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Setting the record straight: the cost of renewable versus coal-fired energy

22 Oct 2019

Paul Semple / Portfolio Manager, Power Debt Fund

Article

The long awaited Integrated Resource Plan published on Friday, 18 October, affirms the increasingly important contribution of renewables to South Africa’s energy mix.

By 2030, the government intends to procure almost 25% of the country’s electricity from power plants driven by our abundant sun and wind resources. However, a question regularly asked is how much do renewables cost relative to coal-fired power, and what has the impact been of renewables on Eskom’s deepening financial crisis?

A misleading narrative peddled by uninformed commentators is that the costs relating to Eskom’s current fleet of coal-fired plants built in the 1960s and 70s, and which are fast approaching the end of their intended operational life spans, should determine the cost benchmark for renewables. The correct answer requires a far wider perspective on the matter.

In fact, it is more appropriate to compare the cost of constructing new power plants for each technology, in today’s terms. Then the fuel supply and the ongoing repairs and maintenance should be added, when calculating the all-in cost of producing a unit of electricity from renewables and from coal respectively. Lastly, the party who bears these costs is critical to the comparison.

It is instructive that over the past 10 years both forms of energy have been developed in South Africa. Medupi and Kusile are Eskom’s new flagship coal-fired plants, whilst some 92 Independent Power Producers (IPPs) have signed contractual agreements to build renewable energy projects and supply electricity to Eskom under the Renewable Energy Independent Power Producer Programme (REIPPP).

The following key differences between the coal and renewable developments are clear: 

  1. Construction cost versus budget
    Medupi and Kusile are still in construction, and although some units are supplying power to the grid, full commercial operation is at least four years overdue. Consequently, their cost to date of just over R400 billion, excluding the interest incurred on the debt used to build the plants, has ballooned to more than double the original estimates.

    In contrast, most renewable energy projects have been built on time and within budget, and critically, the delivery risk has been carried entirely by the IPPs and not by Eskom. On some days almost as much energy is generated by the IPPs in operation, as Medupi and Kusile combined due to their frequent operational failures. This despite the IPP’s construction cost being less than 50% of the new coal-fired plants - and with no hint of corruption, theft or malfeasance. 

  2. Responsibility for maintenance and repairs
    Most of the risk of design and construction of Medupi and Kusile has been assumed by Eskom. Already, there have been equipment breakdowns prior to full commissioning of the plants, which has resulted in added strain to Eskom’s finances.

    In the case of renewables, the IPPs are responsible for maintenance and repairs of the projects over their contracted 20-year operational life span. The financial risk to Eskom of covering these costs, plus increases in other overhead expenses, is completely outsourced to the IPPs.  

  3. Cost of energy produced
    As Medupi and Kusile are owned by Eskom, the cost of each unit of electricity produced should include the fuel required to operate these plants. Together with the construction cost over-runs, massive increases in the price of coal supply contracts have made Medupi and Kusile the most expensive coal-fired plants in the world. This is before the cost of their harmful carbon emissions is taken into account.

    Conversely, the IPPs are paid only for the environmentally clean electricity they produce, at an inflationary linked tariff that was set at the inception of their contracts.

The most striking feature of the REIPPP has been the significant decline in the tariffs bid in each successive round of the programme.

Many people forget that almost 10 years ago, renewable energy technology was not well known in South Africa. The costs of the technology (i.e. the solar PV panels and the wind turbines) were much higher than current levels, and the investment case for introducing billions of Rands into new projects was unproven. The tariffs bid by early investors reflected this elevated risk and the commensurate rates of return were obtained in an open market, that was transparently and competitively run by the government’s IPP office. This paved the way for future projects to be bid, and the establishment of one of the most successful renewable investment programmes in the world.

The widely acclaimed success and growth of investor confidence in the REIPPP, together with the downward trend of international prices for renewable technology, has resulted in a competitor driven decline in the tariffs bid in each consecutive bid window. The weighted average tariff across all technologies awarded in the latest bid window of the REIPPP was R0.70 per kWh, a reduction of almost 66% on the weighted average tariff of R2.02 per kWh that was awarded in the first bid window in 2012.  


Source: Antone Eberhard and Rain Naude

Despite the higher weighted average unit cost of electricity paid by Eskom to the initial IPPs, it is still cheaper than the electricity produced by Medupi and Kusile, in view of the massive increase in the construction costs, the delays in completing the plants, the environmental cost and the costs of the massive debt incurred by Eskom in implementing these two projects.

Furthermore, a fact often overlooked is the full pass-through to Eskom’s customers of the cost of electricity supplied by the IPPs. The National Energy Regulator of South Africa has approved annual electricity price increases so that Eskom achieves full recovery of tariffs paid to the IPPs, as well as the costs of Eskom’s own generated electricity. In the context of IPPs, Eskom plays the role of a cash collector, thus ensuring the cost neutrality of its operations.

However, perhaps the biggest difference between renewables and coal-fired energy is the positive impact the former has had on investor confidence in South Africa since 2012. More than R200 billion of fixed investment under the REIPPP has been made by the public and private sector, which has in turn contributed directly to GDP growth. It is revealing that the slump in GDP since 2016 has coincided with government’s stalling of the REIPPP and has undermined future investments in the country’s renewable energy sector.

Renewables are the cheapest form of new energy generation available today. They are also quicker to construct and, given the shortage of electricity experienced recently, are an obvious answer to ensure new generation capacity is brought online in the shortest possible time frame. Relative to the direct costs incurred by Eskom for Medupi and Kusile, plus the environmental costs of this “dirty” technology, and the indirect cost to the economy from load-shedding as a result of the dire state of Eskom’s coal fleet, renewable energy has to be the pre-eminent solution to South Africa’s new energy requirements in future.

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All tags:

Renewable energy / IRP