Restructuring
and
unbundling

Mpumalanga,,South,Africa-february,17,,2005.,Man,With,Motorbike,Helmet,Looking

Restructuring and unbundling

Mpumalanga,,South,Africa-february,17,,2005.,Man,With,Motorbike,Helmet,Looking

Unbundling

Unbundling is essential to making Eskom work again – even if it will increasingly bear less resemblance to the Eskom of old.

Plans to create a separate independent transmission system and market operator (ITSMO) are hardly new. In fact, legislation to create such an entity was first published a decade ago.

Whatever it’s called, the unbundling, divisionalisation or restructuring of Eskom is finally happening.

It is hoped that by the end of calendar 2021 or at least by early 2022, the ITSMO will have been legally separated and will be operating as a separate entity under Eskom Holdings. It is also expected that a distribution entity and at least one generation entity will have come into existence by the end of next year.

All will be wholly owned by Eskom but run independently, with their own managements and boards.

The ITSMO will operate the transmission market, ensuring its stability while buying power from independent producers as well as from Eskom according to transparent costs. It will also “wheel” power generated independently and distributed to where it is consumed.

In December 2020, presenting their interim results, Eskom’s executive leadership sounded a more optimistic note about when the ITSMO might come into being than they had previously voiced.

In August 2021, though, they sounded a rather more cautious note, stating that “a number of delays” were putting the targeted date of 31 December for the ITSMO’s legal separation “at significant risk” and that “at the moment, our projection is that separation will not be achieved by the target date”. Apart from regulatory foot dragging, it appears that Eskom’s “investors and lenders” could throw a spanner in the ITSMO works. It seems some of them just don’t believe that the transmission entity will ever be financially viable…

CFO Calib Cassim used Eskom's December announcement to stress that restructuring on its own would not translate into three financially sustainable entities. This could only occur, he said, with government support on Eskom’s debt and the imposition of cost-reflective tariffs. (Today Eskom is attempting to divvy up its costs of generation, transmission and distribution, to show what these services and infrastructure actually cost. But customers need to know who is paying how much, for what and to whom.)

The transmission network will require substantial investment, up to R100 billion for an additional 8 000km to mainly transmit power from the Northern Cape and Eastern Cape to where it is most needed, a big opportunity for manufacturers and service providers. Making it possible for private-sector generators to connect and actually deliver their power will be critical – and require more investment.

 

Nersa and Eskom

In July 2020 the High Court, apparently carefully weighing its words, accused Nersa of a modicum of incompetence . The words were contained in a ruling which essentially found that the national energy regulator was not very good at its job.

Responding, in a formal statement, Nersa said that the case (which it lost and Eskom won) was “not merely a case between Eskom and Nersa, but rather a case of Eskom versus the SA economy and electricity consumers”.

Such intemperate utterances speak to the clearly adversarial relationship which now pertains between Eskom and its regulator. In recent years Eskom has repeatedly resorted to the courts in its battles with Nersa, particularly over rulings on its allowable costs and, therefore, tariffs.

Early in 2021, Dr Rod Crompton, for 11 years a Nersa board member and today an independent non-executive director of Eskom, hardly minced his words when he wrote: “The regulator will have to change its stance or throw the whole country into default.”

It is not the Manufacturing Circle’s place to deliberate Nersa’s competence but the fractious relationship between the state-owned entity and its regulator is now clearly not in the country’s best interests.

Nersa’s role in the economy is about much more than determining Eskom’s revenue in terms of the Multi-Year Price Determination Methodology. It is also charged with regulating municipal distribution of electricity, an issue which will soon become of central importance to the country’s electricity landscape. As well as licensing own generation, something it has appeared loath to do.

The regulator licenses all generation, transmission, and distribution – and it is tasked with ensuring that those licences, including the Grid Code, are upheld. Multiple, ongoing municipal failures to properly supply electricity, pay Eskom or maintain local infrastructure are violations of those licences – but Nersa has consistently and conspicuously failed to do anything about those violations.

The Nersa Amendment Bill, which would institute a tribunal or appeals process to settle disputes between a squabbling Eskom and Nersa cannot be passed into law soon enough.

Tariff restructuring

Eskom consistently argues that its tariffs are among the lowest in the world and that it will never be sustainable and debts will continue to accumulate until it is allowed to charge cost-reflective, “prudent and efficient” tariffs.

A 2016 World Bank analysis of sub-Saharan electricity systems certainly appeared to buttress Eskom’s arguments about how cost-effective, on an international scale, its tariffs were. (Interestingly, the World Bank found that almost no African utilities were producing and supplying electricity without some form of subsidy. And whereas under-pricing represented only 40% of other systems’ “hidden costs”, in South Africa this was more than 80%.) The World Bank study found that Eskom’s tariffs were the third lowest out of 39 countries surveyed and that its average tariff, of USc6/kWh, was far off its “benchmark” (efficient) cost of USc10/kWh. An updated version of this report is due out later in 2021.

In 2018 a worldwide electricity pricing survey by reputed German research and analytics consultancy, Statista, approximately bore out the World Bank findings and what these said about Eskom’s relative price competitiveness.

Eskom also points to projected price paths to get tariffs to price reflectivity which have been devised by various reputable organisations – the World Bank, the Energy Intensive Users Group, the CSIR, Business Unity SA, even the National Development Plan. All of these have posited that to be cost-reflective, tariffs would have to have had to have been in the region of 120c/kWh in 2020.

