Eskom’s financial crisis and the viability of coal-fired power in South Africa

February 8th, 2018, Published in Articles: Energize, Featured: Energize

Meridian Economics published a report recently on Eskom’s financial crisis and the decreasing demand for electricity while its costs continue to rise dramatically, driven primarily by its new-build programme. This is the executive summary of the report.

The South African power system has reached a crossroads. Eskom, the national power utility, is experiencing an unprecedented period of demand stagnation and decline, while having simultaneously embarked on an enormous, coal-fired power station construction programme (Medupi 4764 MW and Kusile 4800 MW) which has been plagued with delays and cost over-runs. This has forced Eskom to implement the highest tariff increases in recorded history and has led to a crisis in its financial viability and, at the time of writing, a liquidity crisis (Groenewald & Yelland, 2017).

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Having recently suffered from capacity shortages, Eskom’s inflexible construction programme has now resulted in a significant and growing surplus of expensive generation capacity. Recently, Malusi Gigaba, the minister of finance  indicated that Eskom has a surplus capacity of 5 GW (Creamer, 2017).

Eskom’s Medium-term System Adequacy Outlook (MTSAO), published in July 2017, estimates excess capacity of between 4 and 5 GW in 2019/20, assuming a higher demand than is currently experienced (Eskom, 2017a). The latest MTSAO (Eskom, 2017b) indicates an expected excess capacity of just over 8 GW in 2022 based on its low demand scenario.

Fig. 1: Comparison of system alternative value and levelised costs per station (c/kWh) in a moderate demand scenario.

South Africa has also embarked on a highly successful renewable energy procurement programme. Although this programme initially resulted in expensive renewable energy prices, it has more recently produced highly competitive prices for wind and solar power in line with the paradigm-changing energy transition experienced globally.

Despite these circumstances, Eskom nonetheless has not yet committed to decommission any of its older plants, even as they approach the end of their lives and the costs of running these older stations increase.

In this report we present the results of an independent study into several possible strategies to assist with ameliorating Eskom’s critical financial challenges. Essentially, we have investigated two questions:

  • Should Eskom cancel part of its power station construction programme to reduce costs?
  • Should Eskom bring forward the decommissioning of some of its older coal power stations to reduce costs?

Our method allows us to assess whether the costs associated with running a particular station for its remaining life exceed the value of that station to the electricity system. The comparison hinges on the alternative cost of meeting demand if a station is decommissioned early (or other new plant construction is cancelled or not completed). If the system can meet demand over the same time period through alternative resources (existing and new) at a cost lower than the levelised cost of electricity from a particular station, then it makes economic sense to decommission that station early (or to not complete it).

Our analysis is thus premised on a system-wide analysis concerned with calculating the system alternative value of a station (the station’s avoided cost), which is then compared against the incremental levelised costs of running that station.

The system analysis undertaken by the CSIR Energy Centre for the reference scenario produced results that are in themselves important: in a 34 year, least cost optimised power system operation and expansion plan, no new coal-fired power capacity is built after Kusile, and no new nuclear plant is built either. New coal and nuclear plants are simply no longer competitive.

When new capacity is required, demand is met at lowest cost primarily from new solar PV and wind. In the more plausible moderate demand scenario renewable energy is supplemented by flexible technologies, storage (pumped storage and batteries) and open-cycle gas turbines (OCGTs) for peaking, but no combined cycle gas turbines. In the less plausible high demand scenario, combined cycle gas turbines are only required after 2040 and produce little energy.

In the moderate demand scenario this means that the gas demand for peaking OCGTs will remain low until at least 2030 or later. Overall, the system level analysis shows that South Africa does not need a nuclear, coal or gas power procurement or construction programme.

The results show that it makes economic sense to decommission the older stations early, since the system can meet demand at a lower cost than running each of the stations. This holds for the scenario even where we decommission three stations early (Grootvlei, Hendrina, and Komati – GrHeKo).

Table 1 shows the potential savings associated with the early decommissioning of each station.

Table 1: Estimated system cost savings arising from earlier decommissioning (millions of rand).

By decommissioning GrHeKo early, Eskom can save as much as R12,5-billion in present value terms.

The incremental cost of Kusile units 5 and 6 includes the avoidable capital cost of completing these units. However, we were not able to obtain reliable estimates of the avoidable capital costs for units 5 and 6. We have therefore reversed part of the analysis in this case by netting off the other components of its levelised incremental cost from its system alternative value.

