Our Investor Community enables you to discuss, analyse, blog, live chat and engage with likeminded people on JSE and USA-listed companies and more. FREE to join!
OP-ED: Eskom: For experts in energy, it's hopelessly grim, open-ended Groundhog Day
OP-ED: Eskom: For experts in energy, it's hopelessly grim, open-ended Groundhog Day
Published Date: 2019-01-09 | Source: DailyMaverick | Author: Dirk De Vos
It is now well past time to stop fooling ourselves that Eskom's problems and its indebtedness can be traded out. The focus should be on managing a bad situation as well as possible.
While you are reading this, the Eskom Sustainability Task Team appointed by the President on 15 December is very likely to be hard at work at producing a document by the 29 January deadline. Given some of the people appointed to the task team, it is likely to be an excellent analysis and will also probably produce sensible recommendations.
But that being said, and somewhat akin to the analysis of our educational outcomes following the release of the annual matric results, there is a sense of déjà vu. One is reminded of the film Groundhog Day. It's about a cynical old TV weatherman sent against his will to some American village to report on the annual return of the groundhog. If a groundhog emerges out of hibernation and sees its shadow, it gets scared and runs back into its burrow, supposedly predicting six more weeks of winter weather.
In the movie, the weatherman, played by Bill Murray, finds himself in an endless loop where Groundhog Day is repeated - no matter what he does. Stuck in this endless loop of one repeating day, the weatherman realises that Groundhog Day may be his fate for eternity. Nevertheless, after exploring his dark side, the weatherman starts to become a better person and develop new skills - living each repeated day more perfectly than the previous same day.
Our researchers and experts in energy - and education - appear to be in the same loop. Every year they come with new deeper more detailed data and statistics, better presented, structured, and even more persuasive than the previous year. It is almost as if the researchers feel that somehow, just somehow, their work can eventually persuade policymakers to change course, but very little does change. Actually, the data presented from any previous year would have been sufficient, but our politics makes change difficult so they relive their "groundhog day", every year.
We have long known what to do with Eskom. 2019 will be the 21st year that the 1998 White Paper on Energy Policy was adopted by the government as official policy. It proposed breaking up Eskom and introducing competition. It would be surprising if the task team departs in its long-term recommendations from what should have occurred over two decades ago.
The Task Team's terms of reference include making proposals to resolve Eskom's debt burden. It was reported that a turn-around plan presented by Eskom's management included a R100-billion government bailout. An analysis of Eskom's financials strongly suggests that a massive bail-out is now unavoidable.
Eskom is no longer primarily an electricity sector problem, it has become an enormous macroprudential problem. A bailout that cuts into Eskom's unaffordable debt overhang will certainly blow away commitments to reduce the country's own debt. However, a 20% year-on-year electricity price increases for the next three years will crush any prospects of an economic turn-around and hasten our de-industrialisation, making even the government's existing indebtedness unsustainable. Besides, price increases at the levels proposed will push large users in mining, metallurgy and cement out of business and accelerate the switch to off-grid alternatives by high-income users, in both the commercial and residential sectors.
There is another group of people, at National Treasury, also hard at work on preparing the national budget. By the time the State of the Nation (Sona) address is delivered at the beginning of February, it needs to be largely complete. Any big bailout that the Minister of Finance will have to make a few weeks later will need to have been addressed in the Sona. Inconveniently, this year's Sona is also in an election year.
Up to now, the indebtedness of Eskom has been addressed mostly by debt guarantees provided to Eskom listed in the budget "contingent liabilities". There is little discussion as to just how contingent those liabilities are. The fact is that the guarantees provided to Eskom are becoming more real. This much was clear from Eskom's interim financials. It projects a loss of R15-billion and does not have the cash reserves to cover the loss.
It can't continue like this. A cash-strapped electricity utility creates all sorts of other risks. Most of us know what happens when we ourselves are cash-strapped - we put off doing the things that we know have to be done in the hope that we will address them when (if) better times return. Recent load shedding, on Eskom's own version, is a result of unavailable resources to do proper maintenance on ageing equipment.
Eskom is a textbook example of what goes wrong with monopolies. Settled economic theory shows that a monopoly produces at less than the efficient quantity and if it lobbies the government to keep it that way (say via employing too many people or buying coal from politically favoured suppliers), it creates a deadweight loss. Determining the price of supply is also very difficult. There are no benchmarks or pricing signals. It does not help that Eskom has always operated under conditions of unusual secrecy.
Compounding the monopoly problem is that Eskom, as an independent State-owned company (SOC), has sought to raise its debt to unsustainable levels using R350-billion government guarantee. It has created a quasi-deficit for the country without proper oversight. Making things worse is that as much as R150-billion of this debt is in foreign currency and Eskom now has to provide its creditors with far better returns than the government provides to its own creditors. This amounts to a free-ride because Eskom, or our electricity system as a whole, simply can't be allowed to default.
