How much more electricity generating capacity does South Africa need?

17 July 2014

Daily Maverick

While most debate around South Africa's energy future tends to focus on the best source of new power generation (coal, gas, nuclear renewables), environmental issues and the role of Eskom, much less attention is given to how much generating capacity we are likely to need. But it's a critical question that needs to be answered. By DIRK DE VOS.

The general view, backed by several policy documents such as the Integrated Resource Plan (IRP), the Industrial Policy Action Plan (IPAP2), the National Development Plan (NDP) and so on but, also more directly, by our own experiences of blackouts (load shedding) is that South Africa has a critical electricity generating shortage and that this must be addressed by huge additional generating capacity if the country is to prosper.

This is not necessarily true. Understanding how much new generating capacity is likely to be needed might very well guide us in other decisions such as the "radical restructuring" of our energy sector mentioned by President Zuma in his recent post-election State of the Nation address to Parliament.

One way of looking at things is to compare South Africa to its peers. The table below lists the 25th - 37th biggest economies in the world in US dollar terms, South Africa, being the 35th biggest. It then sets out population size and electricity production:

Within this group, there are very poor countries like Nigeria and one of the richest, Norway. Calculating an "electricity intensity ratio" divides the amount of electricity produced in a country by that country's GDP.

On this basis, South Africa is an outlier, being the most electricity-intense economy. It retains this position when compared to just about any other country not in the table. Even measured against population size, South Africa produces more electricity per head than countries that are far richer on a per capita basis.

Of course, there are anomalies in the table; for example, Norway exports a large amount of electricity to its neighbours, such as Denmark. South Africa exports only a small percentage of its electricity.

Without proceeding further, the only logical response, then, to our apparent shortages, is that our electricity is not priced properly. And this, for nearly 30 years, has been the case.

One of the more interesting documents submitted by Eskom in support of a 16% year-on-year tariff increase was a report produced by Deloitte entitled "The Economic Impact of Electricity Price Increases on Various Sectors of the South African Economy".

In it, the work of University of Pretoria academics Roula Inglesi-Lotz and Professor James Blignaut, studying price elasticity of demand by different sectors of the economy, is extensively cited.

One of the important findings by these academics is that as electricity prices declined from the 1980s, South Africa's electricity intensity has increased dramatically. So while in 1990, South Africa had roughly the same electricity intensity as the OECD (a group of developed industrialised countries) by 2006, it had almost doubled.

These academics were also able to show that when South Africa experienced its last big electricity price increases in the early 1980s when Eskom's build programme was at its height, the price elasticity of electricity demand in South Africa was significantly negative.

For a long period from the mid 1980s, prices have fallen below the total cost of producing electricity and as one could expect, all sectors of the economy have increased their demand for electricity as prices have fallen.

Effectively, we have begun to take up the slack of excessive generating capacity built in the 1980s and before. As we now know, the slack ran out in 2008 but Eskom's average prices are still below what it costs to supply new capacity.

Using an analogy, Eskom has operated in a manner somewhat similar to a company running a fleet of taxis that has decided not to replace or renew its fleet or even provision for their replacement and to pass this benefit onto its customers.

At some point when the taxis are paid up, the customers are paying a fare that covers petrol, basic maintenance and the driver's salary, and respond by using the taxi service excessively; but significantly, the customers give up on trying to improve their own efficiencies and do all sorts of things that they otherwise would not have done.

It can't last, and to some extent, this paints a picture of a classic failure of central planning (or lack thereof). The only difference between Eskom and the taxi company is the time horizons: Cars are financed/fully depreciate over 5-10 years, for power plants it is 20/50 years.

The Eskom/Deloitte document goes on to analyse the effect of electricity price increases in several sub-sectors of the economy and endeavours to calculate each sub-sector's contribution to the economy in terms of value-add and employment absorption based on skilled, semi-skilled and unskilled categories.

There is a lot to fault in this analysis, including basic definitional issues. So mining appears to be a small contributor to GDP at 6%, but much larger sectors, such as finance and business services and the government sector, depend on it. Mining, particularly platinum, is also the largest contributor to our exports.

