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South Africa’s Energy Sector: On the Cusp of a Major Transition

12 Jun 2019

PAUL SEMPLE / PORTFOLIO MANAGER AND JOINT HEAD: UNLISTED EQUITY

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Unsurprisingly, many see the dire state of South Africa’s energy sector as a precursor to even tougher economic times.

Unsurprisingly, many see the dire state of South Africa’s energy sector as a barometer of the increasing financial strain that consumers are battling with every day.  Weaker economic growth, rising inflation and job losses are on most peoples’ minds. Unpredictable electricity supply is blamed on Eskom, and rightly so, but, provided that the government can wrest control of the situation, the utility has the potential to facilitate a game-changing transition in our energy future. However, some hard decisions will have to be made to convert Eskom’s historical monopoly into a conduit for new private sector investment, energy diversification and job creation.

The problem
From being one of the most revered utilities in the world, Eskom is now considered to be one of the biggest risks to South Africa’s economy. Due to a massive failure of strategic and financial management over many years, the utility is burdened with huge debt, inflated operating costs and power plants which, on average, have reached at least 70% of their originally intended lifespan.

Over the next 15 years, almost 50%, or 20GW, of our existing coal-fired generation is scheduled to be decommissioned. Drastic and urgent decisions are needed to ensure that Eskom remains operationally sustainable and relevant, and that sufficient power is procured to meet future energy demands.  

The challenge
As the world increasingly moves away from carbon-intensive energy, South Africa is faced with the challenge to embrace this new normal, as it grapples with day-to-day pressures to keep the lights on. Over and above the need to replace decommissioned power plants, additional capacity is required to underpin the growth and development of our economy.

Since 2007, the cost of power has risen dramatically as Eskom has struggled to remain profitable and grow its investments in new power capacity, most notably the Medupi and Kusile coal power plants. With an increase in the price of electricity of around 520% over the 15 years from 2004 to 2019, it has far outstripped consumer price inflation of 136% over the same period. This trajectory is not sustainable for our country.

Cost of power vs inflation

Figure 1: Regression diagram - the cost of power vs inflation

The opportunity
A significant amount of private sector capital, both locally and internationally, is looking to invest in our energy sector provided that the prevailing regulatory constraints are lifted further. Until it stalled in 2016, the country’s Renewable Energy Independent Power Producer Procurement (REIPPP) initiative was widely recognised as the world’s leading clean energy development programme, and over the past seven years it has introduced more than R200 billion of fixed capital investment into South Africa.

South Africa is blessed with some of the best natural resources in the world. Apart from our geographic diversity, which supports a distribution of sun and wind over large parts of the country, there is also opportunity to develop multiple other forms of power generation such as natural gas, biomass and hydro capacity. Much of this can be built in outlying areas and will facilitate investment in social and economic development where it is needed most.

Investment in local manufacturing started on the back of REIPPP, and, although it has waned since the slowdown of the programme, there is potential to revive these industries if there is consistent demand, driven by a clear and sustained energy development strategy. The success of REIPPP has proven that South Africa has the ability to attract new international investment and can grow its own manufacturing capabilities to supply both local energy development and exports.

The solution
Given the regular shutdowns and maintenance interventions required by the country’s aging coal plant fleet, there is increasing urgency to install new power capacity to satisfy future demand. Whilst Eskom’s power generation is still crucial to the medium-term national supply, it is imperative that the utility does not continue to monopolise the energy sector. Increasing partnerships with independent power producers, supported by local content manufacture, should be pursued as soon as possible.

The speed and efficiency of the rollout of new energy production by the private sector was demonstrated by the REIPPP programme. Had this new investment in renewables not been made over the past seven years, the recent extent of load shedding would have more than doubled. Established best practice from REIPPP can be replicated in other energy programmes envisaged under the recently updated Integrated Resource Plan (IRP-2018).

Although many South Africans are horrified by the financial and operational deterioration of Eskom and the impact this has had on our economy, South Africa can still claim to have the most developed and penetrative national grid and power distribution system on the continent. This valuable national asset can be better utilised to facilitate the connection and transmission of multiple sources of new energy supply across the country ‑ and earn Eskom a critical source of revenue.

New energy production can be built by independent power producers far more cheaply and quickly than Eskom can build its own capacity, as proven by the huge budget over-runs experienced at Medupi and Kusile. Most importantly, the cost will have a full pass-through to the consumer via the existing tariff regime approved by Nersa, with no additional financial burden on the utility, and should serve to contain electricity price increases in future.

Eskom’s supply of base load power should provide the core energy solution in the interim and be supplemented by renewable sources, pending the longer-term replacement of coal by gas proposed by IRP-2018. As was recently confirmed by the significant contribution by renewables to national energy supplies during the spate of load shedding, alternative energy can complement Eskom’s thermal capacity and help to address peak demand requirements.   

Conclusion – The Trade-off
South Africa cannot afford more job losses, but at the same time must adapt and reposition itself to meet future energy demand by embracing the potential evolvement of the sector, in line with international trends. New sources of energy generation, together with associated local content procurement, should be prioritised.

The challenge to reduce carbon emissions is pressing, but there is an opportunity to manage a carefully planned and systematic transition from coal to cleaner forms of energy in line with the recent update to the IRP-2018, which envisages increased sources of energy diversification.

This will entail a natural attrition of jobs as coal plants are decommissioned over the next 15 years, but can be mitigated by retraining staff to work in new manufacturing industries that support new energy development. These new developments should be located in the same areas as the existing coal-fired power stations.

There is significant opportunity for our energy sector to catalyse the growth and development of our economy, provided that the role of Eskom is changed to facilitate new investment rather than to monopolise power generation. The cost to the future of our country for not taking on the challenge will be far greater than the cost of the action required now to start the journey down this new energy path.   

All tags:

ESKOM / REIPPP / RENEWABLE ENERGY