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Can Eskom avoid a utility death spiral?

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Published Aug 5, 2016

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Since 2008, average electricity prices have increased by a massive 160 percent (after adjusting for inflation) and yet there are still no clear answers as to when this enormous growth will end. South African households are under continuing pressure to pay for basics, and businesses are finding their competitiveness being eroded. Eskom is looking to cut its use of private power and has proposed nuclear as the final solution, but it may be making a major business-model mistake.

New builds of huge power stations go against trends in utilities. The rapid decline in renewable pricing is pushing them past the need for government subsidies and “feel-good” imperatives to become a real alternative. Critically, large-scale battery production and new technologies are driving down the price of storage.

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Business model

Committing to a such an investment will lock up scarce funds and close out optionality. It is a decision based on existing technology and an old business model, and does not consider the future energy landscape. Funded with debt, it will probably continue to push up tariffs and this, combined with a decline in renewables and storage costs, will put Eskom into a utility death spiral. Since 2007, solar module costs have decreased 80 percent with the price falling 26 percent every time output doubles (wind-power is also falling fast - 19 percent per doubling).

South Africa’s renewable energy independent power producer procurement programme has experienced the positive cost trend of renewables. The measure used to analyse and compare tariffs with the cost of new power is the levelised cost of electricity (LCOE). Simply, it is the cost of installation, financing and running, divided by the total energy output. We can use it to compare builds and tariff schemes. Last year, the round 4 tariffs dropped 25 percent to as low as 57c per kilowatt-hour (kWh) for wind and an average 79c/kWh for solar. This is compared with LCOE of R1.05 for coal-fired Medupi and Kusile, and R1.75/kWh for Britain’s new Hinkley nuclear plant. Even concentrated solar power, which is priced relatively expensively at R3.94/kWh, came out cheaper than alternative peaking supply from diesel and gas turbines. This is why Deutsche Bank has placed South Africa at grid parity for solar prices.

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Analysts have looked at recent trends and projected future costs based on a learning curve as total capacity increases. If these continue and solar module prices reduce 40 percent over the next five years, renewables will easily beat out growing Eskom tariffs. Generation is only half the story when it comes to renewables: they do not produce a steady flow of power and so are criticised as not being viable for base-load generation. Batteries solve this by allowing renewables to time-shift their power production.

Storage costs have historically been prohibitive. The only viable option in use is pumped hydro, but this is not always feasible. However, the growth in electric vehicles is rapidly advancing battery technology, and new technologies are emerging as other cheap options. For example, lithium-ion costs have been declining rapidly since 2005 and are now below original forecasts for the year 2020. With a 14 percent to 22 percent learning rate, certain estimates see lithium-ion costs declining another 50 percent over the next five years.

Thus, lithium-ion costs in five years could be priced at $220/kWh for use in renewable transmission systems and peaker replacement. This would convert to about R3.50/kWh LCOE. Some forecasts see $100/kWh by 2025, which translates into R1.76/kWh - low enough to take on peaker plants and for effective use in transmission systems in combination with renewables.

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Although this may seem high when one adds solar costs and compares it with coal and nuclear, it actually becomes very attractive to high-end users having to fund Eskom’s growing costs and tariffs.

The change to solar, and then added storage, would be an obvious switch.

Eskom is at risk of losing demand to renewables storage, but municipalities are at even greater risk. Large metros generate about 30 percent of their revenue from electricity sales with profit margins of 15 percent to 20 percent. If high income and business customers begin to defect (or even reduce consumption), municipalities will find themselves needing to charge higher prices for the remaining few who do pay (as there are subsidised and general high debtor customers).

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This creates a vicious cycle of defection known as the utility death spiral.

High-use customers

By our estimates, if Eskom loses 300 000 high-use customers, it will have to increase tariffs 23 percent just to maintain current revenue levels. Placing this on top of general price increases, and then new nuclear build costs, will be disastrous.

There are two ways to overcome this. The first, and more regressive, is changing the revenue model to charge for access to the grid as it is unlikely for customers to go completely off the grid due to cost and flexibility factors.

A better option for Eskom and municipalities will be to redesign the grid and distribution model to focus on the benefits and generating properties of renewables. The government can contribute by pushing renewables through tariff structures, private partnerships, and creating a new job generating industry within South Africa.

In a low-growth environment, there is evidence that South Africa has enough power production in development to avoid the need for nuclear. Furthermore, grid planning is already missing from Eskom’s strategy and, along with other indicative actions, it is improbable that we will see a fleet-footed, innovative approach taken in our local case. Utility companies are typically sclerotic as they are, at the end of the day, a historic regulatory creation to provide power to the masses with a guaranteed income. That guarantee is unravelling though, and even though the timeline for this is unclear, we are not alone in thinking it will be less than 30 years.

Note: Some may point to the desperate need for base-load power to support economic growth and argue that nuclear-powered France and Korea have the world’s cheapest, most reliable supply. As of today, this is a good argument. LCOE prices for nuclear in South Africa have been as estimated cheaper than solar, although one should bear in mind that its high capital costs are severely affected by interest rates.

More importantly though, nuclear will not be ready overnight and a 10-year comparison against declining renewables is the correct one. In fact, the best comparison is Eskom tariffs, for this is the decision consumers and business will face.

* Graham Schwikkard and Aaron Burton are from Datta Burton & Associates, a niche management consulting firm operating out of Australia and South Africa.

* The views expressed here do not necessarily reflect those of Independent Media.

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