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ENERGY CRISIS (PART ONE): If Eskom’s tariff increase is to go, its financing model needs to bite the dust too

A mural of a child holding a bulb in orlando west soweto,most parts of the township are affected by rolling blackouts of stage 6 loadshedding.  Photo: Felix Dlangamandla 

By Dominic Brown and Jaco Oelofsen | Daily Maverick | 08 Feb 2023 

Reducing primary energy costs and providing debt relief are low-hanging fruit in terms of solving Eskom’s tariff increase problem, but these measures will be short-lived unless there is a restructuring of Eskom’s financial model, including breaking from the user-pays principle. This article is Part One in a series of three that addresses South Africa’s energy crisis. The National Energy Regulator of South Africa’s (Nersa’s) approval of tariff hikes of 18.6% for 2023/2024 and 12.7% for 2024/25 for state-owned power utility Eskom has been met with outrage. South Africans are wondering how it is possible to pay much more for considerably less electricity. While it is hard not to be outraged, much of the anger is misplaced.  

As Daily Maverick associate editor Ferial Haffajee points out, “without the 18.65% increase Eskom can’t survive”. Already, Eskom is facing a death spiral with insufficient resources to cover operating, maintenance and debt-service costs and investment in infrastructure. It comes as no surprise that Eskom applied for a substantial tariff increase. But there are options that can allow us to scrap this increase in the short term, and transform Eskom’s financial model altogether in the long term. 

Reduce primary energy costs

  • Renegotiate

According to Eskom, some of the main drivers of its requested tariff increase are a 9% increase in the cost of energy sourced from independent power producers (IPPs) and an increase in its primary energy costs, mainly due to rising diesel and fuel costs. These costs can be substantially reduced.  

One option would be to renegotiate IPP contracts to reduce the price of the purchase power agreements of the contracts of Bid Windows 1 to 4. This would reduce the total input costs of IPPs, which account for more than a third of the total primary energy cost (R43.1-billion out of R138-billion), while only contributing 8% of total installed capacity. 

  • Grant Eskom a direct diesel procurement licence

The South African Revenue Service providing Eskom with a licence to procure diesel from wholesalers, as opposed to the current situation where it is forced to purchase from retailers, would save the power utility just under R6 per litre. Eskom still needs 200 million litres of diesel until March, the end of the financial year. Saving R6 per litre would allow a saving of R1.2-billion on diesel alone.  

  • Cap the coal price

The price of coal has also increased dramatically over the past 15 years, almost tripling in price, primarily due to increased demand for low-quality coal and black economic empowerment coal contracts. Placing a cap on the coal price would be an additional important step to reduce Eskom’s operating costs. The energy crisis is a national emergency that more than warrants drastic measures.

Debt relief

In addition to rationalising Eskom’s primary energy costs, another option is to provide Eskom with debt relief. Just servicing its debt alone costs it R35.4-billion in the previous financial year (2021/2022). R8-billion of this was paid to public entities, primarily the Government Employees’ Pension Fund (GEPF), which has R81-billion of Eskom’s total liabilities. The GEPF has more than R2.2-trillion in accumulated reserves and is 110% fully funded (able to pay out the current and future pensions of all members).  

A moratorium could be placed on the repayment of this debt service without any additional risk to the pensions of the beneficiaries of the GEPF. The Public Investment Corporation has offered partial relief already by rolling over R13-billion of Eskom’s debt that had to be repaid in January this year. This is an important first step, but much more must be done. 

Restructuring Eskom’s debt is another urgent requirement that can be easily met. The national government needs to take on up to two-thirds of Eskom’s debt, as mooted by the finance minister in the Medium-Term Budget Policy Statement announced in October last year. As long as this does not come at the expense of social spending and investment in the rest of the economy, it can be a critical measure offering substantial relief to Eskom’s financial position. 

Part Three of this series will show where the resources can be found to do this. Cancelling illegitimate debts, such as the 2010 World Bank loan, is yet another alternative measure to Eskom’s tariff increase. In 2022 alone, Eskom paid the World Bank R2.6-billion in interest and charges. 

End full cost recovery model and user-pays principle

These measures can alleviate some of the immediate pressure on Eskom’s finances and allow for a scrapping of the tariff increase. They are, however, inadequate to arrest its ongoing financial challenges. Underlying Eskom’s financial woes is a structural problem arising from the adoption of the full cost recovery model and the user-pays principle, following its corporatisation in 2001.   

Corporatisation already started under the apartheid-era De Villiers Commission and turned Eskom into a standard private company, in everything but name. Electricity ceased to be a public good and was treated as a commodity, with all its users being turned into “customers”. In a South Africa freshly liberated from apartheid, this meant turning the then (nominally) equal citizens with rights into customers who got only what they paid for.  

The consequence of this is that the utility is dependent on selling electricity to raise revenue in order to recover its costs, with additional profit and market-rate debt being used to fund new projects. These costs do not simply include expenses that would be marked as such on an income sheet — they also include a profit margin. 

As a result of South Africa being among the most unequal countries in the world, most people are unable to afford rising tariffs. Combined with declining sales volumes of 1% on average each year due to more consumers going off-grid, there are major constraints on Eskom’s ability to raise sufficient revenue.  

Growing debt-service costs, following loans often denominated in foreign currency, add strain to Eskom’s financial position. The fact that some of these loans are considered by many to be illegitimate and have been used for bad financial investments adds insult to injury. This helps us to understand why, as Eskom’s CEO pointed out, Eskom “does not manage to generate sufficient revenue from operations to meet its debt servicing costs and some capital investment requirements”.  

