LINDA NOBAZA: Eskom unbundling a good idea, but aim unlikely to be achieved

Eskom’s unbundling is confirmed. In his state of the nation address, President Cyril Ramaphosa said the process will be completed by December.

The cabinet has already approved amendments to the Electricity Regulation Act for public comment.

The motivation for the unbundling is evidently to improve management efficiency and competition. To quote the president, the unbundling of Eskom “will enable a competitive market for electricity generation and the establishment of an independent state-owned transmission company”.

To examine whether the stated objectives can be achieved we need to understand the mechanics of an unbundled electricity system, conditions that will enable efficiency and competition.

The electricity industry is characterised by two main markets: a regulated one and a deregulated one. In regulated markets such as SA’s, one entity is responsible for the generation, transmission and distribution of electricity. Usually, this entity is owned by the state.

In deregulated markets, the three stages are unbundled and the market is competitive among many players. Deregulated markets are further characterised by two main models: wholesale and retail. The wholesale model is competitive only in the generation stage. The retail model is competitive in all stages from generation to the retail stage.

Though unclear, the envisaged unbundling of Eskom is likely to be the wholesale model. At this stage there is no talk of opening the distribution system to the private sector.

In typical wholesale competition, the distributor buys electricity directly from independent power producers (IPPs). Since electricity is nonstorable, varying electricity demand is a constraint. To hedge against this, distributors may enter into contracts with power generators to guarantee certain amounts of electricity to be supplied at predetermined prices and periods.

Thus the fundamental prior condition for the efficient functioning of the wholesale competition model is that in any given period future demand for electricity must be met collectively by producers. In other words, the collective installed capacity of producers should outstrip demand to enable producers to use price to bid.  

In the case of SA, the available capacity of Eskom and IPPs combined is unable to meet demand. We have a supply deficit. It is an established economic fact that when demand outstrips supply, prices increase. Besides, for as long as there is a supply deficit in a given period, all producers are guaranteed to sell their full available capacity.

The current state of generation capacity in SA doesn’t allow for both competition and efficiency gains after unbundling. In fact, the added bureaucracy with no incremental benefits is likely to increase costs and therefore the final tariff to the consumer.

Even when supply outstrips demand, I doubt the technology mix will deliver the desired results. How do renewable energy producers guarantee the availability of sunshine or wind to meet their forward contracts? To achieve this they would probably need to add to their cost structures storage technologies, which would put pressure on the desired tariff to cover their costs.

Suppose a perfect post-unbundling Eskom. The mere fact that the debt of Eskom and IPPs cannot be guaranteed by the fiscus could mean producers that cannot compete would go bust. South Africans would have to pick up the tab in one way or another.

The solution to the energy crisis in SA needs a rethink. Deregulation of the electricity market requires mainly two conditions, both of which are absent: installed capacity should outstrip demand, and the energy technology mix must be suitable for a forward contract market.

SA should rather look to Norway. In the 1940s, Norway experienced blackouts as its power stations could not meet demand. The rebuild programme was carried by the central government to achieve both availability and affordability, because unaffordable available electricity is actually unavailable.

In the 1990s, in contrast to the 1940s blackouts, Norway experienced a new problem of inefficiency — supply outstripped demand by a big margin, and the allocation of resources became suboptimal. In response, Norway unbundled and deregulated the electricity industry to gain efficiency on both the generation and the distribution side.

• Nobaza, a financial modelling professional with Anglo American, formerly worked for the National Treasury and Telkom. He writes in his personal capacity.