The state-owned company enthusiastically highlights something it believes almost everyone seems to have overlooked, including government’s own Integrated Resource Plan (IRP) – that in 2009 Nersa, no less, projected price-reflective levels of between 120c/kWh and 140c/kWh.

Eskom’s annual financial statements to 31 March 2020 (the latest available) put its actual costs at 125c/kWh. The average tariff it was allowed to charge was 102c/kWh, a revenue shortfall for the 2019/20 year of R58 billion.

There is no doubt that Eskom has a compelling argument to the effect that the difference between the percentage returns it has achieved since 2006 (essentially the amounts it has been allowed to claim) and its weighted average cost of capital is substantial. In constant 2020 rand terms, it has put this at R370 billion – or almost 80% of its equity and external debt. (Chillingly, the shortfall tripled from 2013/14 to 2018/19.)

Eskom’s tariffs are regulated, using a cost-of-service formula in terms of which Allowed Revenue (what Nersa deems this amount should be) which, divided by sales volumes, equates to the average price. For what constitutes allowed revenue, see here.

On 1 April 2021, following victory in the courts, Eskom’s tariff went up by 15.63%. Response to this hefty increase was relatively (surprisingly) muted although the increase’s economic impacts will not become evident for some months. (And those will certainly be skewed by the effects of COVID-19.)

The company has repeatedly asked for two years of 15% increases, after which it promises to only apply CPI plus its carbon tax and allowances for IPP costs. It has now got one of these hikes. Should it get another, Eskom must absolutely be held to this promise. (Regarding “IPP costs”, Eskom has little say over how much government promises to pay independent producers in terms of negotiated power purchase agreements.)

As is widely understood, technological advances mean that the costs of generating renewable electricity are declining all of the time. For the International Energy Association’s latest macro overview of such trends, click here.

The proposed new (2021) tariff overhaul

In January 2021 Eskom released a plan to overhaul its pricing structures for the first time since 2012. It explains that its Retail Tariff Plan 2020/21 was necessary because the tariff structures which had been in force for almost a decade “no longer accurately reflect the Eskom cost splits for energy, networks, and retail” [generation, transmission and distribution]. It also pointed out that with an imminent unbundling of its operations, tariffs should reflect each division’s actual costs.

In particular, Eskom stresses the need to do away with recovering fixed costs through variable (kWh) tariffs. It wants to simplify tariffs which municipalities are charged and, for residential customers, to abolish the well-known incline block tariff (IBT) methodology while introducing time-of-use tariffs.

Time-of-use charges are necessary, it is argued, to reflect the additional costs of providing peaking power (especially very expensive diesel-fuelled OCGT generation) and to discourage consumption during times of high demand. The new tariff plan proposes shrinking the designated morning peak period from three to two hours and increasing the evening peak from two to three hours.

The plan (really only a set of proposals which, in practice will have to get the nod from multiple stakeholders including Nersa) also proposes balancing mechanisms where both third-party generators and large consumers will be penalised for not meeting contracted volumes. The plan seeks greater transparency on subsidies (currently 4% of Eskom’s income) and the costs associated with wheeling.

An important motivation for the unbundled tariff, according to the plan, is to reward investment in self-generation. This makes sense; Nersa’s tariff determinations ostensibly give Eskom a lump sum which it divvies up between its various cost centres.

(Eskom insists that, if accepted and implemented as proposed, the new tariff plan will be revenue-neutral.)

In September 2021 Eskom unveiled a Renewable Energy Tariff pilot programme in terms of which it will supply some (of its own direct) business customers clean, green energy generated at its Sere wind farm near Vredendal in the Western Cape. It will be a declining block tariff.

One emotive issue in the new tariff proposals is the concept of charging users who have invested in own generation a fixed cost for even occasional access to the grid. Critics argue (vehemently) that such a charge would be unfair on those who heeded calls from all corners, including Eskom and government, to practise energy efficiency. Eskom and others say that the utility needs to be paid for the upkeep of infrastructure that own-generators can access if they need more than they can produce, even if only occasionally.

Eskom’s new restructuring plan appears to acknowledge the many hoops it will have to jump through, and the many disparate stakeholder interests that will have a bearing on the final output. Not the least of the uncertainties will be an unpredictable, seemingly adversarial Nersa’s reaction.

Unfortunately, Eskom is communicating its tariff ambitions poorly – and many people simply do not understand the utility’s presentations. Eskom has a job to do on fixing how it communicates on price and tariff; not only must its proposals  and plans be transparent, they must be comprehensible by individuals who are not full-time energy professionals.

In particular, customers need to know what they are being charged for – and by which parts of the vast, opaque machine that brings electricity into their places of work or residence.

We absolutely accept the principle of cost-reflective tariffs. But while business customers using more electricity subsidise customers using less, very few actually know the extent of those subsidies. Or how much municipal mark-ups and levies contribute to their electricity bills. “Cost reflective” needs to be understood not in terms of IFRS or the income statements of Eskom and municipal distributors but in terms that make sense to individual customers and their businesses.

Eskom, the various government ministries and departments that govern and influence it, local and district municipalities are all organs of the state. They have a duty to explain to us, as taxpayers and voters, what exactly we are being charged for our electricity. Manufacturing Circle (working with partners including BUSA) is prepared to catalyse a process to get to the bottom of these hidden costs and charges.