When Judge Masipa announced on Thursday last week that she would not be finding Oscar Pistorius guilty of murder – dolis eventualis or otherwise – twitter reacted with usual aplomb by baying for her blood and generally bewailing the racism of this black female judge that was failing women everywhere by making them unsafe in their own homes. Among the intelligentsia crew, there was much citing of legal expert – although most tended to ignore that there were legal experts on both sides of the argument.
Even Donald Trump took time out from his self-reflection to do a little crowd-pleasing:
For anyone that’s still enraged, I just caution you to remember that you’re in @realDonaldTrump’s camp. The man who spent his Sunday retweeting these:
You need to be more horrified, is my feeling.
Anyway – this week, the court of public opinion will undoubtedly cast its collective eye back again at Eskom, after Government announced support measures yesterday in order to prevent Eskom’s debt from being cut to junk status by the ratings agencies (specifically, S&P – who had placed Eskom on negative creditwatch pending this announcement from Treasury).
So before the rants start to flood in about Eskom’s uselessness and government incompetence and how much we all hate state utilities for being state utilities, I thought I’d find some graphs.
The Graphs That I Found
The first graph, of peak demand versus capacity:
From early 1994, the demand for electricity just started to leap upwards toward Eskom’s installed capacity.
Which might make you think that, well, economics, so, the increase in demand with less than equal increase in supply means rising prices, amirite? Well no. You’d be wrong. Electricity prices, as it turns out, stayed pretty low.
And here are some price comparisons at the end of 2008:
So South Africa had pretty cheap power for almost a decade and a half – at prices that were below the cost of supply. And by cost of supply, I mean two things:
- The cash cost of supply (employee costs, coal, etc); and
- The capital cost of supply (machinery replacement, etc).
And that distinction is important: because Eskom could continue to operate at a cash profit (by having a price that exceeded the cash cost) while continuing to operate at a loss because of depreciation (which is the general proxy for capital replacement).
Which hardly sounds sustainable.
The History of Eskom
- Under Apartheid, the prevailing economic policies of the time were still quite Keynesian – so there was a strong emphasis on State provision of cheap electricity in order to stimulate industry and mining.
- In the 1970s, the idea of supplying electricity into the rest of Africa gave rise to large investment programs into new power plants, etc.
- But by the time these power plants were completed, sanctions were happening, industries were struggling, and Eskom had a whole lot of spare capacity.
- So in the early 1990s, Eskom entered into some supply contracts (specifically, with BHP Billiton) that allowed cheap access to the “spare capacity” electricity. Some of those supply contracts were concluded in 1992, guaranteed supply for 30 years at those low tariff rates, and kicked into place in 1995/6 (just have a look at that first graph again).
- Also, when the ANC took over in 1994, there was no good reason for them not to continue using cheap electricity as part of their stimulus/development plans. After all – the electricity was there to be generated, the capital infrastructure had taken place, so why not give the population a head-start by connecting them to the grid?
- So electricity usage started growing, and according to this report, Eskom declared in 1998 that it would reach full capacity utilisation in 2007.
- Instead of investing in the public sector, government went down the route that would have been thoroughly recommended by the World Bank and the IMF: it tried to attract private investment into the energy sector, and thereby break Eskom’s monopoly over energy.
- Private sector involvement, however, did not really happen – generally attributed to government insistence that it get to dictate electricity prices.
- So when government suddenly realised that all was not well in 2004, they’d already lost 6 years of potential expansion, meaning that an energy crisis was inevitable (because, as I understand it, it takes 7 to 10 years to bring any new developments online).
The Poor Economic Fundamentals
So to be clear, if Eskom were a private entity, we’d be looking at it and saying:
- They’re undercharging.
- And they have even lower-tariff commitments to BHP Billiton.
- They should have been investing in new power plants six years earlier than what they have.
- And they’re facing increasing demand requirements (because of the undercharging).
In fact, we’d probably be calling for a government bailout of a key industry.
Let’s Talk About Those Supply Contracts
Back in 1992, who would have thought that Eskom could ever have run out of supply? They just had so much capacity – and any potential supply issues felt, well, decades away – and surely something could be done in the interim if absolutely necessary…. So why not enter into some supply contracts for the spare capacity? At least it would give Eskom the liquidity to continue maintaining the power plants.
So BHP Billiton established some aluminium smelters with all the cheap electricity, and proceeded to import aluminium ore from Australia, smelt it, and then export it straight back out for manufacturing (to China)*.
*I’m being flippant. But it’s a bit true.
According to this moneyweb article, that tariff today works out to R0.27 per kWh (today). Compare that to the R0.36 per kWh in that price comparison graph up top.
Is it any surprise then that 25% of South Africa’s power consumption is taken up by the non-ferrous and gold mining industry (and 14% is used solely by the non-ferrous metals sector), while it only contributes 4% to GDP (see this Deloitte report)? When you have these large aluminium smelters that are basically established solely to take advantage of low electricity tariffs?
Have a look:
It looks like it would almost be better for government to hire all those non-ferrous metal workers, pay them their current salaries for doing nothing, and shut down that sector entirely. Easier than building another Medupi.
In the interim, we’ll have to accept that there is no such thing as cheap electricity. Because if we don’t pay Eskom directly, then it gets paid for through taxes and government bailouts.
Either way – I don’t think it’s entirely Eskom’s fault. Perhaps more of just a bad situation.
For more, read this article from the Daily Maverick. I think it’s excellent – and I’m sad that it’s not getting more attention.
Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.