But in all this, two issues are striking: Gold mining and non-ferrous metal processing consume 25% of all electricity produced by Eskom but contribute very little to our economy as a whole.

Looking at it differently, if these sectors were charged for the electricity they consumed at something approaching what it actually costs to supply them, they cease to exist. If they did cease to exist, then the rest of the economy would have additional electricity generating capacity representing a quarter of total capacity.

The position of non-ferrous metal processing, which consumes roughly 13% of our capacity, is represented by a few alum inium smelters owned by companies within the BHP Billiton group.

This has been extensively analysed by Chris Yelland, a leading energy analyst and publisher. In short, he explains how bauxite (the ore that contains aluminium) is mined in Australia, shipped to South Africa for processing and mostly exported to China with very little downstream benefit to the economy.

The supply of electricity to these smelters is regulated by a number of long-term contracts ending from 2020 to 2026 at prices calculated at, amongst other things, the price of aluminium, but at between 21c-30c/Kwh. Eskom's current average selling price is around 60c/Kwh.

This is at a rate below the cost of the coal used to generate the supply. Yelland describes this process as being one of South Africa effectively exporting electricity at below the cost. Seen in this way, the aluminium smelte rs work in such a way that we are hollowing out South Africa's capital base.

One can be certain that these contracts will not be renewed and will terminate at a point when Medupi and Kusile are fully commissioned. It would be easy to criticise Eskom's management at the time for these deals but these are the type of decisions one takes when one has excess capacity.
Because of our 30-year hiatus of cheap and abundant electricity, South Africa's economy has come to share some of the characteristics of the unbalanced economies of many petro-states with their cheap oil.

This has allowed us to avoid undertaking the hard inter-generational interventions that we need, such as improving our education and labour productivity. It has likely also allowed for a relatively easy substitution of capital for labour.

We also do things like deep level gold mining and aluminium smelting that represents, at best, a misallocation of capital but more likely the destruction of our capital base. This can't continue.

Eskom has made the point that the electricity tariff paid by South Africans must more closely reflect the cost of supplying it. This is hard to disagree with, but it is very different from what we have become used to having. Most importantly, it puts the current vertically integrated monopoly utility that Eskom is into focus.

Eskom can continue for a while to maintain a competitive tariff, but this is because of its legacy power stations. Medupi and Kusile, which when fully completed, will represent nearly a quarter of Eskom's capacity, have cost way too much to build. One can be sure that a privately owned company feeding into the grid against a fixed tariff on a 20-year contract would not h ave had the same cost over-runs.

The grid itself needs investment but it will need to become smarter. As electricity becomes more expensive, sectors with continuous operations like aluminium smelters will disappear and daily peaks will become more pronounced.

New capacity might need to be commissioned on smaller incremental projects adding in capacity sounding in hundreds of Megawatts and not the mega-projects which add several thousands of Megawatts of capacity at once.

This will impact on the selection of the type of generation capacity selected whether coal, gas, nuclear or renewables. Local municipalities which use electricity supply as a revenue generating hidden tax will have to find other sources of revenue.
More importantly, we will need to review our plans for re-industrialisation. To the extent that any growth strategy relies on cheap and abundant electricity, these will need to be dropped. We will also need to look carefully at the future of our gold mining sector.

Can we say that after 150 years, our gold mining sector has now come to an end? If so, what does this mean for those who are employed in the sector? What about legacy issues like acid mine drainage, and who will pay for environmental rehabilitation of gold mines?
Paying what it costs to produce electricity requires a profound change in the structure of our economy. This is not going to be easy, and it will require clear thinking and, most likely, leadership in the face of resistance to job losses and escalating costs before we find a new equilibrium.

If we make the right decisions now about restructuring our electricity sector by introducing market mechanisms to price electricity, we may be able to manage a manageable glide path to a more expensive electricity regime that requires us to develop other, less electricity-intense competitive advantages.

The alternative of increased unpredictable blackouts, a collapsing generating and grid network along with continued, unaffordable bail-outs to Eskom should concentrate all our minds. The clock is running.

Original article by Dirk de Vos

Categories: Energy

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