Looking a gift horse in the mouth?

I see it is Eskom-bashing time again.  Awful Eskom! How could they turn down the gift of free energy?

Well, they could and they should. Try to put yourself in their shoes.  You are battling to keep the lights on and the wheels of industry turning. Then someone tells you there is a gift waiting for you in the Northern Cape. They say “Take it and pay!”

What do you say? “Thank you so much”? or “Could you come back later, please?”  or “But I didn’t order it.”  No matter.  “The Department has decided.” So you run to your Minister and she says ”Not me! Try the Minister of Energy.”

Slowly you discover this really is a mugs’ game. You thought you knew your job, and suddenly you have a second boss, who tells you to buy stuff you don’t want, at a price you had nothing to do with, while your new boss’ sidekick, the Regulator, tells you to keep your costs under control. No, I wouldn’t want to try to run Eskom.

And Eskom has reason to complain. The Department of Energy’s renewable programme is a great success, and it will in due course provide us with about 10% of our power. But from the Eskom viewpoint, that is a 10% drop in production, and they have assets that were supposed to be financed by producing power. To make things worse, they have to pick up the gift on the donor’s doorstep, not their own, and pay for its transport to Eskom’s own customers.

Worse still, the donor cannot tell you when his gift will be available, nor how big it will be when it arrives.  So you have to run your generators up and down to make sure there is enough power to keep your customers happy. But your generators are unhappy not being run at the nice even pace they were used to, and they wear out sooner than they should. More costs.

Anton Eberhard has recently suggested breaking up Eskom into a privatised generating company and a public transmission company, Gridco, which will buy power from all the private power producers, transmit it through the grid and sell it to distributors at a markup to cover costs.  Great idea.  It works well in Europe, where there are interconnections so that if your windpower dies on you, you can beg from your neighbour.

We don’t have that luxury. Neither does Australia, which is battling with an Eberhard-type model right now*. During one recent cloudy, still day, their Gridco had to pay $Aus14 000/MWh for enough power to stabilize the grid, when their average cost was $Aus100/MWh.

Be careful, very careful, what you wish for.

* https://wattsupwiththat.com/2016/07/14/14000-per-mwh-the-price-south-australia-pays-for-renewables-madness/

  

The "coal cliff"

We are facing an unheralded challenge.  We rely on coal for electricity generation in South Africa. Over 90% of our electrical energy comes from burning coal, and generation consumes nearly half of all internal coal sales. When Medupi and Kusile are fully operational, the coal demand will be about 150Mt per year.  The Department of Energy is encouraging some independent power producers to establish further coal-fired stations, which could boost the demand for coal even further. Great, but we need to know where all this coal is going to come from, and we don't.

Historically, most of it came from large coal mines. Some of these were “tied” collieries in which Eskom had invested capital, and which supplied coal on a cost-plus basis. They were linked to the power stations by enormous conveyor belts, so the costs of transport were low.

Increasingly in recent years, coal has been sourced from small independent collieries. In 2015, 18% of Eskom’s supply was from these small independents. Two challenges emerged.  First, the coal was moved by road, so the cost of transport was considerably higher. Secondly, it proved very difficult to control the quality of the supply.  A typical large power station, generating 3 600MW of electrical energy, will need a 30t truck load of good quality coal each minute of every day, and more often if the coal is of low quality. It is difficult to tell a good truckload from a bad one. In some cases, Eskom had to establish testing facilities at the individual mines to stop delivery of sub-standard material. This challenge does not arise when coal is delivered by belt, because sampling and quality control are far simpler.

In 2015, coal from the larger collieries cost Eskom of the order of R150 per tonne, and that from the smaller producers of the order of R400 per tonne.  The larger collieries, however, not only faced a lower price for their product, but many of them were exhausting the readily mined coal and needed recapitalisation. Eskom, short of cash, is understandably not interested in re-investing and wishes only to purchase on contract. In an interesting twist, Glencore used to own the Optimum mine which was tied to Eskom. Eskom claimed it was producing poor quality coal, and asked to R2bn in contract penalties. Glencore said it could not survive at R150/t and sold the mine to a Gupta-controlled Tegeta. Eskom has just announced it is paying Tegeta R473/t in advance. And if the delivered coal srtill isn't up to standard?

