by Stef Terblanche

Eskom tariffs

A no-win vicious circle

Power lines
Electricity.jpg

South Africa’s expensive electricity is an almost crippling factor in the operational budgets of hard-pressed industrial electricity consumers, including the beleaguered mining sector. It is also putting extra pressure on the budgets of poor households. The bad news is that it is about to become even more expensive if Eskom has its way. And Eskom’s calculations are conservative and may not be enough to cover costs. The alternative could be another power crisis. 

The power utility, which has in the recent past been criticised for big spending on things like staff parties and executive bonuses, has just made its latest multi-year price application to the National Energy Regulator of South Africa (Nersa). It is asking for an annual price increase of 16% until 2018.

If granted, South Africans will, by 2018, be paying around eight times more for their electricity than they did in 2008 when a power crisis hit the country with blackouts as power generation failed to keep up with demand. At the time the key mining industry was temporarily shut down as Eskom reduced their supply.

All mining operations were affected, but gold, platinum and ferrochrome miners were hit the hardest. Mining production for that January fell by more than 16%. The crisis led to major investment plans being scrapped or postponed, including Xstrata’s planned R5 billion ferrochrome expansion and Rio Tinto’s R24 billion Coega smelter.

Many of the mining houses launched innovative new programmes, such as teaming up with independent power producers (IPPs) in co-generation agreements, making efficiency improvements, adopting a variety of cost-saving measures and installing new technology.

Those programmes have come a long way towards reaching the target of 15% reduction in energy consumption by 2015 for mines and other large industrial consumers in terms of an Energy Efficiency Accord with the Department of Energy.

But whether it is enough remains to be seen. More than four years later, electricity consumption this past winter again peaked dangerously close to crisis levels, rising to around 35 GW on a supply capacity of about 36.5 GW.

However, Eskom’s latest price application is based on rather conservative assumptions and if all does not go according to plan then serious problems, including another possible power crisis, may arise.

About 25% of the requested increase will go towards meeting higher operating costs and about a third towards the anticipated increase in the cost of coal. The balance of just over 40% will be needed for replacing ageing infrastructure and increasing generating capacity, including servicing debts incurred to do so.

But there may be serious flaws in Eskom’s calculations. The utility seems to think the price of coal will not increase by more than 10% each year, a somewhat risky assumption given recent developments in South Africa’s mining sector. Employee costs are also very conservatively calculated at not more than 6% per year.

Last year the utility revealed that its executive salaries had increased by 109% for the financial year ended 31 March 2011. At the same time, following costly strikes and court intervention, Eskom had to pay its workers 8.1% increases in 2011 and 2012.

Even as Eskom was making its application to Nersa, labour unrest in the mining sector, including coal mining, was threatening security of coal supply and commodity prices, according to Public Enterprises Minister Malusi Gigaba.

Speaking at Eskom's report on the state of the electricity supply going into summer, Gigaba expressed his deep concern “about the strikes in the coal sector”. Eskom CEO Brian Dames added that the utility had been closely watching as wildcat strikes in the mining industry spread over the past two months. The recently ended transport workers’ strike also threatened coal deliveries to power stations.

And infrastructure replacement costs have frequently spiralled way above the original estimates. Eskom’s tariff increase projections also do not factor in the introduction of a carbon tax.

It also makes the assumption that independent power producers will contribute significantly to the national power grid over the next five years. However, no legal framework is yet in place to allow that. Eskom acknowledged that if the IPPs do not come on line as hoped, it will have to increase its applied-for annual increases from 16% to 20%.

Clearly, any unforeseen rise in the costs of Eskom’s capital expansion programme, or a sudden surge in coal prices, or demands for wage increases above inflation – as has been the norm these past two or three years – will send Eskom’s calculations into a serious tailspin.

The current three-year tariff determination (Multi-Year Price Determination 2) by Nersa ends in March 2013. Nersa is expected to give its verdict on Eskom’s latest application early next year.

For both South Africa’s residential and industrial consumers there is no good news to be had. It is a question of coughing up substantially  more money for electricity or facing another season of rolling power blackouts, or both.

The catch-22 situation is further complicated by the danger that without financially sustainable electricity tariffs Eskom, which is dependent on capital markets to finance capacity expansion, might see its credit rating downgrade. This, in turn, will push up the cost of its borrowing.

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