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A Bold Step Forward for SA’s Energy Sector

06 Nov 2019

Paul Semple / Portfolio Manager (Power Debt Fund)

Tarryn Sankar / Head: Listed Credit

Article

At long last, South Africa’s energy sector has taken a bold step forward with the release of the updated Integrated Resource Plan (IRP 2019) and the Roadmap for Eskom in a Reformed Electricity Supply Industry (Roadmap for Eskom).

The transition to open up the sector to purchasing electricity generated from multiple energy sources and suppliers in future, is challenging yet pragmatic. This will be supported by the functional and legal unbundling of Eskom into smaller, more accountable and efficient operating units.

Although more clarity is needed on how Eskom’s roughly R440 billion debt burden will be managed on a sustainable basis that limits risks to the fiscus, there is a move to crafting a more holistic and coherent long-term response to the Eskom crisis. These papers are no panacea for years of mismanagement and operational regression in the country’s power utility, but they provide a good indication that government’s orientation to Eskom’s challenges has shifted somewhat, even if much work still remains to be done.

The IRP 2019 is a key driver behind the restructuring plans envisaged in the Roadmap for Eskom and underpins a decreased reliance on: dirty coal-fired energy; decentralisation of an outdated and unsustainable vertically integrated monopoly; and increased competition from various energy suppliers - in an effort to drive maximum cost efficiencies.

The IRP 2019
The IRP 2019 embraces a diversified energy mix that accommodates flexibility, in order to take advantage of rapidly evolving energy technology. As the world moves towards a greater reliance on alternative energy sources, the positive impact from economies of scale on technology costs is growing. Energy storage is noted by the IRP 2019 as a game changer for renewables, and the recent discovery of gas resources off the South African (Brulpadda) and Mozambican coastlines also presents enormous opportunity and potential.

Figure1: Updated 2019 plan for the period ending 2030 (MW)


Source: IRP 2019, IRP draft 2018, RMB Global Markets (data as at 18 October 2019)

The bigger contribution of renewables, namely onshore wind, solar photovoltaics (PV) and concentrated solar power (CSP), from around 5% of the current energy mix to almost 25% in 2030, has displaced gas as the previously dominant source of new energy supply. Current infrastructure constraints, such as inadequate ports and overland gas transportation facilities, have extended the timeline for its roll-out. In the meantime, the IRP 2019 plans to utilise the gas for the conversion of expensive diesel-fired power plants (peakers) located around the coast of South Africa to gas-fired power.

Nuclear energy features in the IRP 2019 only in respect of a further investment in Koeberg Power Station in order to extend its life for a further 20 years from its scheduled decommissioning in 2024. This is deemed a prudent initiative, given the high operating efficiencies of Koeberg and the low cost of its planned refurbishment. Any new nuclear capacity will be considered after 2030, depending on technology developments and updated assumptions to the energy mix over the next 10 years.

While coal will continue to play a significant role in electricity generation in South Africa, the scheduled decommissioning of existing power plants will reduce its current contribution of 72% to the energy mix to 43% by 2030, and potentially to 20% by 2050. However, the IRP 2019 plans for capital expenditure totaling almost R70 billion over the next five years, to retrofit existing coal-fired plants to meet minimum environmental standards. More research into clean coal technologies is planned, and, apart from completing Medupi and Kusile, a further 1 500MW of new coal-fired plant capacity is planned by 2030, provided that funding can be procured.

Roadmap for Eskom
The stated vision for South Africa’s energy future sees Eskom’s transition from a vertically integrated monopoly to an entity in which generation, transmission and distribution are functionally and legally separate. This introduces the prospect of competition in electricity generation, both between various Eskom plants and among Eskom Generation (Eskom GX), independent power producers, and embedded generation.

Eskom Transmission will play the central role of Transmission System Market Operator (TSMO), responsible for balancing electricity supply and demand in real time. The TSMO will buy energy from generators, including Eskom’s own power plants housed in its generation entity, in terms of contracted Power Purchase Agreements. In turn, the Eskom transmission entity will sell the procured power to its distribution entity, municipalities and large private sector power users, in terms of Connection and Supply Agreements.

While the move towards centralised purchasing of electricity on a least-cost basis from a variety of generation sources is positive and in line with international norms, it would be preferable if the TSMO were independent of Eskom Holdings. Having the TSMO as a subsidiary of Eskom Holdings introduces the possibility of conflicts of interest in the purchasing of electricity and begs the question: what mechanisms will be in place to ensure the TSMO isn’t favouring Eskom GX in its purchasing decisions? The TSMO should purchase electricity in a transparent, fair and cost-effective manner, and the Roadmap does not detail how this conflict will be managed. We expect this to be clarified as the TSMO is established and its board of directors is constituted.

Figure 2: Roadmap for Eskom


Source: Roadmap for Eskom in a reformed electricity supply industry

The Roadmap for Eskom notes that further consideration will need to be given to the structure of the distribution sector as a whole, as there are currently no policy parameters to deal with this changing landscape. Challenges to reshaping the distribution sector include the dependence of many municipalities on revenue from electricity tariffs and the development of roof-top solar and similar local embedded generation.

It is intended that this new business model will enhance the operating transparency and cost efficiencies of power generation – to the benefit of Eskom, the energy sector generally, and ultimately the South African consumer. The details of this proposed allocation of debt, and the terms thereof, are still awaited by the market. Furthermore, the Minister of Finance has stipulated that any further fiscal assistance to Eskom will be contingent on the progress of the restructure, operational improvements and cost cutting.

The Eskom Roadmap seeks to protect and grow jobs through a just transition of Eskom’s power station and coal sector workers into new sectors that will be developed by the new energy mix. Given the large scale energy-related industrialisation programme that is expected to arise from both local and export opportunities to develop energy sectors across the continent, many new jobs are planned in the downstream value chain. The Eskom Roadmap plans to include retraining and bridging initiatives for workers, and a social safety net for those who are not able to transition to these new opportunities.

What do Investors want to see?
Private sector capital seeks to earn risk-adjusted, commercial returns, which take into account the intended term and liquidity of the investment. There is a significant amount of private sector capital available for investment in the energy sector, and investor demand is premised on:

  • transparent and clear rules of engagement with all stakeholders;
  • fair treatment of all lenders (which is crucial);
  • consistent communication and updated planning, time lines and objectives;
  • commitment to corruption-free contracts, which have the financial backing of government; and
  • a financially and operationally sustainable borrower that is able to repay its liabilities.

Our focus has now shifted from the guiding principles for energy sector reform, as outlined in the Eskom Roadmap, to government’s commitment to energy sector reform, as evidenced by the practical execution of the unbundling in the timeframes communicated.

Conclusion
Whilst the vision for South Africa’s new energy path is encouragingly positive, pragmatic and full of developmental potential, it must translate into urgent execution of the plans set out in the IRP 2019 and the Eskom Roadmap. The energy sector is at a cross road, and actions taken now will have multi-generational social, economic and environmental implications for our country.

Download the PDF version of A Bold Step Forward for SA’s Energy Sector.

All tags:

IRP / Renewable Energy