Eskom is the problem – not the solution

November 20th, 2012, Published in Articles: Energize

by Dick de Vos, QED Solutions

The underlying foundation of the country’s economy is that electricity has been cheap, readily available and abundant. Our economy and its industrial base is a power-intensive one, and South Africa has one of the highest power consumption to unit of GDP 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 like low labour productivity. Other disadvantages like deep and low grade mineral bearing mines and the distance from our main export markets, have been off-set by the low price and ready availability of energy.

Fig. 1a: South Africa levelised costs of electricity (at 5% discount rate).

Fig. 1b: South Africa levelised costs of electricity (at 10% discount rate).

Eskom, founded in 1923, is responsible for nearly all of South Africa’s electricity generation, and it would be fair to say that South Africa’s industrial base exists because of Eskom.  This foundation is now changing at an alarming rate – the current average selling price of electricity has gone from 19,4c/kWh in 2008 to 61c/kWh in just four years, and the recent application by Eskom to the National Electricity Regulator (Nersa) (Eskom’s third multiyear price determination period or MYPD3), if granted, will see this increase to 128c/kWh five years hence.

Beyond that, further increases are in store if additional capacity beyond Kusile is commissioned – higher if nuclear power is to be used. There is now little purpose served in pointing fingers at the lack of planning or indecision in the years following 1994. While Eskom has been quick to point out that if the new tariff escalations are granted, the country will still be in the bottom quarter of global electricity prices, it is still a dramatic move from the cheapest electricity in the world. These will expose our other weaknesses and put a renewed focus on improving unit labour productivity – but this takes a long time to get right, generations even.

Eskom’s application to Nersa for the tariff hikes allows an opportunity for objection. Up to now, many of these objections have focused on the way in which Eskom’s expansion programme is financed and its required return on assets. Here, the objections are that as Eskom is state-owned and as it operates as a monopoly, financing build costs directly out of the tariff is wrong headed. 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 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 hand a future generation a debt free facility. Consumers want to have a reasonable tariff for the electricity that they use – they are not interested in participating in another entity’s asset financing. Further, 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 jointly by the International Energy and the OECD Nuclear Energy Agency demonstrates the impact of the costs of financing (in this case using a discount rate) with the graphs in Fig. 1.

But there is another valid objections. Eskom’s media presentation on the tariff hikes simply states that Medupi and Kusile build costs are in line with international benchmarks.  We know that the price tag for Medupi is roughly R91,2-billion and for Kusile around and R118,2-billion before financing costs. Given a generation capacity of about 4800 MW, Medupi capital costs before financing costs are R25-million per MW of capacity.

There is no ticket price for coal-fired power stations but the EIA-OECD study which studied 27 coal fired stations in different countries provides a guide. It found that most coal-fired power plants have construction costs of between $1,5-million to $2,5-million per MW (or R12,9-million to R21,5-million using a R8,60 rand dollar exchange rate) in OECD countries down to around $0,6-million to $ 2-million (R5,16-million to R17,2-million) in non-OECD countries. Prof. Anton Eberhard, in a paper entitled “The future of South African coal: market, investment, and policy challenges in 2011”, estimates that Eskoms paid on average than $27 p/t (or around R200/t). Accepting a lower calorific for domestic coal, Eskom’s fuel prices are roughly equivalent to its peers also supplied with domestic coal.

Based on this, the scary thing is that when the 16% year-on-year increase 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 need to be added on top of all this in the near future. Both Medupi and Kusile appear to have cost way too much to build. Why are they so expensive?

Like any monopoly, Eskom does welcome an alternative vision. In its presentation to Nersa, it discloses the costs associated with independent power producers feeding in electricity to the grid from renewable resources. Eskom’s application, let us remind ourselves, seeks to have its tariff increased to around 97c/kWh (in 2012 money) as a minimum, 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 – akin to complaining about the AA per km rate in somebody else’s car with what you spend only on petrol in your own. Eskom, to use words du jour, 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 small step in this direction is the Independent System and Market Operator Bill tabled in parliament earlier this year. Sadly, this bill has gone nowhere. It should be revived but strengthened to effect a formal separation of the grid from Eskom. This will allow an independent operator of the grid to procure energy from other independent power producers based on a non-discriminatory 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 more confidently expand its Cahora Bassa Hydropower capacity knowing that it will not be prejudiced by Eskom’s own needs. It could go much further even.

Contact Dirk de Vos, QED Solutions, Tel 021 426-4590,

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