different to the final owners and the misalignment of interests is particularly a problem in the case of a monopoly utility.

The misalignment of the interests of Eskom’s conduct and our interests has been a constant feature over the years. One can point to any number of examples – the building of large, risky, complex power stations and other capital projects; the lack of interest in energy efficiency; the inordinate secrecy under which Eskom’s management conducts itself; the conduct of its management (See Denton’s report) and the way that it discloses its activities in its financial reports or to the regulator.

Just about every effort to reform our electricity market and to introduce competition has been stymied. Eskom’s management can do so because they set out to accumulate political capital. They can do this by providing benefits to their political principals such as selling electricity at below cost or supporting a nuclear programme.

Lately, when more political capital is needed, there is a move to blackmail of sorts. Eskom’s ballooning debt, much of which is held by the government employees’ pension fund, produces great returns as junk status debt but is also a macroprudential risk for the country. Eskom says it plans to continue borrowing more than R55-billion for each of the next five years which will see its debt top out at R500-billion or a quarter of the country’s current debt burden. It should be obvious that, if for any reason Eskom is unable to meet its debtholder obligations, the government will have to step in and bail Eskom out. In this way, Eskom can make its debt problem become our problem – perhaps it already has. Having a politically powerful counterweight to the independent power sector in the form of the wholly dependent road coal transport sector is yet another weapon in Eskom’s arsenal against the rest of us.

In our current political environment where there is almost no leadership, the government does not have the will or frankly the ability to implement its policies. Eskom has us cornered and the arrogance, lack of accountability and disdain of its management’s communication shows that they know this too.

Civil society organisation OUTA has responded by circulating a petition to get behind an effort to have the competition authorities force an unbundling of Eskom. It’s a long shot for many reasons.

There is however a small gap worth exploring – Nersa, or rather the processes for which Nersa is responsible. Nersa is in a rebuilding phase and has just appointed a new CEO. It is too much to expect Nersa to tame the Eskom beast on its own but the new Multi-Year Price Determination (MYPD) process is about to get under way which is supposed to determine Eskom’s tariff trajectory from the five years commencing 2019.

The MYPD sets Eskom’s tariffs over a period of five years.

Now Eskom, even though it operates as a vertically integrated monopoly, actually has three separate licences: generator, transmission and distributor licences – but the public sees just one application for all of them.

Tariff setting in this country is complex, but there are two steps. In the MYPD process, Nersa endeavours to set Eskom’s basic tariff over the following five years. Then, in each following year, there is another process, the RCA, which can adjust the tariff for departures based on actual historical performance. If there are shortfalls in revenues or unexpected costs, the tariffs for the future years are adjusted. Every year, the municipalities that distribute Eskom’s electricity are also supposed to have their tariff applications approved by Nersa and these become the tariffs payable by their customers.

The way the MYPD tariff setting works is also difficult to understand but there is a two-phase enquiry:

  • First, there is a determination of the value of all of Eskom’s assets or its Regulated Asset Base (RAB). This is different from the value of these assets as reflected in Eskom’s balance sheet. The RAB is based on historical replacement cost of the assets (instead of the depreciated value). Once the RAB is determined, the regulator is required to determine what Eskom’s permitted return (or profit) it should be able to make on the RAB.
  • Second, Eskom’s direct costs, like fuel, staff, maintenance and the costs of buying electricity from REIPPP projects, are determined. The test for permitting these costs are a theoretical construct – Nersa should only permit the costs that would be those of a “prudent operator”.

The permitted return on the RAB and the permitted direct costs are then added together. The tariff on a per-kw/h basis is the result of this composite figure divided by the amount of electricity Eskom expects to sell.

The MYPD process also contains a public participation process that is supposed to help Nersa come to its determination. The shortcoming is that since Eskom’s MYPD documentation is presented in one composite application, it is impossible to make sense of what is actually going on in respect of each licence or area of activity.

Nersa could change all this by making just two decisions today, both of which are within its powers:

  • It can require Eskom to make separate applications in respect of each generator for which it has a generating licence and then another application for the transmission grid.
  • Instead of considering the distribution licence as part of the MYPD, Nersa could require that Eskom has its tariffs at distribution level considered in the same way as the other 180-odd municipal distributors.

The outcome of the MYPD might well be the same but the transparency we would secure by having spate application processes for each type of licence is far, far greater than anything we have had up to now. Eskom’s lack of transparency is one of the most powerful weapons it has had to counter any efforts to reform itself or the electricity sector. With transparency, our debates about restructuring are less speculative and more informed. Broader civil society, including hopeful coal miners and the coal road transport sector, would know where they stand and not just rely on what Eskom’s management tell them. Transparency is a great tool for bringing some much-needed democratic accountability.

This proposal is a modest one but its merit is that it requires just two small administrative decisions and, after all, as the saying goes: “How do you eat an elephant?” Well, “one bite at a time”. So Nersa, how about it? DM

Photo by StormSignal.

  • Dirk de Vos
    dirk-de-vos.jpg
    Dirk de Vos

    Dirk runs a corporate finance and advisory firm, QED Solutions (qedsolutions.co.za) out of Cape Town.

  • South Africa

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