De Ruyter on business, regulatory and operational issues facing Eskom

CEO discusses Nersa and the electricity price, Medupi and Kusile, and municipal and Soweto arrear debt.
André de Ruyter says one problem in dealing with arrear debt is that SA has 'spheres’ rather than 'tiers’ of government'; the responsible department simply doesn’t have the authority to instruct municipalities to pay. Image: Moneyweb

This is the fourth article from the interview by Chris Yelland with Eskom’s André de Ruyter on April 15, 2020. It covers various business, regulatory, pricing and operational issues facing the power utility, and the views, solutions and way forward envisaged by the new CEO for the embattled utility.

Read the first three articles:
Eskom CEO on the need to restructure
Eskom CEO on debt and monetary issues
Eskom CEO on climate change and the just energy transition

On lessons learned as a former Eskom customer

In the past the companies you served were key customers of Eskom, and you are now sitting on the other side of the table from them. What lessons do you think Eskom has to be alive to – particularly in a post-Covid-19 world? What has to change at Eskom?

As a customer, I learnt that there are significant gains to be had from energy efficiency as a key cost-saving driver for industry generally. If I look at what Andrew Liveris did at Dow Chemicals about 10 years ago, he said: let’s reduce energy consumption at Dow by 25%, and in the following year he achieved this. He then said: let’s take out another 25%, which he also duly did. So that’s one example.

Another example is my experience in Germany, where, as you probably know, the price of electricity is among the highest in the world. But at the same time, Germany is the second biggest exporter of manufactured goods. So, clearly, the notion that low-cost electricity is the key enabler to industrial success is something that we need to challenge.

It is true that South Africa does not have the fiscal space, and Eskom doesn’t have the cost base, to enable it to deliver electricity as a competitive advantage.

But having said this, I think we need to recognise that our industrial customers are primarily on the Megaflex tariff, which includes a cross-subsidy from these industrial customers to other customers to a tune of about R9 billion per annum.

I would argue that a better way of addressing the need for some cross-subsidy to lower-income residential customers is a straight transfer from the fiscus, rather than cross-subsidisation via the tariffs.

There is also an environmental levy amounting to about R8 billion which is borne by industrial customers.

In discussions with our key industrial customers, they have indicated that removal of these cross-subsidies would make them significantly more cost competitive. If you do the maths, the removal of these two subsidies could see a 6% to 11% reduction in electricity costs to industrial customers depending on their load profile, which is a really significant cost saving.

So, if we want to enable manufacturing and industry in South Africa, then one also has to look at the tariff structure itself.

On Nersa and the price of electricity

Electricity customers across the board say Eskom’s electricity prices are too high, while Eskom says they are too low and must rise by 30% to be cost reflective. In the meantime, it appears that Eskom’s relationship with the regulator, Nersa, has broken down. What is to be done?

That is the R450 billion question right there, Chris. It is a difficult question, and we understand no one likes an increase in the price of what is essentially a grudge purchase, namely electricity.

We cannot and will not rely on electricity tariff increases to bail us out. We are not asking customers to cross-subsidise our inefficiencies. We are saying: give us electricity tariffs that are reflective of normal, appropriate, benchmarked costs. This is what we have proposed to Nersa.

Unfortunately, when we disagree with Nersa’s determinations, the recourse that we have under current legislation is for us to take the decisions on review in the courts. This is not where we as a utility want to be, nor is it something we particularly relish. But it is something that we are required do to resolve our differences.

If you look at the recently-gazetted integrated resource plan for electricity (IRP 2019), it indicates the average price of electricity should be about R1.33 per kilowatt-hour (kWh), while our current average tariff average is at R1.02 per kWh.

This difference means we are sitting with a revenue shortfall of about R67 billion a year. This is not a figure that Eskom has dreamed up itself – it is number based on the cabinet-approved IRP.

However, we don’t think that Nersa’s multi-year price determination (MYPD) methodology is being adhered to currently, where the regulator is providing a return on assets that is close to zero. Of course, we do need to get our cost base under control, and I have previously alluded to some of the areas where I believe we can do better.

