HomeFeatures/AnalysisThe state of the ESI in South Africa

The state of the ESI in South Africa

ESI Africa approached the chairman of the South African National Energy Association (Sanea) Brian Statham for his views on the events that led to South Africa’s power crunch of 2008, and the overall state of the electricity supply industry in the country.

Following the power crunch that manifested itself in early 2008, South Africa’s electricity supply industry has remained in a state of considerable flux. A key initiative to alleviating uncertainty will be the belated Integrated Resource Plan 2 (IRP2), due out sometime in the fourth quarter of this year.

The lead up to and causes of the events in early 2008 have been much publicised. Yet it is worth posing the question one more time; how did a sector as predictable as that of electricity supply end up in such a self-destructive situation in South Africa? Power demand tracks economic growth with a high degree of certainty, particularly in an economy like South Africa’s, which is still strongly driven by energy intensive industries.

“It is important to remember that when the ANC government came into power during 1990 to 1994 it had never been in opposition, and it found itself at the bottom of a very steep learning curve,” Statham says. “One has to make allowance for the fact that the ANC did not have the learning opportunities most other governing parties have before they get into power. What learning opportunities they did have were obtained primarily from China and Russia, whose models were based on centralised control by the state – very different from the global liberalisation policies very much in the ascendency during the early 1990s.”

As the ANC came into power, during the mid-1990s a flood of consultants and aid organisations came to South Africa, all with a liberalisation agenda. “The ANC government found itself in a state of confusion as its historical knowledge was confounded by what it was being told by the various consultants and aid agencies.”

The thinking was that Eskom, even though it was one of the world’s top rated electricity supply utilities at the time, would be broken up and replaced by a competitive electricity supply sector. The structures and plans were in place to do this, but what the consultants and aid agencies neglected to mention was that private sector capitalists were not going to come running to invest in a fledgling ill-defined democracy. The prevailing policy was that Eskom would halt any expansion plans and in this way create space for people to come and invest. “However, though the door was open, nobody came,” Statham says. Eskom’s global reputation for excellence was also daunting for potential competitors.

In about 2003 the penny dropped and Eskom was asked to build new power stations to supply the generation capacity needed. But in the meantime Eskom had dismantled much of its capability to build new power stations. Executives had received bonuses for streamlining the organisation down from 66,000 to 30,000 people. With hindsight that was a recipe for disaster.

“The new build mandate presented an enormous challenge. Eskom’s newest power station, Majuba, was completed in the mid-1990s. The utility was out of practice and there were a lot of new faces in the organisation,” Statham says. “Meanwhile, aside from civil works, the capacity outside Eskom in South Africa to build power stations had also been eroded.”

The rest is history. The South African economy took off, the country ran out of capacity and it failed to have a national plan in place. “Coal prices escalated internationally and, as befits an open economy, coal companies are under no obligation to sell their product to Eskom when they can concentrate on the lucrative export market. This has led to over-reaction in some quarters and has helped spark some of the talk about nationalisation.”

Now, why go into this history, with which many of the readers of a publication such as ESI Africa will be very familiar? The reason is that the lessons of the recent past in South Africa’s electricity supply industry are very relevant in terms of current developments.

Currently, the conventional philosophy is that we need Independent Power Producers (IPPs) to help get the country out of its power generation capacity shortfall. We have seen a number of IPP project developers, mostly in the renewable sector where the investments are relatively small compared with other sectors, active in South Africa.

Here lies Statham’s warning where history in the sector has presented an object lesson. “I fear there are a lot of people promising the Earth and yes they will be able to sign letters of intent, but I suspect we are seeing mostly marketing teams and not those who are responsible for financial closure. One should reasonably expect two to three year delays in the actual finalisation of any significant deals.”

Various IPP project developers have said all they require is a Power Purchase Agreement (PPA) and they are ready to go. “However, Eskom has little experience with PPAs and obviously it was cautious to sign agreements the consequences of which it did not fully understand. At the same time, Eskom does not have the balance sheet to stand good for such potential agreements, while it had no assurance it could pass on the costs to its customers.” That assurance did come 12 months ago, but until then fiduciary prudence stymied Eskom.

And it is here where Statham believes that another selfdestructive red herring is being propagated in the electricity supply industry – the belief that there must be an independent system and market operator (ISMO). That now seems inevitable but Statham believes it diverts focus, which should be on ensuring power is being supplied, toward establishing a new entity instead.

“The fact is that any self-respecting PPA agreement will have defined take or pay terms, with both supplier and offtaker having to commit to making certain capacity available and to buying a certain amount of power. Thus with such an agreement signed, Eskom would have nowhere to run, no matter what its intentions may be. The National Electricity Regulator of South Africa (Nersa) would be able to enforce the agreement.

“The plan to go ahead and establish an ISMO company is an emotional decision and does not change anything. The issues of a state owned ISMO company buying power from a generation company whose major stakeholder is the state, and concerns about parties with potential vested interests that might lead the ISMO company to favour Eskom, are not removed. This is a red herring at a time when the electricity supply industry cannot afford such things.”

Statham believes the distraction of senior management that should be focusing on how to provide power is not helpful, added to the fact that there will be jockeying for position as to who heads the new ISMO company. The distraction of National Control operators, who should be focused entirely on ensuring the grid stays up rather than wondering where their future lies, is not what is needed at this point. “It only creates the illusion of progress, is indicative of short term thinking and the assumption people like to make that those who managed things in the past invariably were incorrect.”

