Exporting more electricity to Southern Africa may rescue Eskom

11 December 2017 Authored by Consultancy.co.za

Cross-border trade can alleviate regional shortages, profit Eskom, relieve local consumers and aid renewables, write Jason Mann and Victoria Barr, senior advisors in FTI Consulting’s South African economic and financial consulting practice. 

Recent reports have highlighted the many challenges facing Eskom, including, most pressingly, difficulties in continuing to service its debt. Underlying Eskom’s liquidity issues are a number of structural problems with the electricity sector in South Africa (SA), of which we want to highlight three: electricity generation is carbon intensive, increasingly inefficient and the supply deficit that led to load shedding a few years ago has been replaced by an excess of generating capacity. 

The good news is that two of these problems could be mitigated by greater electricity exports to South Africa’s neighbours. However, significant increases in exports will require improved interconnection and transmission infrastructure in the Southern African Development Community (Sadc) region. 

South Africa ranked 105 out of 125 countries in the World Energy Council’s 2016 environmental sustainability index, driven by the country’s continued dependence on coal for electricity generation. Investment in new large coal-fired power plants such as Medupi and Kusile has undermined the progress made through the highly regarded Renewable Energy Independent Power Producer Procurement Programme (REIPPPP) and entrenched SA’s high-carbon energy mix. With supply now in excess of demand, Eskom is stalling the signing of power purchase agreements with the renewable independent power producers.

Eskom is struggling with efficiency issues

Like other state-owned entities in SA, Eskom is struggling with efficiency issues. An inability (or unwillingness) to constrain expenses in both capital projects and raw material supply contracts, plus a disproportionate increase in headcount, has led to spiralling costs. 

After insufficient expenditure on maintenance of existing plants and inadequate investment in new generation capacity led to load shedding in 2008 (and again in 2014 and 2015), Eskom embarked on a large capital expansion programme, primarily focused on new coal-fired power stations accompanied by plans for new nuclear capacity. In parallel, the Department of Energy approved the REIPPPP, which added more than 3GW of renewable generation capacity between 2011-16.

At the same time, SA’s lacklustre economic growth, energy efficiency improvements and increases in "distributed" or decentralised generation — such as small-scale wind and solar power — have led to stagnant or declining demand for grid electricity. This combination of operational inefficiency and excessive investment in what increasingly appears to be unnecessary capacity has led to rapidly rising electricity tariffs. This trend is likely to continue for years to come, further damping demand in a vicious cycle, which may threaten Eskom’s viability.

Political will?

Solutions to these three problems exist — the key question is whether the political will is there to implement them.

The structural reforms needed to resolve the conflict of interest at the heart of Eskom’s efficiency problems are well understood — the 1998 energy white paper set out plans for the separation of generation from transmission and distribution and the introduction of a competitive market in generation. A bill to introduce an Independent System and Market Operator was published in 2011. Unfortunately, there is little appetite in the current government for the structural reform of Eskom.

While South Africa has a surplus of generation capacity, many of its neighbours face the opposite problem

Thankfully, the other two problems are less intractable and could both be mitigated by increasing electricity exports to neighbouring countries. To reduce carbon emissions, SA needs to increase the proportion of renewables (or nuclear) in its energy mix. With wind and solar now the cheapest new-build generation technologies in SA, the REIPPPP provides an excellent vehicle for doing this. The problem is that the current surplus of generating capacity leaves Eskom with little incentive to sign the power product agreements, connect independent producers to the grid or undertake the necessary strengthening of transmission infrastructure to bring renewably generated electricity from where it is being produced to where it is needed.

However, SA’s surplus of generation capacity is an unusual problem in the region. Many of its neighbours have exactly the opposite problem. Recent droughts left heavily hydro-dependent countries such as Zambia and Malawi with severe supply shortages and extensive load shedding. Increased cross-border trade of electricity could be a win-win solution for SA and its neighbours, generating revenue for Eskom and alleviating power shortages elsewhere. Thinking optimistically, it could relieve price pressure on South African consumers and encourage Eskom to connect the renewable independent power producers to the grid, greening the country’s energy mix. 

SA is currently connected to the Southern African Power Pool by 7GW of interconnector capacity to Namibia, Botswana, Mozambique, Lesotho and Swaziland, and exports to the region are already underway. While sales of electricity to domestic customers declined by 1% in the year to March, Eskom’s international sales increased by 12%. Unfortunately, the relative size of domestic versus international sales meant that overall sales still fell over the period (by 0.1%). 

Therefore, significant increases are needed in exports from SA to the region. However, this will require new cross-border transmission infrastructure or "interconnectors", as well as the strengthening of existing domestic transmission in power pool countries, such as the Alaska-Sherwood line in Zimbabwe. Of the 2.8-million megawatt hours (MWh) of matched trades between members of the pool in 2016-17, only 1-million MWh (37%) was actually completed, largely owing to constraints in the transmission infrastructure. Alongside this, the right commercial and regulatory arrangements need to be in place to ensure that, once built, usage of the interconnectors is maximised. 

There are currently nine power pool transmission projects at the feasibility/project preparation stage and a further seven at the pre-feasibility stage. These include plans to connect the three members of the pool that are not currently connected (Angola, Malawi and Tanzania), as well as projects to strengthen interconnection between SA and Botswana, and between SA, Mozambique and Zimbabwe.

Exporting more electricity to Southern Africa may rescue Eskom.

Financing infrastructure investments

How can this new transmission infrastructure be financed? Government investment has been the dominant model for interconnectors in Africa, either with government-owned companies each financing their side of the transmission line (such as the Cahora Bassa line between Mozambique and SA) or through the creation of a special purpose vehicle (SPV). Motraco, which connects SA, Mozambique and Swaziland, is an SPV owned by the three state-owned utilities — Eskom, EDM (Mozambique), and SEC (Swaziland).

However, interconnectors can also be privately financed, and this model has worked well in other parts of the world. Given the current fiscal climate in many southern African countries, this is an option worth exploring. There are a number of different private finance models but the most common for interconnectors is "merchant investment", where a private investor builds and operates the interconnection asset and generates revenue by arbitraging the price differential between the two markets it connects.

There is no single "best" solution – interconnectors have been successfully developed under a range of different investment models, both public and private. The choice of investment model will depend on the nature of the project, investor requirements and policy preferences, among other factors.

But increasing investment in interconnection and transmission in the Sadc region should be an urgent priority for South Africa.

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