ESKOM and INDEPENDENT POWER PRODUCERS – What Is The Root Of The Problem?

To appreciate the quandary in which the South African Energy Sector [and with it, South African Industry as a whole] finds itself, we need to be clear on certain fundamental truths :

 

 

The Sustainability Trifecta

First, producing energy is only one leg of a sustainable service model Рand it is the area least fraught with ill-defined problems. The ill-defined problems are those generated by interface with the  users of the energy produced. Those problems are associated with the remaining two legs of the sustainability trifecta.

The second leg is the distribution of power to the end user. This is a tiered structure with Eskom delivering bulk energy [as a general rule] and municipalities delivering retail [there are exceptions to the general rule].

The third, and possibly the most vexing, leg of sustainable service is the collection of payment for energy used.

The sustainable process therefore involves generating the power, distributing the power, and collecting payment for the power distributed.

The Model Is Not The Problem

Independent Power Producers [IPP’s] generally are seized with the maximization of efficiency in the area of generating the energy. Their delivery is to the Eskom grid and their payment is by Eskom. This is however a small part of the management and risk of a sustainable process -they rely on the ESKOM State monopoly supplier to deal with the problematic two legs, as is in fact mandated by legislation.

As a model, there would appear, on the face of it, to be no problem whatsoever in Eskom maintaining the distribution and income sections of the sustainability model and subcontracting the generation of energy to the private sector, who may well be able to carry out that operation better and more economically. This assumes no corruption, with proper and effective Environmental and Financial audit and policing of the IPP’s.

Necessary Controls

Environmental, because producing energy without any environmental constraint will always be cheaper than producing that same energy in the context of an environmentally sustainable, “green” environment.

Financial, because the State cannot allow a significant portion of the fundamental energy sector that supports the entire economy to risk failure through financial irregularity and mismanagement.

The Flaw

There is however a basic and possibly critical flaw in such a proposal. That flaw arises from the accumulation of massively inefficient capital expenditure, funded by borrowings and generated by the noble, if short sighted and incredibly irresponsible, experiment of creating a workers paradise [Dames’ Folly]. The issue was not alleviated by massive corruption and inconceivable incompetence flowing from unbridled nepotism.

Dames’ Folly

The outcome of the “noble experiment” [aka Dames’ Folly] was the Kusile and Medupi power station disasters, where South Africa has managed to produce what is arguably the most expensive energy generating plant in the world. Another outcome of the nepotistic, racial-imperative driven incompetence has been the state of disrepair and inoperability of a significant portion of the existing conventional fossil-fired energy producing infrastructure.

This has been, if anything, exacerbated by the misappropriation of funds earmarked for the bringing back into service of these zero-capital-outstanding [that is – paid for] and therefore effectively cost efficient generating facilities.

The Obvious Spiral

In the emergent shortfall these cost effective fossil fired generating facilities have been replaced by oil and gas fired generating plant at an even greater level of capital inefficiency and an even higher level of cost per unit power generated. The spiral into incipient bankruptcy has been narrow and obvious to all except the most myopic – into which class one has to place the highest management structure of the energy sector – from State Ministerial level down to the musical chair charade that has been the Eskom Commission and its constituent commissioners.

The Nutshell

Naturally, the result of late and non-delivery of energy led to the closure of a very large number of bulk energy users and a commensurate drop in energy demand. The current Eskom balance sheet therefore has an enormous loan creditor value that is not represented by a commensurate generating facility that can service this huge loan debt. In a nutshell – Eskom can’t pay interest and repay loans out of the reduced sale of energy.

One has to question the intellectual integrity of a commission that has sought and received the right to hike energy prices by more than 100% in a market that is oversupplied with energy. This in itself has contributed to a further suppression of demand for energy [economics 101 -as the price goes up the demand reduces] and has generated an apparent need for efficiency in power generation because at the Eskom current cost structure, it is not terribly difficult to produce cheaper [and probably cleaner] energy.

Havoc On The Balance Sheet

But cheaper, cleaner energy produced by IPP’s is not going to resolve the incipient bankruptcy of the State Monopoly energy provider – conversely, it is likely to lead to the closing down of much of the remaining capital-effective fossil fired generating facilities. This will wreak havoc on Eskom’s balance sheet [closing down a power station simply removes that income generating asset from your inventory, making the imbalance between your loans and your ability to repay them even more apparent [if possible] than is already the case].

Collapse Of Monumental Proportions

That leads to the downgrading of the Debtor and an inability of that debtor to roll over [replace their existing loans with new loans when the old ones are due for payment] their loans when due. So Eskom won’t be able to pay its loans. That is effectively bankrupt. It will also lead to joblessness [because modern facilities are much less labour intensive than 30 year old designs] and concomitant unrest generated by unionists who can see the impact of incipient joblessness on their constituents.

Increasing the energy price further to create a larger margin between comparatively cheap IPP energy production and the income from consumers will not help – see economics 101 -as the price is increased so the demand reduces. Reduced demand for energy comes from reduced structural economic growth. South Africa has been de-industrializing for the last 20 years and at the end of the day the inability of the energy sector as a whole to pay the piper will lead to a possible collapse of monumental proportions.

Of course that can’t be allowed to happen in an environment where the state is not run by air-heads.

The Solution

That being the case, the solution is that the state is going to have to subsidize the South African energy price substantially to encourage growth and to put a finger in the dyke to stop the outflow of competence and productivity associated with de-industrialization.

The big question is – does the ANC government have the intestinal fortitude to face this fact and does it have the capacity to react urgently and massively to assert a competitive energy price in South Africa with the aid of the efficiencies offered by IPP’s – not only in the generation area, but throughout all three components of a sustainable energy delivery model?

The incapacity of the current regime to perceive any other than a window to the next election is well documented. This does not augur well for a soft landing.

Johan A Kruger, Ph. D.

Dr Kruger is CEO and Chairman of Lamergyre Alloys Limited, a macro re-industrialisation startup.
The views expressed in this article are those of the author and do not necessarily reflect the official policy or position of any other agency, organization, employer or company.