One of the major cost elements in our income statement is the interest bill of R28 billion to R30 billion per annum. So, a reduction and refinancing of Eskom debt, including the potential of green financing, becomes very important, as this could significantly increase the viability of Eskom as a going concern, and arrest the so-called utility death spiral.

So, in terms of the MYPD methodology, it is our contention that Nersa must ensure Eskom’s sustainability as a business by ensuring adequate returns and incentives for new investment while limiting excessive returns.

World electricity cost benchmarking indicates that our electricity prices are still quite low. I think we, as a country, therefore need a mindset change in respect of affordable electricity tariffs, and we need a dramatically different approach to electricity pricing.

On Medupi and Kusile

Some 12 years after starting construction, Medupi and Kusile are still not completed, and those units that are in commercial service are not performing properly. In the meantime, cost overruns have brought Eskom to its knees. What still has to be done to complete these projects and sort out the poor performance?

At Medupi, we have achieved commercial operation on Units 6, 5, 4, 3 and 2, with Unit 1 undergoing commissioning but already providing up to 600 megawatts (MW) into the grid. We are also seeing steady increases in the energy availability factors of the units at Medupi.

But we do have to address a number of problems arising at Medupi – [the] milling plant and its reliability, and boiler exhaust air temperature into the downstream pulse-jet fabric filter plant for particulate emissions. So there is a significant amount of rectification work that still has to take place in order to get Medupi to the point where it can perform as advertised.

The same mill plant performance and exhaust air temperature issues as above apply to Kusile. There are also challenges with the gas air heater, the induced draft (ID) fans, and blocked bags in the pulsed-jet fabric filters that have caused delays at Kusile.

As you know, we also have had issues with some of our contractors and their financial stability, which have exacerbated some of the delays at both Medupi and Kusile. So, we are dealing with each of these issues as they occur.

Looking at the project timelines, we expect the last unit at Medupi (Unit 1) will achieve commercial operation by December 2020. At Kusile we expect to get Unit 2 to commercial operation by July this year, Unit 3 by September this year, Unit 4 by June 2022, Unit 5 by June 2023 and Unit 6 by December 2023.

Looking back at these projects as they were initially conceptualised, I think it is fair to say that we didn’t do adequate up-front design on the projects, and our project execution methodology – with Eskom acting as the single point of control over the multiplicity of different sub-contracts – was in all probability flawed. There were a large number of interfaces that were difficult for us to manage, and the schedule was, in my view, incredibly aggressive, which caused us to compromise on some of the design optimisation and improvements.

Even as we are in the process of commissioning a number of units, we are now having to fix some of those initial design decisions that were made under a lot of pressure at the time, and that puts us in a very challenging situation.

On municipal and Soweto arrear debt …

Recent revelations within parliament’s standing committee on public accounts (Scopa) indicate a total disarray in government efforts to make any progress in addressing Eskom’s municipal arrear debt. What is the current level of this debt, and what will be the impact of the Covid-19 lockdown and economic slowdown?

Total municipal arrear debt (excluding Soweto) is now sitting at about R28.3 billion, with Soweto arrear debt at about R19.6 billion. These are very large numbers, and we need to take firm steps to arrest the ever-increasing arrear debt.

We have shown in our engagements with Emfuleni (Vaal Triangle) municipality – where we obtained an order of court to attach some of their assets and are in the process of reaching a payment agreement that will be converted into a further court order – that we are willing to take a strong line on overdue debt to ensure that electricity delivered is paid for.

The challenge at a constitutional level is that we are not dealing with different ‘tiers of government’, but rather with different ‘spheres of government’. While this may sound like semantics, what it means is that the Department of Cooperative Governance and Traditional Affairs (Cogta) simply does not have the authority to instruct municipalities to pay, which would have been possible if you had a ‘tiered’ system of government.

We have received good political support from the president, the finance minister, and government officials.

After the president and finance minister’s statements that Soweto residents must pay up, we saw an uptick of payment rates in Soweto from 12% to about 25%.

So there has been support. But the way our country is organised from a constitutional perspective is such that central government cannot simply instruct municipalities to do their bidding. That is the reality we have to face and navigate our way around.

