Business

Can SA still af ford to keep Eskom?

Lynley Donnelly

Privatisation is mooted as the utility's proposed tariff hikes look set to put the squeeze on users. Lynley Donnelly reports.

Critics have pointed out that ­Eskom's recent tariff application is based on an already outdated integrated ­resource plan. (Oupa Nkosi, M&G)

Eskom's request to the energy regulator this week for R1trillion over the next five years has been denounced as unaffordable – but it is only the beginning of what South Africa needs to build new power stations to replace its existing ones.  

Large industry, trade unions, independent power producers, economists and business organisations are up in arms over the ­utility's third multiyear price determination application. But according to Eskom, the utility may have to reopen its application to ask for more money.

Eskom has applied for an annual increase of 16% for five financial years, from 2013-2014 to 2017-2018.

As part of its revenue requirement, Eskom is seeking R355-billion to pay for primary energy, mainly coal, R270-billion for operating costs, including salaries, and returns of R187-billion, which will include R140-billion to service debt. The company is asking for the revenue to see the country through to the "substantial completion" of its Kusile power station in Mpumalanga.

The decision regarding who builds the rest of the new capacity outlined in the department of energy's electricity plan until 2030, the integrated resource plan of 2010, has not been made.

In its application to the regulator, Eskom has modelled what it could cost the company to build 65% of the capacity outlined in the plan, including the proposed nuclear build. The difference will be built by independent power producers. It has also projected what it would cost the company to build 100% of the capacity detailed in the 2010 plan.

According to Eskom, the 65% scenario would drive the third multi-year price determination tariff increase request to 20% over the next five years, followed by a 9% increase in the following five years.

In rand terms, this equates to a revenue requirement of R1.2-trillion over the first five years and R2.4-trillion in the following five years: a total of R3.6trillion. If a decision on who should build this new capacity is not made soon, Eskom may have to apply to revisit its costing, it said.

Revenue requirements
According to Eskom finance director Paul O'Flaherty, the revenue requirements will not differ too much if Eskom is required to build 100% of all new power-generation capacity up to 2030. The utility cannot, however, provide a breakdown of what this would mean in terms of tariff increases beyond 2018, or rand costs.

The request for Eskom to model the two scenarios in its application suggests that the state is paying lip service to the idea of increasing the involvement of private power producers in South Africa's energy future.

The astronomical amounts in question have led critics to question Eskom's affordability. The proposed increases would put more pressure on the two most vulnerable sectors of the economy, mining and manufacturing, said Adrian Saville, chief investment officer at Cannon Asset Managers. "Under the current environment, put these charges into the equation along with recent wage settlements and it represents a deepening of the challenges these sectors face."

Saville said the state should consider partially or wholly privatising Eskom to release the R500-billion in trapped capital that the company represents. Its assets were revalued last year, taking them to R500-billion, and Saville said there were a number of creative ways to redistribute this value to South Africa.

The sale of Eskom could provide the state with sufficient funds to build new power stations, essentially "a second Eskom", but rather than retaining shares in that entity the state could disperse them to ordinary South Africans, such as all children under the age of 18 or all unemployed people.

This would represent a form of true black economic empowerment, Saville said. These shares could be locked up for a period of time, but if people were able to borrow against them to access capital, this would bring many into the formal financial system. It would also bring competition into the electricity market.

"[From] what the state has done in terms of running other state-owned utilities such as South African Airways, it is clear the state is not a great operator," said Saville. "I don't understand why it does not allow the private sector [to play a greater role]."

No privatisation
But Eskom chief executive Brian Dames said there was simply "no policy" to privatise Eskom. The parastatal was asking for R355-billion in primary energy costs alone and "no privatisation will deal with that", said Dames.

Eskom has already tried to sell 49% of Kusile as part of the work it has done to develop its funding plan. "But the return requirement by private investors was a lot higher than what Eskom is prepared to accept as a return and it becomes more expensive," said Dames.