Energy privatisation for lower tariffs? 

Eskom has not adopted a fully fledged “cost-reflective tariff model”, and thus does not “reflect the true cost of generating power”. A “more” cost-reflective tariff model would increase tariffs dramatically. Eskom already indicated it needs a cost-reflective tariff structure “to reflect unbundled costs more accurately” as well as the changing energy environment in which the energy sector is more fully marketised. By all accounts, Eskom has been selling electricity at below the rates that it would deem reasonable to charge if it were given the “freedom” to fully set its own prices.  

Changes to the Electricity Regulation Act and Electricity Pricing Policy — first published for comment in February 2022 — doubled down on the principle that electricity tariffs must be set at a level that is cost-reflective and inclusive of a reasonable rate of return, high enough to ensure continued private investment and funding, and ensures both the stability and diversity of the country’s energy supply. Nersa has recognised that this could enable a move towards a less regulated and more market-led pricing structure

Some argue that this is all good and well because the marketisation of the energy sector is well under way, and should Eskom price itself out of the market we may soon be able to simply purchase electricity from a cheaper supplier. Eskom’s recent announcement that it will allow private generators to sell their electricity on its internal power pool seems to be a significant step in this direction.  

This perspective is misleading. Eskom produces the lion’s share of South Africa’s electricity today and will continue to do so until the end of the decade at least. If private solar and wind farms are able to sell their electricity at lower rates than Eskom when the sun is shining and the wind blowing, this cuts into Eskom’s market share and results in lost revenue. In times when the sun isn’t shining and the wind isn’t blowing, Eskom will have to make up this lost revenue through extraordinarily high tariffs — which would have to be approved, lest it undergoes complete financial collapse and thereby endangers the country’s energy supply. Further, the costs incurred by Eskom (or the National Transmission Company) in upgrading the grid to allow for new private power producers are considerable, and these costs will only rise as Eskom or the NTC continues to attract more debt in order to fund this urgent task.  

Finally, in a market-based energy sector, there are fewer protections in times of crisis and economic shock. While the amendments to the Electricity Pricing Policy and Electricity Regulation Act do make provisions for ensuring that tariffs take account of any shocks, these provisions are weighted against other objectives, such as full cost recovery. 

In the United Kingdom, disruption caused by the war in Ukraine caused household energy costs to rise by 40% in April 2022, with a further increase of up to 80% planned before the state intervened. For many households, the cost of electricity almost tripled last year. The reason? “Competing” power producers in the UK’s energy market saw massive increases in the price of inputs such as gas, the cost of which they were able to largely pass on to consumers because of weak intervention by Ofgem (the UK’s Nersa).  

In the United States, a 2021 storm took much of Texas’ generation offline. In their market-based energy system, electricity providers responded to the massive loss of supply with huge price increases, in some cases deducting thousands of dollars directly from consumers’ bank accounts for only a day or two of power usage. A publicly owned, vertically integrated and not-for-profit energy utility would be able to shield consumers from sudden volatility by running at a loss with the support of the national fiscus.  

Address energy poverty

The tariff increase approved by Nersa does not reflect the entire increase in cost that will be experienced by end users. Municipalities may add a further increase. Rising electricity prices will perpetuate and potentially exacerbate energy poverty in the country. The introduction of the provision of free basic electricity in 2003/04 has not managed to effectively solve this problem. 

First, the provision of 50kWh per household per month is inadequate to meet even the most basic of needs — it is estimated that a household needs at least 350kWh per month. Second, less than 3 million out of the 11 million households to which the government allocates resources for free basic electricity actually receive it. The reason is that municipalities are reliant on selling services and therefore are disincentivised from registering indigent households which are eligible to receive free basic electricity.   

In 2019, for example, municipalities bought electricity from Eskom to the value of R19.5-billion and sold it to make a total revenue of more than R28-billion and a profit of R8-billion. Without these resources, municipalities’ finances would be even more precarious, and there would potentially be an even greater negative impact on service delivery. This is a serious barrier holding the country back from addressing energy poverty.  

Shifting the allocation of free basic electricity from an equitable share grant to a conditional share grant (allocations of money conditional on certain services being delivered or on compliance with specified requirements as opposed to being used at the discretion of the municipality, as with the equitable share grant) can help to compel municipalities to register the eligible households to receive free basic electricity. Doing so would reduce the revenue of municipalities and further compromise service delivery. This can be overcome by increasing the division of national revenue that goes to municipalities.  

A decade and a half of above-inflation tariff increases has made electricity unaffordable for most South Africans. Mass unemployment and unparalleled levels of inequality force many to load shed themselves, as households must choose between buying food and buying electricity. This perpetuates energy poverty and the exclusion of many from the provision of electricity.  

It is therefore critical that we rein in electricity prices. This is possible but would require an immediate reduction in Eskom’s input costs. We have suggested that placing a cap on primary energy costs and restructuring Eskom’s debt are low-hanging fruit. However, these measures will be short-lived unless there is a restructuring of Eskom’s financial model, including breaking from the user-pays principle.  

The government must provide Eskom with a sustainable level of funding to ensure that it can operate effectively to end energy poverty, and for investing in generative capacity by improving infrastructure and upgrading the grid. DM/MC

Dominic Brown and Jaco Oelofsen work for the Alternative Information & Development Centre

*This Opinion Piece was first published by the Daily Maverick

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