So this is an ongoing challenge, and there are obviously a number of complex associated political, economic, and social issues arising. But we are dealing with this in a firm, business-like manner, and we are trying to protect our rights and revenue to the extent that we can.

Chris Yelland is managing director at EE Business Intelligence

© Copyright 2020 – EE Business Intelligence (Pty) Ltd.

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I think we are kicking the can down the road. The time has come for decisive action. The ANC have demonstrated beyond reasonable doubt that their involvement in SOEs and parastatal enterprises is a guarantee of grandiose wealth destruction, poor service delivery and impoverishment of those dependent on the services. Employees of such organisations have grown fat on the largess of state plunder but will ultimately be cast asunder when the regime is bankrupt- coming to a place near you soon. This chill winds of change are blowing hard in the direction of SAA. A lot of livelihoods on the line courtesy of a fatally flawed business model.

Germany is in the business of manufacturing high value hi tech goods. The electrical energy input as a fraction of the total selling price is small. Germans are also smart and highly educated unlike the average South African. Even their BD teams have PHDs.

De Ryuter talks of tariffs, levies and cross subsidisation. This is not he language of the free market. If SA inc. is to re industrialise, then we need free markets and low taxes. This includes eliminating carbon taxes, race based employment discrimination and government mismanagement/ interference in the free market. Political interference includes not taking action against those thieves who steal electricity and/or simply don’t pay. Kid yourself not: this is a political ploy as mass prosecution of the thieves will lose the ANC votes.

Nersa is also an anachronism that has no place in the land of the free. A lot of people spent a lot of time arguing as to what constitutes a “fair price”. The conclusion was that a fair price is that agreed upon by a willing buyer and a willing seller. (In a similar vein there cannot be a fair tax). Thus setting the price of electricity by Nersa is fatally flawed. The model under which Nersa operates is fundamentally unsound and flawed. Setting prices is the language of the Soviet Union. It is no wonder that there are electricity shortages just like in the USSR.

The only solution is to privatise this sorry mess. There is a ray of hope. In general it is the production of electricity not the distribution thereof that is falling short. Eskom must be broken up into 1. private electricity generation companies (sell of each power station), 2. the grid company and 3. sales companies. Number 1 and 3 will have numerous competitors. Thus any residential consumer can purchase their electricity from a number of sales companies and no longer have to deal with corrupt municipalities. The grid company can purchase electricity from a number of producers, all of which will now be IPPs of a sort. If renewable electricity (CSP, PV, Wind) is so cheap and readily available then coal will be ousted. Bring it on I say. The grid will be run as a regulated monopoly.

If good folk want to go off grid and make their own electricity storing it in batteries, then more power to them. If companies want to produce power then let them. If the grid company wants to buy excess energy according to an arms length commercial transaction, then why not?

The CSIR has a document detailing the path forward for electricity supply in South Africa. This model is also intrinsically defective for two reasons. The first is the premise on which it is based and that is decarbonisation, not sustainable, accessible and affordable electricity. The second is that it is not based on market principles. It is just another decree from above, not based of millions of people making market choices.

This is the first in this series I have read. Congrats to Moneyweb, Chris Yelland and de Ruyter. A pleasure to read questions and answers by 2 professionals who know their business.

If this approach to journalism gathers momentum and becomes the new-normal it is to be welcomed.

Overstaffing and over-inflated remuneration lies at the heart of the problem. Side stepping this issue or shrugging it off wont make Escom healthy, whatever fancy explanations are used.

Thank you for the interesting article, Chris, its states in the article: “If you look at the recently-gazetted integrated resource plan for electricity (IRP 2019), it indicates the average price of electricity should be about R1.33 per kilowatt-hour (kWh), while our current average tariff average is at R1.02 per kWh.”

Well we can confirm that Knysna Municipality charges already as follows:

> R1.28/Kwh & R1.84/Kwh if usage exceeds 350kwh
> plus a basic fee of R215.38 per household

Proof can be provided

Said it before and will say it again, as you reduce your usage they find mew and innovative ways to screw the consumers with levies.

While earnings for Municipalities and Eskom go up for no Zero improvement on service delivery.

Remove levies that add no value and consumers can invest in reducing our usage.

End of comments.

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