Due to socioeconomic pressures, state-owned electricity companies typically set prices that are too low to finance new investment. This is exactly the position in which Eskom and South Africa find themselves in 2009.
Developing countries often find it hard to finance investment from either internal funds or borrowing from the state and are under pressure to turn to the private sector.
This is usually either though privatisation or by long-term power purchase agreements with independent power producers (IPPs).
In both cases a typical problem is that electricity prices are below the cost that would be adequate to compensate new investment.
The low tariffs in South Africa explain the failure of government policy to attract IPPs into the market.
This is despite stating that IPPs would be responsible for 30% of power generation after 1998. Had capital been set aside and a real rate of return charged on its assets, Eskom would be able to finance new-build projects.
Our electricity prices would have risen at a rate that would have allowed for self-funded capital investment.
The current crisis can be seen as a direct result of government’s policy to promote growth by artificially maintaining low tariffs.
Raising tariffs to an acceptable level to allow Eskom and IPPs to operate is the first step.
Electricity policy needs to focus on ensuring security of supply at the most efficient price for both the generator and the end user.
A criticism of the future energy strategy in South Africa is that there is little incentive for Eskom to provide power in the most efficient and cost-effective manner. After all, it has no competition.
Market efficiency has been proved to drive cost-efficient alternatives.
A key question that needs to be answered by Eskom and the government is why we are still stalling on the issue of IPPs?
It is estimated that in the next three years IPPs could deliver 3 500MW of capacity before Eskom is able to bring online the first unit of Medupi, its planned new coalfired station.
It is disingenuous of Eskom to suggest that its cost of generation is lower than the cost of generation from new-build plants simply to protect its monopoly.
South Africa has an immediate problem to secure electricity supply to meet current and future demand. It also needs to do so at a price that is reasonable for all parties.
Global trends in power plant construction suggest that there are various alternatives to building plants such as Medupi and Kusile.
Market efficiency would ensure that those companies best able to address all the issues of security, quality, quantity and cost of supply would succeed.
Global trends in the past decade in the electricity sector have been to lower costs and prices by forcing improved efficiencies through commercialisation and exposure of the industry to greater competition and private ownership.
In South Africa there are few incentives for Eskom to improve efficiencies.
Frost & Sullivan asserts that allowing IPPs to enter the market will require tariff increases, but not to the extent that Eskom has asked for in its application (to the regulator).
If the government wishes to drive growth in the economy, policy on energy must focus on meeting the demands of consumers. Policy should not be dictated to protect the monopoly of parastatals.
Although one can assume that Eskom is trying to build power plants efficiently, the main focus is not on achieving the lowest cost possible.
Eskom’s planned projects can be described as world-class with top-end technology aimed at operating for at least 40 years.
As a result, the overall capital layout per megawatt is substantially higher than it potentially could be.
There is no real incentive for Eskom to be as efficient as it can be as a result of its natural monopoly. It has been proved globally that competition increases efficiency and reduces wasteful spending.
IPPs that build identical power stations to those being constructed by Eskom will most likely not be able to construct these power plants faster than the utility.
But, it is envisaged that IPPs in the South African context will not build ‘world-class” facilities and hence could reduce construction times. There are several IPPs that would be able to come online before Eskom’s next major plant, Medupi.
Marc Goldstein is an energy analyst at Frost & Sullivan