In the present climate, no-one else is particularly keen to invest in the coal business. It does not help that export prices are at a low ebb. 2015 was the first year for a long time that export revenues were lower than local sales, even in the face of a weak rand. To add to coal’s woes, there are environmental ambitions to reduce greenhouse gas emissions, and coal is a primary emitter. We* call them “ambitions”, because coal is over 90% of the source of our electrical energy. Replacing that 90% with some other source would demand far more capital than we can raise over the next 20 years. We are stuck with an ongoing need for coal for at least a generation.

We have a need for coal, but there seems to be a blindness about where, in only a few years time, that coal is going to come from. The supply from the existing mines is drying up.  There has been plenty of exploration, and new reserves have been identified, but we need investment now if we are to continue to generate power post 2020.

One plan that appears well advanced is to fuel the Mpumalanga power stations with coal from the Waterberg. There are several small miners waiting in the wings, while Exxaro’s Grootegeluk mine could readily create more capacity than that needed for Medupi.  Transnet has done extensive design work on a line from Lephalale to Emalahleni, but it will take at least five years to construct. Coal could be supplied from the Waterberg early in the 2020’s, so work needs to start now. However, the costs of transport will be significant.

Investment in the industry will only follow if coal prices increase.  They have been increasing, but too slowly to attract the needed investment. Even these relatively modest price increases have worried some in Government.  There has recently been a proposal by the National Energy Regulator, NERSA, to change its methodology for determining multi-year electricity pricing. If NERSA has its way, Eskom will have to account for the coal purchases by each power station. It will have to show that it is using the coal efficiently and that it is properly controlling the quality of coal supplied. NERSA intends to set different pricing structures for the cost-plus mines, for coal purchased in terms of fixed price contracts and for short-term contracts.

To add to the challenge, the Energy Minister announced, in her recent budget speech, her intent to start a super-regulator to check NERSA’s decisions. So Eskom’s management’s decisions will be second-guessed by NERSA, whose decisions will be second-guessed by a new super-regulator. As a recipe for disaster, it has few equals.

The last time there was this sort of interference with market mechanisms in the energy supply industry, NERSA’s predecessor, the National Electricity Regulator, fought the good fight against inflation by controlling Eskom’s price increases below the CPI. For a few years, the cheapest power in the world got even cheaper. Then the bubble burst and we suffered blackouts, as well as huge price increases.

We have still not recovered from the damage to our economy. The cost when we first lost power was about R75 per kWh . As we adjusted to the lack of supply, the cost dropped. People installed their own generators and took other steps to mitigate the disaster. Today the cost of lost power is of the order of R7 per kWh.  That is twice what it costs Eskom to run their diesel-fired gas turbines, but it keeps the lifts working and the supermarket fridges cold.

What it does not do is to allow the unrestricted growth of industry. Since 2008, we estimate that about 60 major projects that could have created over 100 000 jobs have been cancelled because the power needed to run them was not available. There is a thesis that the growth in the economy and the supply of energy are no longer linked.  Any study of global economies soon shows that this thesis is flawed, to put it politely. Our own growth and our energy supply were in lockstep for 50 years. China’s economy and its power generation have similarly been linked for 25 years.

We need power to restore growth. Our past investment in coal-fired generation means that we are locked into coal for the foreseeable future. It is critically important that we recognize that the coal industry needs investment, and that investment will not happen while Government talks about introducing price controls and worse, actually does so. Eskom’s procurement policies, requiring all coal suppliers to have more than 50% BEE ownership, is making the challenge all the more challenging.

Where, oh where, is our coal going to come from?

* We? My friend Xavier Prevost, helped to write this, most of which appeared in Business Day yesterday

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!

Begone, prophets of doom!

The prophets of doom have a long history.  Job was prominent among those who suffered, yet remained confident even when his supposed friends told him the end was nigh. Recently, the breed has spawned a new source of doom - "The fossil fuel industry must be put out of business by 2050 to avoid dangerous climate change" intoned one David le Page recently in the Mail &Guardian. He is part of a long tradition of those who have advised abandoning all hope when facing difficulties.  Fortunately history has a message for him and his kind – the human spirit is such that it can rise to almost every challenge.

