Break up Eskom, for all our sakes
The underlying foundation of the country's economy is that electricity has been cheap, readily available and abundant. By Dirk de Vos.
Our economy and its industrial base is power intensive and South Africa has one of the highest power consumption-to-unit of gross domestic product ratios anywhere.
Cheap and abundant energy has, for a long time, represented our comparative advantages and shaped our economy. It has allowed South Africa to avoid addressing things such as low labour productivity. Other disadvantages, such as deep and low-grade mineral-bearing mines and the distance from our main export markets, have been offset by the price and ready availability of energy.
Eskom is responsible for nearly all of South Africa’s electricity generation and it would be fair to say that the country’s industrial base exists because of Eskom. This foundation is changing at an alarming rate: the average selling price of electricity has gone from 19,4c/kWh to 61c/kWh in only four years. Plus, the recent application by Eskom to the National Electricity Regulator (Nersa), if granted, will see this price increase to 128c/kWh five years hence.
Beyond that, further increases are in store if additional capacity beyond the Kusile power station is commissioned — higher if nuclear power is used. Eskom points out that if the new tariff escalations are granted, the country will still be in the bottom quarter of global electricity prices, but it is still a dramatic move away from the cheapest electricity in the world. This will expose our other weaknesses and put a renewed focus on improving unit labour productivity, but this will take a long time to get right.
Up to now, many of the objections to Eskom’s proposed tariff hikes have focused on the way in which Eskom’s expansion programme is financed and its required return on assets. The objections are that because Eskom is owned by the state and operates as a monopoly, financing build costs directly out of the tariff is wrong. Essentially, the tariffs need to be high enough to meet the debt obligations as they fall due — despite the fact that the power plants, financed in this way, will have more than half of their useful lifespan left once the debt is fully paid off.
Seen in this way, existing electricity users pay all the capital costs through the tariff and will hand a future generation a debt-free facility. Consumers want to pay a reasonable tariff for the electricity they use — they are not interested in participating in another entity’s asset financing. Furthermore, the 8,16% required return on assets (or discount rate) is far too high. A return equal to government debt is suggested instead — lower costs of financing are why Eskom is a state-owned enterprise, after all. Eskom is a relatively simple business, operated on a huge scale. A study undertaken by the International Energy Agency (IEA) and the Organisation for Economic Co-operation and Development’s (OECD) Nuclear Energy Agency highlighted the impact of the different costs of financing, in this case using a discount rate.
But there is another valid objection. The price tag for Medupi in Limpopo is roughly R91,2bn and, for Kusile in Mpumalanga, about R118,2bn, before financing costs. Given a generation capacity of about 4800MW, Medupi’s capital costs before financing costs are R25m/MW of capacity.
There is no ticket price for coal-fired power stations but the IEA-OECD study, which looked at 27 coal-fired stations in different countries, provides a guide. It found that most coal-fired power plants have construction costs varying from $1,5m/MW and $2,5m/MW in certain countries to $0,6m to $2m in others. Furthermore, Eskom’s fuel prices are roughly equivalent to its peers that are also supplied with domestic coal.
Based on this, the scary thing is that when the 16% year-on-year increases result in a doubling of the Eskom tariff, it will still be below what it needs to be to fund Eskom’s new build and financing costs. None of this includes likely carbon pricing that will be added on top in the near future. Both Medupi and Kusile appear to have cost way too much to build. Why are they so expensive?
In addition, Eskom’s environmental record is terrible. At 0,96kg of carbon dioxide per kilowatt-hour fed into the grid, Eskom is one of the world’s worst emitters. Arguably, a more pressing problem is Eskom’s consumption of water. Its power stations consume about 1 433l of water per megawatt-hour fed into the grid. Several studies show that 98% of South Africa’s available water resources are allocated and there is no room for increased water consumption.
Independently financed operators
In its presentation to Nersa, Eskom discloses the costs associated with independent power producers feeding electricity into the grid from renewable resources. Eskom’s application seeks to have its tariff increased to at least 97c/kWh, yet it compares the costs of buying renewable power from independently financed operators with its own 30c/kWh generating cost. This is, kindly put, disingenuous.
Eskom is too big to fail, yet it is failing all the same. Breaking Eskom up should now be front of mind. This process could start with separating the grid from electricity generation. The first step is the Independent System and Market Operator Bill, tabled in parliament earlier this year. This bill should be revived and strengthened to effect a formal separation of the grid from Eskom. This would allow an independent grid operator to procure energy from independent power producers on a nondiscriminatory basis.
An independent grid operator should also take over Eskom’s role as South Africa’s representative in the Southern African Power Pool. Mozambique, for example, could expand its Cahora Bassa hydropower capacity knowing that it would not be prejudiced by Eskom’s own needs.
Mozambique also has reserves of 100 trillion cubic feet (tcf) of natural gas. This is a game changer. Eskom’s current coal-fired power stations generate just short of 200 000GWh of electricity a year. Theoretically, if these were replaced by combined-cycle natural gas-fired power stations, we would consume just 1,4tcf of Mozambique’s natural gas annually and halve our CO2 emissions.
If there is to be any benefit in Eskom’s proposed tariff increases, it might just be that it spurs us on to think about viable alternatives.