On building beyond Kusile, Dames was adamant that "whether it's 65% or 100%, we are clear we cannot do all of this alone. We have to work on very creative funding solutions to find other balance sheets to assist us."

One of the proposals to fund capital expansion is to get large customers to sign up to long-term off-take agreements to prefund new build.

This was a financing model Eskom would consider, Dames said, because it had been successfully implemented in places such as the United States.

But a similar type of contract, namely the special pricing agreement Eskom signed with BHP Billiton's aluminium smelters, has been damaging for the power utility.

Dames said any future long-term contracts would not be linked to commodities, unlike the BHP Billiton contract that had been connected to the price of aluminium, which has since fallen.

Heavy power users
This week, industry was critical of Eskom's approach in its tariff application.

The price increases would lead to a contraction in growth and threaten jobs, said Mike Rossouw, chairperson of the Energy Intensive Users Group, which represents companies that are heavy power users.

He took issue with the way Eskom had presented the information in its application, notably its breakdown of the 16% tariff increase, attributed to 13% for Eskom's needs and 3% to pay for power from independent power producers under the renewable-energy procurement programme. "This leads people to the wrong conclusion and implies that independent power producers are more expensive than Eskom," said Rossouw.

The costs of Eskom's new build programme would exceed those of independent power producers using conventional hydrocarbon technologies, he said. And although power from renewable-energy producers might be more expensive, the state had taken this policy position to introduce renewable energy to South Africa.

Eskom recently told Parliament that financing charges for the new power stations, Limpopo's Medupi and Kusile, would add an additional R25-billion and R40-billion to the price of each power station respectively. This would take the cost of Medupi to about R116.2-billion and Kusile's price tag to about R158.2-billion.

The levelised cost of power from Medupi – or the all-in price of electricity from a project over its lifespan, including items such as operating expenses – is likely to be closer to 97c/kWh, a figure confirmed by the national energy regulator.

This rate belies the notion that Eskom can provide new capacity at far cheaper rates than independent power producers. Critics point out that these rates are close to those for electricity from renewable power.

Real issues
The company has consistently maintained that the cost of power from Medupi will be substantially lower. It also claims that the business case costs of Medupi and Kusile, excluding interest during construction and transmission, remain "unchanged" at R91-billion and R118-billion.

Rossouw also criticised Eskom's failure to address "real issues" such as the cost inefficiencies in the production of electricity.

Rather than fixing these problems, he contended, it had opted to raise the price of power for consumers.

Eskom has committed to making R30-billion in internal savings over the coming five years.  

Rossouw questioned the fact that Eskom had to model the integrated resource plan 2010 scenarios in its application. "Is this government ­preparing for its failure to attract independent power producers, who are facing huge policy constraints?" he said.

The tariff application also gave no clarity on how the cost overruns of Medupi or Kusile were being financed, particularly as their completion costs remained unknown, said Doug Kuni, managing director of the South African Independent Power Producers Association. He also pointed out that the tariff application, including the scenarios on future build, was done in line with an integrated resource plan that was out of date.

The document had not been revised on a biannual basis as intended, he stated, and had not taken into account changing market developments such as the boom in natural gas and what this meant for electricity production.

Capital expenditure
But in its application Eskom states that its capital expenditure programme is not incorporated in the revenue request. Only a return on capital expenditure through depreciation and return on assets, including those under construction, is included.

The tariff application has also made extensive assumptions about coal costs, which comprise 56% of its primary energy costs. Eskom has allowed for only a 10% increase in coal costs, despite coal price increases of 30% last year.

Dames said South Africa had to strike a balance between the domestic need for coal and the need for exports.

The majority of Eskom's coal was contracted, he said, and containing costs was part of the contractual ­discussions Eskom had with large mining houses.

However, beyond 2018 Eskom will be short of 40million tonnes of coal.

"We need new mines to be opened up. It is an urgent issue," said Dames.

He added that this would require Eskom to re-examine its cost-plus models for contracting coal to encourage investment by mining firms and to keep the price low.

"It must also include the consolidation and development of the junior mining sector in South Africa," he said.

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