OP-ED

Eskom unbundled: Contradictions in the plan will exacerbate the energy crisis

By Jaco Oelofsen 23 July 2020

Eskom should be revived as as a fully integrated, public utility, a new report concludes. (Photo: Markus Spiske)

Three international energy research organisations have worked with Eskom trade unions to compile a report – Eskom Transformed: Achieving a Just Energy Transition for South Africa – due for release on 23 July 2020. This is the first of a three-part series on the analysis contained in the report, as well as proposed strategies for South Africa’s energy sector. The researchers argue that the future of an unbundled Eskom includes a multitude of problems.

It seems that the Ramaphosa administration has finally run out of patience with long-promised reform at Eskom. The delivery of Finance Minister Tito Mboweni’s supplementary budget last month came with open and insistent demands that Eskom picks up the pace in following the “unbundling” roadmap adopted in late 2019.

Meanwhile, unions have raised the alarm about the sudden and rapid redeployment of Eskom employees in line with the utility’s long term roadmap – the irrational urgency of which could indicate a shift to an “unbundling at all costs” approach in some parts of the state.

As unbundling has come to be seen as the only common-sense solution to Eskom’s crisis, most consider this latest push to be in the right direction. There seems to be a near universal buy-in to a certain picture of South Africa’s energy future; one where Eskom takes a back seat, while for-profit power producers enter the market in full force.

In March, Public Enterprises Minister Pravin Gordhan summed up this picture by describing what he saw as the three trajectories of the South African energy sector: First, the “energy transition” from coal to renewables. Second, unbundling and the “ultimate separation of generation, transmission and distribution”. Third, “a future where there isn’t this 95% dependence on Eskom as a generator”.

Until now, not enough attention has been given to a serious analysis of how all these trajectories will actually play out. Drawing on international and local experience of for-profit energy regimes, the Eskom Transformed research team argues that these trajectories hold serious contradictions which will further exacerbate the crisis of the energy system, wasting the opportunity for imaginative and progressive reform.

Why unbundling?

One of the most common traps of the Eskom debate has been the tendency to resort to a common dichotomy. The choice, they tell us, goes like this: We can choose to prop up a corrupt, bloated, fossil-fuel spewing state-owned enterprise (SOE) from a bygone era, or we can choose to modernise the energy sector by streamlining Eskom, splitting it up into its various functions, and letting independent renewable power producers enter the market to do the heavy lifting.

The first step, from one to the other, is what Gordhan euphemistically referred to as the “utility transition”, a process involving the “unbundling” of Eskom’s generation, transmission, and distribution components into different entities.

We must understand that the “utility transition” – unbundling – is a necessary step to a market transition in the energy sector more generally. At the moment, South Africa’s energy sector is dominated at all levels by Eskom. Eskom Generation generates the power, Eskom Transmission directs and manages it, sending it to Eskom Distribution and municipalities, who in turn sell it to the person at the end of the line. Independent power producers (IPPs) are allowed to feed into this loop when the state opens bid windows for new contracts, but they are only meant to supplement the system.

The contract system ensures profit for IPPs, but it is also very expensive for the state. If the state wants private investors to come on board in large numbers, then the landscape of South Africa’s energy sector would need to change, both in order to lower the cost to the state, and to ensure continued private investment.

This is where unbundling comes in, and the key to the whole plan lies in turning Eskom’s Transmission division into what is known as an Independent Transmission System and Market Operator (ITSMO). This is basically a buyer and seller of electricity, with a board, shareholders, and a mandate to maximise profit. Once Transmission has been turned into an ITSMO, it will then take over the function of buying electricity from power producers – from both Eskom’s own plants as well as IPPs – and selling it to municipalities and customers.

How does this differ from Eskom’s current structure? The key point is that this ITSMO will eventually stop issuing expensive contracts and start buying and selling electricity in what Eskom’s roadmap calls an “open-market model”. This means that not only will power producers be able to enter the market freely, but they will also start competing with one another in order to sell their power to the ITSMO. In other words, the energy sector will turn into an energy market, with the ITSMO deciding whether the price is right.

The hope here is that this will give us three main benefits: cheaper electricity due to more competition between power producers, an end to load shedding due to new power producers coming into the market, and a transition from dirty to “clean” energy, as most of these power producers will be using renewable sources like wind and solar.

Unbundling the hidden costs of private power

Let’s say that the state is able to follow through on their roadmap. Eskom has been unbundled, Transmission has become an ITSMO, the state has politely held the door open for private investment, and for-profit wind or solar farms are beginning to pop up around the country. What now?

It is at this point of Eskom’s trajectory that the problems will begin to creep in. As more renewable energy comes online, the technical complications and financial burdens increase.

The low “levelised cost of electricity” (LCOE) of renewable energy – the measurement cited in articles claiming renewables are now the “least-cost option” – ignores the serious costs of integrating and running a grid with an increasing proportion of renewable energy.

Increasing the share of energy produced by renewables would require an overhaul of the transmission and distribution systems to deal with the problem of variable generation: South Africa’s geography and climate are well suited to renewable energy generation, but even here the sun does not always shine on all solar panels, and there is not always enough wind to generate electricity from particular wind turbines.

