Recent warnings that SA may face load-shedding during the festive season are a reminder of the negative impact for consumers and the economy of Eskom’s continued management and financial woes.
Historically, SA's electricity was very cheap and plentiful because Eskom built large coal-powered stations that operated with significant economies of scale. The stations were built on top of enormous low-grade deposits supplying coal at minimal cost. Many of these coal mines were owned by Eskom but operated by private contractors with proven mining expertise. Eskom paid the operator on a cost-plus basis for a small margin.
The result was exceptionally cheap coal and very cheap electricity. When local sources of coal were depleted power stations were closed and new ones opened elsewhere operating on the same model.
Failure to build new power stations to meet local demand growth led to the 2008 load-shedding and severely disrupted Eskom’s traditional production model. Old mothballed power stations had to be recommissioned to bring additional capacity quickly into the grid. The coalfields that historically supplied these stations had been worked out, forcing Eskom to buy coal on the open market. Transporting this coal by road, always a costly business, was the only option and Eskom’s margins came under further pressure as a result of the global commodity price boom.
Debt and operational costs must be reduced. Coal supplies must be secured until current capacity is replaced.
When Eskom belatedly embarked on a programme of building, it chose to concentrate production in two enormous power stations, Medupi and Kusile. These have been subject to extraordinary cost overruns and delays. In 2008, Eskom predicted Medupi would be fully operational by 2015, but this is now expected only in 2020. The overspend and delays forced Eskom into higher-than-expected borrowings and interest repayments. It also had to extend the life of the expensive recommissioned plants.
Astonishingly, in 2016 Eskom announced the end of its own coal mines. Then CEO Brian Molefe was quoted as saying Eskom is in the business of buying coal, not financing mining operations. This new approach may have been seen as a way to relieve the pressure on an increasingly debt-strapped Eskom of the ongoing capital costs of mining. Alternatively, it was meant to create a large market for connected private coal suppliers. Either way, Eskom would now pay full market price plus transport costs for coal, competing in an open market with rival buyers, a far cry from its old cost-plus, single producer model.
Resultant upward pressures on Eskom’s production costs were passed on to consumers through swingeing price rises. The impact was especially painful because historically cheap electricity had encouraged unusually high electricity dependence in SA industries. Indeed, this was actively encouraged in the early 1990s when Eskom’s overcapacity was channelled into the development of energy-hungry aluminium smelters at Richards Bay and Maputo.
The price of electricity has risen almost fourfold since 2008. Painful adjustments followed for energy-intensive users, as borne out by the fact that electricity demand is now 3% lower than in 2008 despite the economy growing 15%. At the same time, both manufacturing and mining production have fallen 5%. These declines have harmed overall GDP growth as well as exports and employment in our most labour-intensive sectors.
Environmentalists will correctly argue that the previously low price of electricity was artificial and ignored the environmental costs of burning coal. SA is now moving to greater use of sustainable renewable energy such as wind and solar. This is a better path to follow, but it does not diminish the pain of the required adjustment processes when the rise in electricity prices is so rapid.
Eskom’s hoped for journey back to financial and operational sustainability cannot be achieved through further damaging price hikes. Debt and operational costs must be reduced. Coal supplies must be secured until current capacity is replaced.
Achieving all this will not be easy, but restoring Eskom and other state-owned enterprises to sound health is critical for SA’s economic prospects.
• Keeton is with the economics department at Rhodes University.
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