Some perspectives on getting the electricity industry back in business

May 8th, 2014, Published in Articles: Energize

 

While Eskom is struggling to keep the lights on and all electricity stakeholders are familiar with the challenges around coal supplies, schedule delays at Medupi and Kusile, and unprecedented levels of breakdowns on Eskom’s ageing fleet, there is a debate getting lost in the noise on where the industry is supposed to be heading.

Piet van Staden

Piet van Staden

In this debate there are divergent views, from the Department of Energy (DoE) taking the independent system and market operator (ISMO) bill through the parliamentary process (but apparently not making much progress), to Eskom cautioning that the carving out of the system operator will present new risks of its own, to NGOs such as the Free Market Foundation pushing for liberalisation into a competitive generation industry.  Then there is also a group of potential power suppliers lobbying for a “willing buyer, willing seller” dispensation where bilateral agreements between generators and loads should somehow be accommodated in the regulatory regime.

It is time for a robust debate on the future structure of the South African Electricity Supply Industry (ESI). In this debate the short-term operational and tactical interventions required to keep the lights on must be separated from the structural changes required to put us on the right track for the longer-term.

The SA ESI is unique in terms of the relative size of its industrial and mining base (more than 60% of electricity goes into energy intensive industries and mining), and therefore the availability and cost of electricity is crucial to prevent a contraction in these primary industries. We simply cannot afford to get this wrong and even if the country vision is to move gradually to a low carbon economy, we need the jobs, value creation and foreign exchange benefits of the primary industries to see us through the transition period which may take several decades.

So what then are the immediate next steps to get us back in business and on the right track for the longer term?  Here are a few thoughts from an energy intensive user and co-generator:

Eskom as national utility and supplier

Although Eskom’s days as a monopoly supplier are over, it will remain the dominant electricity supplier for many decades to come, and SA needs a successful Eskom to get onto a higher growth path. This is a reality and to dream about unbundling and the privitisation of generation at this stage is not helpful.

The new CEO will have his job cut out to turn the organisation around and it is hoped that he will be given a firm mandate to focus inwards and fix what is broken, and not be drawn into political battles or restructuring projects. At present the trend of increasing unplanned capacity losses and the extreme volatility in the trend points to a loss of control over the situation and this exposes the country to severe risks of planned load shedding and power outages.

What is required now is a brutally honest focus on the root causes of the many incidents followed by interventions to restore the equipment integrity, such as the 80:10:10 strategy, backed up by a work force which is zealous about the task at hand and which focuses on doing things right the first time.  Nersa should consider Eskom’s call for more money favourably if it’s required for prudently incurred expenses on extra resources, more spares, power purchases from third parties, IDM etc., since the economic and social costs of not having electricity is prohibitive.

In my view a competitive electricity industry may not be the optimal way to go in SA for several reasons:

Technology: Successful liberalisation of power markets often coincided with a technology shift to combined cycle gas turbine generation.  It is a low capital cost, short lead time technology, more suitable to the risk appetite of private investors.  If we are to gradually move away from coal for environmental reasons and look at regional hydro and nuclear, we are out of the typical IPP league and into the regulated utility space, which is characterised by a low weighted average cost of capital backed up by sovereign guarantees.

Electricity price: Efficient competitive markets will drive the price towards the marginal cost of production which will always be higher than average costs with a largely depreciated generation fleet.  In a regulated industry the average blended price will allow for depreciated assets to help to fund newly built plant, while a competitive market requires the price to somehow fund the new plant.  Shareholders of private generators will also require a higher return than what Eskom is allowed by Nersa. The cost of Eskom’s current build plan (plus interest) must be paid back, and if new investments take market share away from Eskom, it will have to repay the debt from fewer sales, resulting in even higher prices. The reality is that for competition to work the taxpayer must write off Eskom’s debt and customers must accept higher electricity prices.

Planning: A well thought through long term build-plan by the DoE which arrives at an optimal mix of technologies must surely be better than abdicating the decision to build to a market with a short-term focus and limited capabilities.

A single buyer model then?

Competition “for the market” instead of “in the market” seems to be the most appropriate industry model for South Africa.  It gives us the best of two worlds, being able to sweat the depreciated assets of Eskom longer at its blended average cost in the national interest and bring private capital into the power market.  If an ISMO does its work, and diligently sticks to governance requirements, it can contract for the right technologies from IPPs to meet the country’s energy and environmental needs. It is my opinion that the DoE should get the ISMO Bill through Parliament as soon as possible, even if the network business stays with Eskom for now.

The views expressed here are the author’s and not necessarily those of his employer or the Energy Intensive Users Group.

Contact Piet van Staden, EIUG, Tel 011 344-2761, piet.vanstaden@sasol.com

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