Eskom’s ‘death spiral’ under the microscope

21st November 2017 By: Terence Creamer - Creamer Media Editor

Eskom’s ‘death spiral’ under the microscope

Photo by: Duane Daws

A major topic of discussion during recent public hearings into Eskom’s 2018/19 revenue application, was whether a further double-digit tariff hike could trigger a “utility death spiral”, whereby rising tariffs and utility costs spark an exodus of energy-intensive customers from the network, leaving the remaining customers with ever escalating power bills.

The Energy Intensive Users Group (EIUG), representing Eskom’s 32 largest mining and industrial customers, which collectively consume 40% of the country’s electrical energy, was particularly vociferous in its warnings. However, Business Unity South Africa also highlighted the threat, noting that Eskom’s combined sales to industry and mining were already 14% below 2011 levels. If granted, Eskom’s revenue application “would trigger further defections from the grid,” the business body cautioned.

The topic was further interrogated during a Wits Business School panel discussion on Monday, facilitated by Dr Rod Crompton, a former regulator and the newly appointed director of the business school’s Energy Leadership Centre.

Crompton asked a panel, which included former Finance Minister Nhlanhla Nene, Eskom corporate specialist Deon Joubert, Fieldstone Africa MD Jonathan Berman, former EIUG chairperson Piet van Staden, as well as former regulator and current Powerx CEO Thembani Bukula, whether Eskom was indeed in a financial death spiral.

Responses to Crompton’s straightforward enquiry were far from complicated, however, with Van Staden describing it as a “complex problem that has a very simple, easily understandable, wrong answer”.

There was no debating that Eskom was experiencing financial hardship, or that the utility’s difficulties had the potential to spill over to the national fiscus, owing to the fact that government explicitly guarantees R350-billion of Eskom’s debt and implicitly stands behind all its obligations, which are set to rise to R500-billion in the next few years.

Berman even argued Eskom’s death spiral was not limited to its finances, owing to the fact that it also faced political, policy and structural death spirals, which had intensified in light of serious allegations of corruption and maladministration.

Nene indicated that he felt a sense of culpability, given that, while Finance Minister, he had overseen the 2014 conversion of a R60-billion subordinated loan to equity, as well as an injection of R23-billion into the utility, arising from proceeds of government’s sale of its stake in Vodacom.

“Little did we know that, in selling the family silver to prop up Eskom’s balance sheet, there was a leak that was far beyond what we were trying to plug,” Nene said, alluding to strong indications that the utility had since been used to enrich a politically connect elite.

“Looking back, it was the best we could do [to stabilise Eskom], but we should have been much more stringent with our conditions.”

However, Nene described the death-spiral question as one that did not require a direct answer, because Eskom was “too critical and central to the economy to be allowed to fail”. That said, the utility still required “serious surgery” if it was going to emerge from the current crisis.

Van Staden cautioned, though, that Eskom was facing two significant transitions that were making its current business model “unsustainable”.

The first was a supply-side transition, where the falling cost of renewable-energy technologies was undermining the competitiveness of Eskom’s coal fleet, while showing up the problem of being locked into an expensive and inflexible build programme.

The second was a demand transition, where the end of the commodity super cycle, together with efficiency improvements and the rise of embedded generation, was resulting in a decoupling of economic and electricity growth.

“We are now in a situation were price elasticity of industrial demand is quite crucial and is a primary driver of the lack of demand,” Van Staden argued, referring to the phenomenon where a small change in the price of a product is accompanied by a large change in the quantity demanded.

Eskom’s Joubert countered that argument by suggesting that, while many commentators were pointing to price elasticity of demand, there were several other factors contributing to declining volumes, not least the weak state of the domestic economy and the increasing role being played by the services sector.

At the equivalent of $0.063/kWh, Joubert argued that Eskom’s retail tariff remained competitive relative to most countries in Africa and many countries globally. The tariff also remained below the point where substitutes and alternatives to grid electricity become economically viable.

However, he admitted that the gap for municipal customers, whose tariffs were subject to subsidies and surcharges was far narrower, which created the possibility for defection by those customers more able to afford own generation. Some 42% of Eskom volumes are sold to municipalities.

Bukula felt at least part of the reason for the current predicament facing Eskom and the country lay with the Electricity Pricing Policy of 2008. The policy, he said, had been crafted primarily to enable Eskom to recover all its costs and to fund the building of 10 000 MW of new capacity off its balance sheet. However, it had paid far too little attention to the consumer.

“This policy assumed an efficient and a prudent operator – something that Eskom has proved not to be,” Bukula said, adding that this lack of efficiency had given rise to the death-spiral problem.

Any future policy and legislation, Bukula added, should improve choices for customers; a move that would inevitably result in a far-reaching restructuring of the electricity supply industry, whereby Eskom would be responsible for the “wires and system operations”, but exited the business of selling kilowatt-hours.

All five panelists agreed that avoiding the utility death spiral and managing the energy transition would be all but impossible without greater collaboration between stakeholders.

“Our circumstances and conditions have changed, so our solutions should also change. Policy cannot be static,” Nene concluded.