There will be a lot of suggestions on what to do next. But it is now well past time to stop fooling ourselves that Eskom's problems and its indebtedness can be traded out. The focus should be on managing a bad situation as well as possible. The Eskom Task Team will have its own recommendation but here are some additional suggestions:
Staff Overhead: Eskom will have to address its cost overheads. In the near term, it needs to reduce its staff complement from 47,000 people to where it was in 2007, at around 36,000 people. In doing so, it will need to be sure that it does not lose the critical skills that it needs. These critical skills might already have exited Eskom and should be incentivised to return.
Regularise the coal supply contracts: Eskom should be compelled to publish the details of every coal contract that it has and is planning to enter into and do so at the level of each power station. At power station level, daily information on stockpiles and outcomes of compliance testing should be published. Perhaps, the monitoring of the performance of all coal suppliers could be done independently but certainly, the quality and quantity of all coal delivered must be properly monitored. Eskom should always buy coal directly and not do so through intermediaries or traders. Where intermediaries are used, they need to disclose their margins or commissions. All future coal contracts or tenders must be published, and every subsequent contract must be on the terms of the tender.
Reprioritise decommissioning/commissioning generating units: All of Eskom's power stations are bespoke builds each made up of six or more largely independent generating units. Years of poor maintenance has left them in a poor state - the primary cause of recent load shedding. Instead of decommissioning at a power station level (according to the age of the power station concerned), decommissioning should be reprioritised at a unit level. Decommissioned units can then be a source of spare parts for functional units that remain. We need a full technical assessment of Medupi and Kusile to figure out the extent of the multiple technical problems and what is salvageable. Any claims against any contractors should also be pursued with vigour. Some suppliers have already provisioned for these types of claims.
Resuscitate Eskom's internal market mechanism: During the process of getting the ISMO bill as far as Parliament, Eskom implemented a comprehensive internal market in terms of which each generator would bid into the grid based on the pricing that it could offer. This process determined the dispatch order of different generators based on their different cost and generating profiles. These processes should be revived and the outcome of them made available to the public for further analysis and consideration.
Restructure/Refinance Eskom's debt: It should be obvious that a focus on having Eskom service its debt can no longer work. Eskom has both too much debt and the cost of that debt is too high - and will get more expensive as it seeks to refinance this debt in the coming years. Having Eskom pay a large premium for its debt over what the government pays makes no sense at all. Being so indebted prevents the other much needed and frankly inevitable structural reforms to our electricity supply industry from happening. One way to do this, although it appears at first to be a retrogressive step (and it would be if done permanently), is to de-corporatise/nationalise Eskom and its debt. If done sensibly and transparently, it may even be seen as credit positive for the country. A signal that the government is serious about fixing the biggest risk identified by the credit rating agencies - even as national debt would be significantly increased.
Align all capital expenditure to the Integrated Resource Plan (IRP): South Africa undertakes its resource planning through an IRP process which helps to plan what generation capacity should be added over different time periods. The 2018 IRP is near completion, and once accepted by cabinet becomes official. The 2018 IRP proposes significant additions of renewables but these have to be accommodated by the grid. To do this, investments need to be made to enable the grid to utilise this capacity.
Commence the process of separating Generation, Transmission and Distribution: While re-introducing the ISMO Bill and passing it into legislation is the existing plan, it might be preferable to introduce a proper formal separation. Each generator operated separately would then have a stand-alone management team and be subject to a power purchase agreement (PPA) with the national grid. The national grid, operating independently, would be able to then enter into formal power purchase agreements with these generators and others contemplated by the IRP processes. The distribution side, a part of the electricity system also suffering from years of under-investment, should be consolidated and ring-fenced from local government budgets. Properly structured distributors will then be able to be primarily responsible for demand-side management. This includes shifting loads away from the peak periods through the time of use metering/pricing, frequency management as well as contracting generating or battery/storage capacity to address frequency response and variable loads.
Bring on the energy transition - but make it just: Eskom's existing power plants are nearing the end of their useful lives. The IRP shows the energy mix that should replace this capacity and increase this capacity. Those most affected by this transition, such as Eskom employees and workers in the Eskom supply chain including miners, need viable employment alternatives. For various reasons, no renewables are planned for the Mpumalanga region where most of Eskom's power plants are situated. This should change. In terms of natural resources, Mpumalanga is nearly as good for renewables development as other areas, but it has distinct advantages: the density of the existing transmission infrastructure, and the proximity to the largest load centres. Mpumalanga should immediately be declared a renewable energy zone. Just to replace Eskom's capacity would require 2000MW - 3000MW per annum of new-build wind and solar PV. Rights to develop this replacement generation capacity could be allocated to a combination of Eskom, trade unions, and local communities. Funding could be readily secured on the back of Eskom as well as private power purchase agreements. Eskom, as well as union pension funds, could play leading roles in financing the replacement build, supported by syndicated pension funds, including the likes of those managed by the PIC. This alone would create significantly more relatively well-paying jobs than currently exist. An energy transition like this would also attract international funds that are mandated to invest in clean energy.
The film Groundhog Day, like everything else, eventually finds some resolution. Nothing lasts forever, the repeat loop of what to do about Eskom will have to be broken as well. As in the film, one gets a sense that with Eskom, some sort of resolution is emerging. The only question is how many repeat loops remain. Maybe we are finally at the end? The longer we put off getting to grips with the inevitable, the more painful it will be. DM