Picture: ISTOCK
Picture: ISTOCK

Municipalities are important customers for Eskom, buying more than two-fifths of its electricity. But many municipalities are in as much financial trouble as the power utility.

Eskom’s financial woes can therefore not be fixed unless and until the business model for municipal electricity distribution is also fixed.

Two major changes are needed. Municipal dependence on electricity revenue needs to be replaced with a local business tax. And municipal customers, and municipalities themselves, need to be free to buy electricity from the cheapest source. Neither of these changes will be easy, but both are necessary. Without them, efforts to reform Eskom will be in vain.

There is a synergy of interests between the cities and large intensive electricity users, together accounting for more than 70% of Eskom’s sales. Both want and need least-cost, reliable energy. In the face of vested interests, their combined voice may shift the balance of power to effect the necessary changes.

The picture presented in Eskom’s latest financials on municipal debt is not pretty. Eskom reported that the amount of overdue money owed to the utility by municipalities had increased from R5bn to R13.6bn. The 170% increase in just three years was, in Eskom’s own words, alarming. Not included is a further R3.3bn worth of electricity that was sold but not considered collectable.

The combined total of nearly R17bn represents about 10% of Eskom’s sales. This added debt burden increases costs, reduces cash flow and threatens Eskom’s financial viability.

Behind these numbers is an important but largely unrecognised story — the business model for distributing electricity in SA is broken. Eskom cannot be fixed unless this business model is also fixed.

The structure of the electricity distribution business still reflects apartheid geography. Before 1994, "white" municipalities provided electricity in "white" suburbs and commercial areas, and Eskom provided electricity to the townships and to other large, mainly industrial, customers. This structure was left largely unchanged when local government was reformed in 2000 because of anticipated far-reaching reforms to the electricity distribution industry. But numerous proposals to reform the inequitable and inefficient industry structure, starting with the 1997 Energy White Paper, did not go anywhere.

The reasons for this are clear. Municipalities depended on electricity revenue to support their other activities. Reform without financial compensation was not in their interest. The constitution gave municipalities an effective power of veto on the reforms and national government was unwilling to either compensate municipalities or change the constitution. Consequently, the municipal distribution industry was left largely unreformed.

The existing set-up worked well enough, at least for municipalities that were able to manage the electricity function reasonably effectively. These municipalities were able to extract a surplus from the sale of electricity that they could use to subsidise other services and costs.

Surprisingly, the steep increases in the price of electricity purchased from Eskom even benefited these municipalities. They were able to pass on the price increases and at the same time boost their gross surplus — electricity sales revenue less the cost of purchasing electricity from Eskom.

For the six largest metros, this represented a financial gain of R7.3bn from 2010-2015. But this unexpected outcome masked important underlying trends in the industry.

Municipalities depended on electricity revenue to support their other activities. Reform without financial compensation was not in their interest.

The six largest metros buy two-thirds of Eskom’s electricity sold to municipalities. While the metros are widely regarded as the strongest of the municipal electricity distributors, even they are not immune to the winds of change overtaking the electricity industry.

Electricity sales in these metros are lower today than they were 10 years ago, even though the metro economies grew by more than 20% in real terms over that time.

Over the same period, prices increased by close to 200% after adjusting for inflation. The price increases have driven sales down and commercial losses up, much of this from the theft of electricity.

While the cost of purchasing electricity from Eskom has increased significantly, the cost of renewable energy has come down. The cost of electricity from new wind and solar projects is now less than Eskom’s average cost of supply and about a third of the cost of electricity from Eskom’s newest power station, Kusile.

These trends show that SA has already entered a new era with respect to electricity demand and supply, with decentralised supply options out-competing the traditional monopoly generation of electricity. This has important implications for the municipal electricity distribution model, as well as for Eskom and national energy policy.

Changing market dynamics require a rethinking of the planning models, generation mandates and the business model for distributors. In the past, consumers were price takers — that is, electricity was supplied and distributed through a monopoly and users of electricity had little choice in their source of supply and the price. Large economies of scale meant it was less costly for electricity to be supplied in this way. This is now no longer the case.

The inversion of relative costs means change is inevitable. Instead of placing hurdles in the way of embedded generation or local procurement of energy, there is a need to embrace an open-ended and more flexible approach to investment decisions and implementation.

A larger contribution of new wind and solar energy at the local level, together with local gas peaking plants, will reduce the overall cost of electricity and be good for both cities and SA as a whole. Government policy needs to change to allow for the decentralised procurement of electricity generation capacity by cities and facilitate rather than inhibit consumer choice.

This also means municipalities will not be able to extract a surplus from the sale of electricity in future. To secure the finances of municipalities, a replacement for this revenue will be needed. The most likely option is a business tax.

How will this change come about? Metros and the Energy Intensive User Group (EIUG) account for 70% of total electricity usage in SA. The EIUG may benefit from peaking challenges (contributed primarily by domestic consumers at the city level) being addressed at the city level so that national energy planning for expansion of generation capacity can concentrate on reliable cost-effective base load power. There is therefore a synergy of interests between the metros and the EIUG in their engagements with national government on the future of the electricity industry in SA.

SA has put off fundamental reform of the electricity distribution industry for 20 years, but change is inevitable. It may be time for the cities and large electricity users themselves to take the initiative to effect that change.

• Eberhard is an economist and public policy professional.