This determines the avoidable capital cost at which the option of cancelling Kusile units 5 and 6 costs the same (given the costs of the alternative resources that will then be used) as completing it. This is the threshold capital cost saving. Therefore, if the capital cost saving is more than this threshold it will be more economic to cancel the construction of Kusile units 5 and 6 than to complete it, even considering that other resources will have to be employed in future to replace the supplies that would have come from units 5 and 6.

Table 2 shows that this threshold capital cost saving level is approximately R4,7-billion for the moderate demand scenario and our stated assumptions.

Table 2: Kusile cost saving threshold (moderate demand scenario).

To put this into perspective, assuming that Eskom will still incur a 15% budget overrun on the remaining capital budget for the station, the cancelling cost savings threshold required is approximately 1,9% of the total capital cost of the station, or approximately 13% of the estimated cost to completion of Kusile. Table 2 shows what net savings will result if the cancellation saving is larger than this threshold.

Our further estimates show that decommissioning GrHeKo and avoiding the completion of Kusile units 5 and 6 could giving rise to a financial saving in the region of R15 to 17-billion without affecting security of supply. These estimates do not reflect the additional large savings in the impact on human health, local environment and climate change.

These are large and difficult decisions to make and are fraught with vested interests that will be affected. We have already seen from Eskom’s ongoing governance crisis, that the government and Eskom are partially paralysed, and could struggle to take the right decisions in the public interest.

It is exactly for situations like this (i.e. where democratic governance fails), that countries create independent regulators (or independent public protectors, independent courts, etc.). It is therefore critical that the National Energy Regulator of South Africa (Nersa) ensures that these issues are investigated and addressed, and that Eskom is only allowed to recover efficient costs in its tariffs.

Ensuring a just transition for existing employees is of paramount importance and should be the subject of a multi-stakeholder political process and further analysis. Workers and communities should not bear the brunt of Eskom’s financial crisis. Part of the savings realised could be used to cushion the impacts on workers and communities, and provide support for re-training, skills development, relocation, etc.

Lastly, we consider the possibility that Eskom’s financial position is even worse than generally understood at the time of writing. The analysis presented above was focussed on the relative economics of the options considered and did not consider the financing implications of each option. However, if Eskom’s financial crisis continues to worsen, as we suspect it might, financial constraints will have to be brought into the picture.

In this case, further possibilities must be considered in the light of the systemic risk to the state and the entire economy posed by Eskom’s financial crisis. Assuming that the economy’s ability to absorb further tariff increases and government’s ability to provide further bailouts and sovereign guarantees are rapidly diminishing, Eskom will have to urgently find other ways of maintaining its solvency and avoiding a liquidity crisis. In this scenario, the only option will be to reduce the haemorrhaging of cash. The question will be: how can this be achieved without letting the lights go out?

Although not discussed in this report, it appears that Eskom has some scope for cutting back on human resources costs, and on reducing its primary energy costs. However, this is unlikely to be achievable over the short-term or to be sufficient. Two key insights that emerged during this study are therefore critical for considering how best to address this question:

  • The level of surplus capacity that Eskom now anticipates for the foreseeable future is at least equal to an entire Medupi or Kusile power station, or more.
  • By the time this spare capacity would be required in future, it will be cheaper to provide it by a combination of alternative means (renewable energy, gas turbines, battery storage, etc.).

Essentially the unavoidable conclusion is that Eskom is still spending vast amounts of capital on a power station construction programme that South Africa does not need and cannot afford. Drastically curtailing Eskom’s power station capital programme (beyond Kusile 5 and 6) might be the only way to restore its solvency. This will of course come at a high cost in terms of the penalties to be paid by Eskom in future, and the impact on personnel working on the construction projects. But, the lights will stay on, Eskom’s cash flow situation could rapidly improve, and confidence in Eskom and the economy would be restored.

In this scenario South Africa might well face a stark choice: Abandon a large part of the Kusile (and possibly part of the Medupi) project or allow Eskom and possibly the state to default on its financial obligations and pay an enormous economic and social price.

In either case it now appears critical that Eskom puts in place a process to plan for the urgent decommissioning of its older power stations and prepares for the possibility that its capital programme will have to be curtailed. Furthermore, it will be unrealistic to expect Eskom to drive these decisions on their own. It will be necessary for key government departments, Nersa, consumers and other stakeholders to act in order to protect the integrity of the power system and enable the South African economy to participate in the global energy transition to lower cost, clean energy resources.

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Acknowledgement

This executive summary is published here with permission.

Contact Dr. Grové Steyn, Meridian Economics, Tel 021 200-5857, grove.steyn@meridianeconomics.co.za