Tuesday, July 14, 2015

Will Eskom survive?

My phone rang - "Could you come and talk to us?" 

"Who are you?" I replied. 

"I'm a parliamentary researcher," he said.

"Well, what do you want me to talk about?" I asked.

"Should we give Eskom the R30 billion they are asking for. Can you advise us?'

And so it was that I and an economist friend, Rob Jeffrey, found ourselves before the Standing Committee on Appropriations, talking about more money than I usually discuss. We said that if Eskom were truly a business, its shareholders would ask what it intended to do to get out of the mess.  Instead, there has been an awful silence, as if going bankrupt were something to be faced with stoicism.

The end result is that Parliament has managed to refinance Eskom by selling off Vodacom.  Nowhere has there been any discussion of what should be done do avoid a slow, insidious decline into dysfunction. 

We identified a prime cause of the problem as being a disturbed cash flow. This was the result of political demands being made on something that should be governed by economics not politics.  For example, back in 1999, there was the political decision to forbid Eskom to build the next big coal-fired power station.  This was somewhat irrational, because Eskom had both the experience and the skills to build power stations and bring them on line within budget and on time. It demonstrated this definitively as it completed the Majuba power station. Every year for 6 years a new unit came on line on 1 April. Medupi and Kusile have only too clearly shown that the experience and those skills are critically important if you are going to build power stations.

Recently, there has been the decision to require Eskom to purchase coal from some small, Black-owned coal mines at a cost of over R450/t, when the going rate from the large mines is less than R200.  Now there is nothing wrong with providing a subsidy to achieve socially desirable ends, but there is everything wrong in hiding that subsidy within a Public Enterprise. Eskom has squeaked about the cost of coal, Government has thundered about the need to stop exports, and then remembered that coal exports are now one of the things that keep this economy afloat.

There are several other examples of political decisions that have contributed to the destruction of what was once a thriving and efficient business.  It must be stressed that we are not criticizing the political decisions as such – South Africa is a democracy, and we all have to live with our political decisions.  Our concern is that Government has seen fit to load the costs of these decisions on Eskom.  Because it is a business with a huge cash flow, it has been able to carry the costs for just so long.  Now the back of the camel is broken.

This is why we have thought long and hard about what needs to happen to restore Ekom to its historical functionality.  We believe the solution is to identify the parts of the business that should be in open competition, and excise them so that when called on to perform a political function, that function can be properly costed and seen as a subsidy.

It would be simple to create an electricity supply company, responsible for generation of electricity as a national asset.  It would be called ESCO, and would be in open competition with, for instance, the renewable energy generators and the new breed of co-generators that the Department of Energy is fostering.  ESCO would hold the present generation facilities of ESKOM, and it could build new facilities using the sort of financing model employed with such success in the Department’s Renewable Energy programme.  That programme has raised nearly R200 billion against nothing more than long-term power purchase agreements, which will bring us of the order of 8 terawatt-hours (TWh) of electrons annually. R200 billion could buy somewhere between a fifth and half of the nuclear power programme, which would yield between 15 and 40TWh of electrons - cheap at the price.

Equally, it would be simple to create a company to distribute electricity. It would be called EDCO, and it would be in competition with municipalities and others who wished to enter the market. ESKOM already distributes about half of South Africa’s power, so EDCO could readily be set up and have both a significant cash flow and a strong asset base.  It would need to have Government support to enforce collection, but once achieved, the business would be self-sustaining and could yield a reasonable dividend.

There remains the question of how to get the electrons from the generators to the distributors.  We have a national highway that performs this duty.  One of the problems is that it is not presently cost-reflective – it doesn’t matter how far the electrons have to travel, or what the losses are along the way, the cost of transport is nominally the same. There is no apparent cash flow to create a business. The transmission grid is a huge asset, but it needs to expand.  Funding the expansion has been a direct charge on the national purse.

We believe that this, fundamentally, is the reason why Parliament has struggled for nearly a decade to create an Independent System and Market Operator (ISMO).  Eskom already performs all the functions of an ISMO.  We envisage creation of an electricity transmission commission, ETCOM, to buy electricity from ESCO and other generators and to sell to EDCO, municipalities and any other distributors.  Initially ETCOM would take over the transmission assets of Eskom. Its capital requirements would remain largely a charge on the fiscus.  However, it would need to develop a model for the costing of power transmission. Electricity should cost less in eMalahleni, next to the power stations, than in Johannesburg.

ETCOM would initially be a commission, funded from the fiscus.  As its economic model evolved, it might be possible to allow competition into the space.  For example, the ESCO generation unit called Koeberg might contract directly with the City of Cape Town for the provision of power down the City’s own transmission line, who would pay less than for the power they bought from ETCOM, who in turn had transported the power from Mpumalanga. As competition emerged, ETCOM could slowly morph into being a company in its own right.

We see a major role for the National Energy Regulator, NERSA, in regulating this process as it develops.  At present NERSA operates in a difficult morass, particularly with power transmission not being cost reflective.  Trying to price power requires the annual production of a 200-page report. We can foresee it growing its role to the point where licensing new generation facilities or new entrants to the distribution market become more important than the task of trying to cost electricity nationally. It would be far simpler to monitor the costs of the production of power with an identifiable business, ESCO. With EDCO pricing distribution, it would be far simpler to bring under control those municipalities who are at present overcharging to balance their books.

We need a path forward to ensure that Eskom survives. The national investment in refinancing must not become a case of throwing good money after bad. Our model may not be perfect, but we believe it to be rational and to provide an essential element in a debate that is currently not being held. Let the debate begin!

1 comment:

Alfred Brown said...

The first bit of solid logic and rational thought that I have read on the matter for a long time. let's hope and pray that the right people are listening, but somehow I doubt it. There is another related topic which "Nutty"and friends should address - i.e. the planned nuclear power generating program. We don't presently have the ability to build one measly coal fired power facility - Medupi, on time or within budget, and will it work without continuous breakdowns? To decide to build seven nuclear stations is ridiculous; we would presently struggle to finance just one! The world and it's technology is changing at an astonishing rate. Add together the time to negotiate the deals, plan the facilities, construct the plants and run them for their operating life of circa 50 years and, wolla! you find that the decision was a stupid one. Why? Because the power generated will be far too expensive. Better, easier, more efficient and less expensive alternatives will become available. All the developed countries are addressing the same problem, some with Bill Gates' financial support. Prof Alf Brown.