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Our Eskom Fork in the Road

De Vos is a director with strategic consultancy QED Solutions.

To get to grips with what should be done about the Eskom crisis, we need to get to grips with the kind of business it is.

Most of Eskom’s physical infrastructure was largely built in the late 1970s and early 1980s. Escom (it changed its name to Eskom in 1987) was the government’s participation of what became known as the minerals-energy complex. Escom’s main purpose was to provide cheap electricity to the mining sector which would then, using ultra-cheap black labour – a result of apartheid policies – export their minerals, generate foreign exchange, pay their taxes to keep the whole system of apartheid in place.

The intertwined nature of the mining sector and the government is reflected in the coal supply arrangements. South Africa has vast coal resources and coal would be the resource to drive the minerals-energy complex forward. Escom would build its coal-fired power stations that were designed to operate low grades of coal next to large coals fields mostly owned by the mining majors. The deal was that collieries would get funding from Escom to open and develop the coal resource and then provide the required low-grade coal, often via conveyor belts, directly from the mouth of the mine to the power station and do so at very low prices on a fixed cost or cost-plus basis.

These arrangements were good (using someone else’s capital always is) but not great. The way to make it really work was to export high-grade coal that Escom couldn’t use. To do so, the coal majors at the time clubbed together and built the coal export terminal at Richard’s Bay. Another government entity, South African railways, built the rail infrastructure linking all of this up.

The almost casual inter-connectedness of these arrangements, made far away from any public scrutiny, emerges in court cases. One 1986 Appellate Division dealing with the income tax effects of these arrangements in respect of the Matla coal mine sketches just how loose the arrangements were. Basic questions like who actually owns the mine, its infrastructure or the mining rights appeared not to matter.

Up to the 1960s providing power to cities was not an Escom function. Cities generated their own power. We can still see traces of this. The Kelvin power station in Johannesburg is still owned by the city and the Athlone power station seen alongside the N2 used to power most of Cape Town. Escom was built for the mining sector. Poor planning and unaccountable management meant that Escom built far too much capacity which couldn’t be used. As a result, the grid was extended to cities and towns as well as rural areas – but not as far, for a large part, as the houses in areas where black people were forced it live. It needed to sell its surplus somewhere.

So, there is it. Eskom at the dawn of democracy. A largely coal-fired electric utility with a terrible environmental record powering one of the most energy intensive economies in the world. Not a pretty picture but that is what it was.

Eskom’s management would have known that big changes were coming with a newly elected government eager to undo the damage of Apartheid. In 1998, the government officially adopted the White Paper on electricity reform. It recommended that Eskom be split into its component parts – generation, transmission and distribution. The official policy also recommended more private sector involvement in the electricity system. Eskom’s management had other ideas. By then Eskom had got rid of much of its debt so it entered into a series of price compacts to keep electricity prices the lowest in the world and also self-financed the extension of the grid in a massive electrification drive. It got involved in other things too: the ill-fated pebble bed modular nuclear reactor programme and the aluminium business via supplying electricity to smelters at almost no cost – and getting a kicker on the global aluminium price.

The plan worked. The government found it is hard to break something up that appeared to be working so well. Except it wasn’t. By selling electricity at below the full cost of producing it, it was destroying its own capital base. By the time the go-ahead for the Medupi and Kusile projects, Eskom had to borrow everything it needed.

It is hard to overstate what a catastrophe Medupi and Kusile have been. The decision to proceed, the design, the scale, the technology, the project management, the financing and the procurement processes to build these power plants were all disasters. Corruption along the way made things even worse. These two projects are largely responsible for Eskom’s R400-billion debt. We should know this – even if they run for 100 years – they will never, ever produce a positive return on investment.

In the meantime, as we are now aware of the latest bout of load shedding and by Eskom’s new management’s own admission, the old minerals-energy complex side of the business is in tatters. Eskom’s plant from the 1970’s and 1980’s is getting to the end of its design life. Every machine that runs and gets hot sets a limit to the reliability and its useful life. Failing to service or conduct maintenance as has happened to “keep the lights on” simply hastened the process.