This overhaul will require a drastically upgraded grid allowing for increased coordination across distribution and generation facilities, as well as the national construction of large and expensive storage facilities. The costs of incorporating renewable energy generation into the grid, especially in large quantities, are therefore substantial, and they will inevitably fall on the shoulders of the transmission utility.

An unbundled transmission acting as an ITSMO could recoup these costs in two ways. First, they could pass the costs to the IPPs through fees or a lowering of the price paid for their energy. Provided this proposal could get any political traction, it would scare off investors enough to endanger the nascent renewable energy market. However, its political viability is in any case doubtful, given the political power of capital in energy market governance. Instead, the likelier way to react is, according to market logic, by passing the cost on to distribution and, in the end, the consumer.

In reality, this is exactly what many European utilities have done; countries like Germany have experienced the stark contrast between the falling LCOE of renewables, and the rising tariffs paid by consumers. Passing the system costs of renewables through to the end user will have profoundly negative effects on the economy, disproportionately impacting those most vulnerable and precarious in our society, as well as further reducing the demand for electricity. As the outcry that met Eskom’s many proposed tariff increases has demonstrated, this is not an option that South Africans are willing to accept – nor should they.

Most importantly though, Eskom’s current crisis has illustrated the dynamic that plays out when electricity tariffs are increased to meet financial shortfalls. Eskom is currently trapped in a “death spiral”, a term used in energy policy to refer to a situation where an energy utility raises tariffs to meet deficits, leading to decreased consumer demand and thus decreased income, which it then attempts to recoup by again raising tariffs.

As the above argument has outlined, there is good reason to believe that an ITSMO could end up in the exact same death spiral, turning into simply another financially unviable SOE in need of constant bailouts. The trajectory of unbundling is thus circular – it leads us right back to where we started.

Energy markets and zombie utilities

And how would Eskom Generation do in this new, post-unbundling world? If Eskom Transmission were to be unbundled and transmission turned into an ITSMO, then presumably the generation component would compete on a level playing field with IPPs. While still supplying the bulk of capacity, Eskom’s ageing and debt-ridden coal fleet would then be put in competition with renewable IPPs.

The prospects of survival look slim for an unbundled “Eskom Generation” stuck in a competitive energy war with IPPs. Unbundling will surely result in Generation inheriting the worst of Eskom’s balance sheet, given that Medupi and Kusile have attracted the bulk of its debt.

Even if its debt burden were to be relieved, it would still be left to compete against renewable IPPs which can produce power for cheaper, especially given the fact that they pass many of their costs on to the ITSMO.

Finally, coal has become anathema to investors, and so Eskom Generation would struggle to attract even the minimum investment needed to expand or maintain its operations. “Eskom Generation” will quickly become financially unviable, if it is not bankrupt from the start.

There are some who believe this to be a good thing, as reducing our reliance on coal is one of the biggest contributions we can make to lowering our carbon footprint. However, at the same time, the unfortunate but undeniable fact remains that South Africa still needs fossil fuels. This is true now, it is true for an unbundled Eskom, and it will remain true for the near future – coal currently generates over 90% of our energy, and no country can transition out of that in a decade or two. There is therefore simply no way that South Africa could allow Eskom’s generation to go offline without triggering a total economic collapse – even if the most optimistic renewable build targets are met.

Capacity payments (paid for through the already strained state budget), would thus be required to prop up the economically failed generation entity. In all likelihood, Eskom Generation will become what is known in the energy world as a “zombie” utility; a utility that is not financially viable but too important to fail, kept in a constant state of semi-death by state bailouts and capacity payments. This is not idle speculation; many European energy utilities are already stuck in various stages of this process.

Where to from here?

The Eskom Transformed report has two main components. The first shines a light on the currently unquestioned future of an unbundled Eskom and, as briefly summarised here, shows how there is a multitude of problems lying in wait. Future articles from the Eskom Transformed team will dive into these in more detail.

However, the second and most central part of this report is to revive the idea of Eskom as a fully integrated, public utility. This conclusion is not based on ideology, but on the outcome of research that tells us, contrary to what we have been told, that the private sector is functionally incapable of delivering the large-scale transition to renewable energy needed in South Africa today, if we are to have a future tomorrow. DM

Jaco Oelofsen is a researcher working at the Alternative Information Development Centre in Cape Town. His field of work includes energy policy, climate and economic justice. This article arises out of the work of three research organisations, TUED (Trade Unions for Energy Democracy, New York), and TNI (Transnational Institute, Amsterdam), which have worked closely with trade unions organising workers at Eskom – National Union of Mineworkers (NUM) and the National Union of Metalworkers of SA  (Numsa), resulting in a research report: “Eskom Transformed: Achieving a Just Energy Transition for South Africa“. The report develops proposals for resolving the Eskom crisis in ways consistent with our collective commitment to energy democracy, low carbon development paths, and combating the deepening ecological crisis. The research report deals with both an analysis of Eskom’s crisis and our proposals for the way forward.

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