Statham is also not married to the idea of eliminating cross subsidisation at all costs. He takes this back to the thinking of how the industry just bought into the assumption that the free market works for the supply and demand of electricity. “This theoretical belief has not yet been proven in practice. In the evolution of the electricity sectors in the UK and Europe during the first 80 years of the 20th century, it was determined what would be done and the resources were committed to doing it. China is not following the free market approach when building capacity, and in places where this approach has been tried it has not worked.” The implication is that South Africa should avoid buying into philosophies propagated by global conventional thinking. This is another mistake recent history has taught.

Part of the reason such systems tend not to work is the assumption that the buyers and sellers have equal power. It will work well enough for powerful energy intensive industries that form agreements with suppliers of power and then have some entity wielding this power, but small and medium enterprises would be nothing more than price takers. It is well known that electricity is a major lever for development, and the majority of those in the country who do need electricity to improve education, living standards and small entrepreneurial enterprises would not benefit from such a system.

“It is not just a problem in South Africa. In Europe and the UK, no substantive new capacity has been built and they are running out of spare capacity. There have been trades which have seen assets transferred in the UK, but no new capacity has been built. Claims by Scandinavian countries that are using newly established wind generation plants to provide a large percentage of their electricity must take into account that without the spinning reserve base load in Europe that would not have been possible.”

Statham suggests that some form of government intervention is needed, and the rolling eight year national plan used in Australia at least provides some guidance. At this stage in South Africa, developers of different energy source capacity won’t go ahead if they don’t know whether that energy type is favoured in the national plan. “For example, no one knows what the role of nuclear energy is to be in South Africa, and who in their right mind would make a major investment in that energy technology under those circumstances?”

However, with the ISMO seeming inevitable and Eskom’s reputation severely damaged by the events of early 2008, Statham thinks it likely that in the future Eskom will have a narrower focus. His suggestion, no doubt unpopular within Eskom which would like to play in all energy fields, is that it stick to running coal fired and nuclear power stations, as well as pursue underground coal gasification technology as it is doing, while also looking at carbon capture possibilities. “South Africa must have renewables as part of its energy mix and it is necessary for the country to manage its carbon footprint. Eskom, which has neither a track record in renewable energy nor any particular expertise in this area, need not be the entity that undertakes this. All people internationally will care about is whether South Africa is meeting its commitments, not whether Eskom is the entity doing it.”

Coal is certainly not going to disappear as an energy source, particularly taking into account that China, India and the US all have massive coal reserves which are going to be used to generate power. “The electricity supply industry will find ways to make coal acceptable, and coal will be part of the global energy mix for a long time to come. And this is where Eskom’s knowledge base and know-how lies and where it can be a robust but narrower player.”

However, one of the major constraints in the future development of IPPs in South Africa is diminishing, that being the pricing of electricity. Pricing is starting to approach levels where IPPs can be competitive, and if the tariffs being proposed for IPPs give some early movers an advantage before the sector settles, so be it.

Statham says Nersa should not be overly concerned about that, as long as the model is within a reasonable range. With hindsight, South Africa having what was among the world’s cheapest electricity was an illusion. It came as a result of what was effectively asset stripping at Eskom, and the groups that designed incentive mechanisms that rewarded the meeting of short term targets never suited to an industry such as the electricity supply sector hold some responsibility for this. The shortfalls in investment now need to be made up, and in effect the industry had been borrowing from its future. Statham says it is important that whatever comes out of the IRP2 process be included in the national planning being undertaken by the National Planning Commission. Even now he sees too many competing interests, while what is required is a national unity on the way forward. This alludes to how different energy sources are competing and lobbying, and even as to how different government departments come up with their own plans, which are not coordinated in the national interest.

An example is that the country has world class environmental regulations, but these are pointless with a large portion of the population living in poverty. An example of the negative consequences of planning that is not fully integrated was the plan for the Regional Electricity Distributors (REDs), which did not take into consideration that increasingly powerful metros would not want to cede control of assets that essentially form part of their power base. Thus after more than ten years the REDs plan has come to nought but at the same time municipalities have ring-fenced assets they were not sure they would own in the future. “Under such circumstances the distribution businesses became the unwanted stepchild and were not prioritised for maintenance funds, and we are seeing the results.”

On a regional basis the Southern African Power Pool (SAPP) has plateaued too, with the most recent venture, Wescor, never entirely convincing, having fallen apart. Even the groundbreaking Motraco venture between Swaziland, Mozambique and South Africa has been indirectly criticised recently. This is due to the perception that the anchor client for the project, BHP Billiton’s Mozal aluminium smelter, was getting electricity at very cheap rates while South Africa undergoes an electricity supply shortage. What is forgotten is that the deal clearly included some derivative on the price of aluminium and for many years Eskom made good profits on it.

However, the main reason for the lack of further progress on the Southern African Power Pool has been Zimbabwe. It is the key node linking the thermal power resources in South Africa and Botswana to the hydroelectric potential of Zambia and the DRC.

“Should some stability come to Zimbabwe’s political situation, it is envisaged that a lot of funding will become available which could foster projects to grow the SAPP. Zimbabwe remains the critical force in the outlook for the SAPP.”

Of course funding is a key issue in the power sector, as Eskom has demonstrated by the difficulty it is having just funding Medupi, let alone its next project in its base load build programme, Kusile. “South Africa needs to stop being so hung up on conventional ways of thinking foisted upon it by outside,” Statham says. He believes that both China and India would be willing and interested investors under the right circumstances, and if they invested in funding major electricity projects in South Africa and the region, the traditional first world countries would have no choice but to follow, considering the commodity treasure chest at stake. Obviously one has to take care when dealing with a powerful international entity, but overall Statham sees China representing more opportunity than threat to South and Southern Africa.

“One has to get into a partnership with the Chinese. They are willing to take a long term view, and are willing to wait ten or fifteen years to get a return on their investments. And if they come as major investors in the power sector, the others will come. I see this as a big opportunity.”