South Africa’s Eskom problem

Having not built new capacity for more than 20 years, Eskom seems no longer capable of building power stations at a reasonable cost and within reasonable time frames. By Dirk de Vos.

Dirk de Vos

It’s been nearly two months since Eskom presented its proposed tariff increases to the public as part of its third multi-year price determination (MYPD3) for 2013/14 through to 2017/18. Although there have been some useful inputs from civil society, there has not been any real engagement from Eskom on these contributions.

Effectively, MYPD3 will result in a doubling of the tariff over a period of five years to R1,28/kWh (or 97c/kWh in 2012 money). Because Eskom is South Africa’s only electricity utility — it’s involved in everything from generation to transmission and distribution — it is at the heart of our economy. How we, as a country, manage the inevitable tariff increases is crucial given we have an industrial base built on cheap and abundant electricity.

We are about to find out what is the elasticity of demand for electricity against different supply price points. This will be measured against mines and factories that have to close down, and businesses that cannot pass on their increased input costs.

Already, the demand for electricity is declining: Eskom sold 110 766GWh in the six months to 30 September 2012, down from 114 043GWh for the same period a year ago.

But because Eskom is a vertically integrated monopoly, it is what analysts call a “black box”: it is hard to work out what is going on inside. Much commentary has focused on the way Eskom is financing its new generating capacity — namely the Medupi and Kusile power plants — as well as the use of higher tariffs to rebuild its balance sheet and the apparently arbitrary requirement of an 8%-plus return on assets. Other commentators have pointed to a ballooning fixed cost overhead and even to the amount of electricity used and not charged through illegal connections.

Eskom states that it has disclosed its numbers transparently, but this is not the case. On the contrary, there is considerable obfuscation on the disclosure of some of the numbers. A clear example of this is the stated revenue requirement for renewables. Eskom thumb sucks a 7% revenue requirement for this on the basis that, according to its MYPD3 application, it expects to pay R2,39/kWh for solar PV and R1,74/kWh for onshore wind. The truth is that these sources of power have fallen dramatically. Round 2 bids see solar PV at R1,65 and onshore wind at 89c.

The next renewable bidding rounds will likely see further reductions, especially in solar PV pricing. The real costs of purchasing renewable energy will be well below Eskom’s stated figures. Misleading people further, Eskom compares these prices with its own generating cost of 23c-30c/kWh. Those selling renewable energy into the grid could turn this argument on its head and say that their generating costs (sun or the wind) are zero.

Eskom’s disclosure of its own generating costs, made up largely of the purchase of coal, is revealing but probably not in the way the company intended. Its own generating costs represent about a third of the current tariff and decline to a quarter of the proposed tariff in future. It is therefore hard to understand its complaints about the increasing cost of coal supply.

The price of coal supplied to Eskom is not the main driver of the proposed tariffs; instead, it is its build programme that’s causing the problem. Leaving aside how the new build programme is being financed, Medupi and Kusile appear to have cost way too much and taken way too long to commission.

From answers to questions in parliament, we know that the price tag for Medupi and Kusile is about R91bn and R118bn respectively. Finance charges push up total cost of Medupi to nearer R116bn and Kusile to about R158bn. This is partially because they will have taken almost a decade to build.

Given generation capacity of 4 700MW, Medupi will cost nearly R20m/MW before adding capitalised interest prior to it being commissioned. Kusile will be closer to R25m/MW and that’s without adding pre-commissioning finance charges. Some industry estimates put the total pre-commissioned capital expenditure at a whopping R180bn and R191bn respectively.

A study by the International Energy Agency (IEA) in 34 countries, and which covered 86 coal-fired power plants, showed that most such plants have construction costs ranging between US$1,5m and $2,5m/MWh (R13,5m-R21,7m on an R8,70/$ exchange rate) in OECD countries and between $600 000 and $2m (R5,2m-R17,4m) in non-OECD countries. Construction times for these facilities average around four years.

Using the IEA study to benchmark Eskom’s figures shows its capital costs and the financing of its build programme are what are driving increased tariffs. Having not built new capacity for more than 20 years, Eskom seems no longer capable of building power stations at a reasonable cost and within reasonable time frames.

Whatever your position on renewable energy, we should understand that South Africa has a terrible environmental record. Eskom is one of the world’s worst emitters of carbon dioxide per kilowatt-hour generated. As a result, the country is probably the worst emitter of measured against GDP. The proposed tariff increases do not include carbon taxes, which are very much part of our future.

The value of introducing renewable energy into the mix might not be about improving our environmental record, but about introducing independent power producers using competitive bidding processes.

Seen in this way, Eskom now can be viewed as the equivalent of Telkom 20 years ago, before the introduction of cellphones. Before  mobile telephony, Telkom was the only telecommunications operator in town. We need to remind ourselves that Vodacom’s initial business plan had it break even on just 350 000 subscribers.

Right now, there is very little wriggle room for reducing the proposed electricity tariff increases. Indeed, we can count ourselves lucky that the old legacy power plants, now fully depreciated, work to moderate the tariff increases. What we now need to do is to think hard about what to do in the future. Depending on the elasticity of demand for electricity, national treasury might have to take a deep breath, increase South Africa’s debt further and capitalise Eskom’s balance sheet and take on the financing of the new capacity directly.

One obvious step is to separate the management of the grid from power generation. A piece of legislation, known as the Independent System and Market Operator (ISMO) Bill, meant to do just this is stuck in parliamentary processes. A strengthened version of this bill, allowing for independent grid operators to procure power from independent power producers using a variety of energy sources should be introduced. It is now time to revisit the role of Eskom as a whole, restructure South Africa’s entire electricity sector and encourage private investment.

  • Dirk de Vos consults to the telecommunications and renewable energy sectors
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  • http://www.facebook.com/ian.d.samson Ian D. Samson
  • Davebee

    So why is Brian Dames still calling the shots at Eskom? Why is this allowed to go on and on and on? If this firm cannot perform then those non performing top ten managers must be shown the darned door and new NON CADRE, non politically connected staff recruited to get this vital show on the road.
    Will it happen? No, as the ANC induced, jobs for the Boyz, cadre mentality will prevail even if the price of electricity rises to SMOTHER all business sense. There is Zuma-think at play at Eskom and bugger all business sense I’m afraid!
    The tragedy being that innocent non ANC citizens will pay for this industrial disaster.

  • http://www.facebook.com/franc.retief Franc Retief

    Nice article, but I was looking for a comparison between Eskom construction cost per h and OECD and non-OECD

  • TTRZ

    Owned and run mostly by the government. What do you really expect?

  • http://www.facebook.com/johan.posthumus.16 Johan Posthumus

    A well-written article Dirk. I do think we should not look at Eskom in isolation though. The price of electricity in South is influenced significantly by socio-economic and political factors which have nothing to do with Capex, finance costs, etc.
    The non-payment of electricity accounts in Soweto (and other townships) is contributing to the price of electricty but more important is the attempts to keep the price of electricity to the poor down. In the MYPD3, the intent is to keep the price of electricity to the poor static and to increase the price of electricity to large users (Megaflex tariff structure) by 22% p.a. for 5 years. Can the large users absorb this hike and remain competitive? And what does that mean for the economy at large if we say to ourselves that the economy is an energy-intensive economy by world-standards?
    Dunno hey…

  • Andy Roc

    Lucky for Escom and it’s customers, coal prices have dropped significantly over the past year, so perhaps the price of electricity will drop!

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