Le Page’s thesis is that if mankind consumes much more fossil fuel, the additional carbon dioxide in the atmosphere will cause the average global temperature to increase more than 2^oC above what it was in the pre-industrial era before 1800.   It is a difficult thesis to substantiate, if only because we do not know exactly what the average temperature was in the early part of the 19^th century.  We only started to have some idea of the global temperature around 1860, when calibrated thermometers became widely available.  Since then, it has warmed by a little over 0.8^oC.

The million dollar question is how much of this warming is caused by added carbon dioxide.  Clearly not all of it, because the temperature shot up between 1910 and 1940, and there was little increase in carbon dioxide over that period.  So we don’t know how much extra carbon dioxide is likely to cause the atmosphere to warm by 2^oC.  It seems decidedly irrational to propose getting rid of fossil fuels, all our coal, oil and natural gas, to achieve a target which is so ill defined.

Proposing to get rid of fossil fuels becomes even more irrational once you realize than nearly 90% of all the energy we use comes from fossil fuels, worldwide.  South Africa uses fossil fuel for nearly 95% of its needs. So the world cannot be weaned off fossil fuels overnight.  Indeed, right now the use of fossil fuels is growing rapidly, and that growth seems likely to persist as China develops, India follows and Africa finally takes off economically.

There is a direct relationship between economic growth and the consumption of energy.  When nearly 90% of your energy comes from fossil fuels, then there is an equally close relationship between economic growth and growth in fossil fuel use.  So in calling for restrictions on the use of fossil fuels, Le Page is in fact putting in a plea for less development.  That is all very well if you are part of the developed world, but if you are in the process of developing, and have millions living in poverty, then you actually view such pleas as highly irresponsible.

Events in India illustrate this very well.  When China announced it would start to curb its growth in emissions after 2020, and would aim for zero further growth after 2030, India went on record as saying it was not in the least interested in any curbs on emissions.  Its development problems were such that eliminating poverty was far more important than addressing climate change. Recently, it has banned foreign funding of Greenpeace and other non-governmental organisations which it saw as posing a “significant threat to national economic security.”  A decade ago, India was emitting about twice as much carbon dioxide as South Africa; today it is emitting about four times as much and growing at about 100 million tons per annum.

We must not underestimate the benefits of fossil fuel use. If the internal combustion engine had not come into widespread use during the 20^th century, we would have seen massive starvation on earth.  In 1900, nearly half the area devoted to agriculture was used to grow fodder for draft and carriage animals.  By 1940, fodder was still vital.  Surprisingly, the largest use of horses in warfare was the German invasion of Russia in 1942, which involved about one million animals.  Fossil fuels have allowed us to convert huge tracts of land to the job of feeding people, not animals.  That, and the increase in productivity due to scientific farming, has meant that the supply of food has grown faster than the human population, so starvation is no longer a real threat for most people.

While renewable energy may have its place, we have to remember that modern economies need constant power.  The South African economy is stuttering right now because even the fossil fuel supply is intermittent.  Try to imagine what life would be like if the most of our power stopped the moment the sun went down.  Yes, we as individuals could probably cope with gas cooking and paraffin lamps or candles. However, most of the energy we generate does not go to individuals, but to keeping our developed economy going.  Less than 100 organisations in South Africa use about two-thirds of all the energy we produce.  Modern economies demand energy to generate wealth, and that energy needs to be available every hour of every day.  An intermittent supply is better than nothing, but much worse than a continuous supply.

Indeed, we can measure the cost of not having energy, and compare it to the cost of generation.  The loss of power early in 2008 hit the South African economy with about R75 for every kilowatt-hour that was lost.  Compare that to the approximately R0.60 that Eskom spends at present to produce a kilowatt-hour. It is infinitely better to have too much power than too little.

Of course, we need sustainable development. But there is no point in committing economic suicide in an attempt to sustain ourselves, as Le Page would have us do. According to the Brundlandt definition, “Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” Yes, we have to worry about future generations, but we also have to do so without compromising our ability to meet our own needs.  My generation coped with the previous generation’s love affair with the Mutually Assured Destruction of nuclear weapons.  I have every confidence that my children will cope with the far lesser threats of climate change in ways that will amaze us.

Disaster strikes!

Eskom has just destroyed a generator at Duvha. The loss of 600MW of generating capacity for "many months" is a disaster. The reserve margin is already low. Read Eskom's medium term risk mitigation report if you want to understand just what this means. Tighten your belts, and await power cuts. So much for job creation!