At the same time, the long-term coal contracts that have supplied Eskom with cheap coal have been allowed to run out with no replacements. After a century of mining, the Mpumalanga coalfields are becoming exhausted and massive re-investment is necessary to mine out what remains. Eskom estimated in 2013, that just short of R100-billion in new capital is needed to meet its future coal requirements. Trucking coal in, on short-term contracts is immensely expensive and inefficient. Developing coal mines in the Waterberg region is an option but for this to work at the scale Eskom requires, about R40-billion in new rail investment will be needed.

How does anyone square this particular circle? Eskom’s own estimations are that 4,000MW of capacity will have to be decommissioned by 2025, another 10,000MW by 2030 and thereafter 75% of Eskom’s current fleet will be retired by 2040. This being the case, how can R100-billion in new capital expenditure for new coal mines or R40-billion in new rail links be justified? Even if it could be justified, who is going to provide the capital? Eskom used to provide it but it can’t anymore and other investors are increasingly wary of backing big coal projects.

Eskom’s financials, as reflected in its recently published interims are dire. It has got to the point where cash flows from operations is now insufficient to service its R500-billion debt pile. Spiralling coal costs, a result of the breaking its own apartheid era business model, unreliable generating capacity and a completely excessive personnel/salary overhead is driven Eskom over the edge.

Eskom may hope that is 15% per annum tariff increases coupled with the clawbacks from previous years which will add another 5% per annum on top of that might solve its problems. That is unlikely. Eskom’s own estimates are that a 19% tariff increase reduces GDP by 0.3% per annum translating into lost 137,000 jobs per annum. These are a very conservative estimate. But using them, Eskom’s proposed tariffs will see the economy lose R40-billion in lost output and cost as many as 450,000 jobs in three years. At some point, Eskom’s large energy-intensive customers (about 32 companies largely in mining & metallurgy) and representing 40% of Eskom’s electricity demand, might find themselves unable to pay these tariffs and close down completely.

Already Eskom is seeking a R100-billion bailout from taxpayers but that it probably R100-billion too little. A R200-billion bail-out, the minimum, would immediately add 10% to our already unsustainably high indebtedness. Any thoughts of retaining or regaining investment credit status would then be beyond absurd.

There is a fork in the road and it is time for big decisions to be made. It comes down to this: either pretend it’s still 1970 and recapitalise Eskom starting with a massive bailout and then have taxpayers fund the additional R140-billion to develop coal mines and coal infrastructure followed by a rebuilding of coal-fired stations; or change course completely and do what the Integrated Resource Plan says is the least cost route – a build-out of a system based largely on renewable energy.

The renewable route would need as much as 2,000MW – 3,000MW per annum of new-build wind and solar PV just to replace retiring Eskom coal-fired power plants. Perhaps a good part of these could be allocated to Eskom itself, its unions, selected pension funds, developers and long ignored local communities. International climate funds would also be able to play a significant role.

We have an opportunity now to manage the way in which retiring electricity generation is replaced. If correctly managed, the replacement electricity generation fleet has the potential to transform the whole power sector for the better. This could include the citing of significant capacity on disused coal mines as part of a rehabilitation effort. Needless to say, a renewable energy transition has enormous implications for the reduction in externality costs of coal mining and the combustion of coal, sharp reduction in CO2 emissions, improvements in air quality and the adjacent natural environment.

A just energy transition is also about jobs and livelihoods. Although renewable power plants do not require much labour to operate, the build process at the rate required would create 30%-50% more jobs than exist in Eskom and its associated coal mining activities.

there is a powerful array of interests against the renewable energy route. This includes Eskom itself. Since the Apartheid era, and under different management and political dispensations, it has always resisted intrusions into its monopoly. Allied to this are the labour unions, particularly those representing Eskom current employees and workers unions in the coal mining sector. Other pressure groups against the necessary changes include junior coal miners and the truckers supplying Eskom with coal. It is going to take courage to deal with these interests and it will have political costs. But the important decisions about South Africa’s energy future cannot be deferred any longer.

There is a fork in the road and we have to choose our path now. DM


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