Energize Inbox, April 2018



Our winning letter

re: Igniting Eskom Generation: Turning the deadweight into economic fuel, Energize, March 2018

Dear Editor

This article is an important contribution to the debate about Eskom’s future and the institutional reforms required to place the power sector on a financially and environmentally sustainable footing. I would like to make the following comments as constructive criticism in order to further advance the debate on the issues raised.

We agree with the view that Eskom’s existing coal assets have a limited life, should not be treated as holy cows, and should be used in South Africa’s best interest. Given Eskom’s current financial crisis and the low probability that it will be able to trade its way out of it, proposals such as restructuring and assets sales are likely to form a central part of an optimal use strategy for the way forward.

Adjustment Asset value
Author’s calculations (asset value) (R billion) 446
Adjustments
Sales price for Medupi and Kusile @ 77c/kWh -97
Energy volume adjustment to CSIR reference case -92
Tax cost adjustment -29
Capex and financing costs to complete Medupi and Kuslie -85
Environmental retrofilts (non-compliant lowest case) -63
Adjusted net generation asset value 80

It is now widely accepted that bringing forward the decommissioning of older power stations and possibly curtailing Eskom’s capital programme, as mentioned by the authors, is likely to be part of the way out of Eskom’s financial crises. However, asset sale arrangements are not a panacea and are unlikely to raise sufficient proceeds to retire Eskom’s debt.

It will be critical to ensure that power procurement agreements (PPAs) for existing coal fired plant do not lock South Africa into polluting coal power with the concomitant negative climate impacts if cheaper and cleaner options are available. This will most likely require more flexibility (optionality) towards the latter half of the life of the coal PPAs.

Many of the power stations are beholden to a small number of possible coal suppliers, which could drastically limit the level of competition that can be achieved, and therefore the price that might be realised, when taking a single power station to market at a time. Careful market, auction and PPA design will be required to ensure that sales prices are maximised in the public interest. This might well require that bids for more than one station be received when a one station is to be sold.

Modelling assumptions and the value of the proceeds

Sales prices

The authors’ assumptions appear to be too optimistic about the selling price for Medupi and Kusile power which is assumed to achieve 97c/kWh. This is excessive when compared to the author’s estimate of Eskom’s current average generation cost of 55c/kWh and their estimate of the average long-term market price level of 70c/kWh for firm generation (which we believe to be closer to 60c/kWh). Assuming a price much higher than the market price in effect assumes that Eskom will use its market dominance to extract monopoly rents. This is problematic for two reasons:

It would amount to excessive pricing that is an unlawful abuse of dominance in terms of section 8 of the Competition Act. It would also not be realistic as at least some customers (e.g large metros, industrial and commercial consumers) would switch at least a portion of their demand to lower cost options.

Energy volume

The energy sales volumes assumed in the calculations appears to be optimistic. Compared to the CSIR’s least cost reference case produced towards the end of 2017 for the Meridian Economics CoalGen study the author’s calculations assume 25% more energy sales from the coal plant under consideration. This is despite the fact that the CSIR reference case does not retire the Group 0 plant earlier and also assumes a six unit Kusile.

Capex and additional funding (debt) to complete Medupi and Kusile

The completion of Medupi and Kusile’s four units as assumed in the author’s calculations will require additional capital expenditure that will have to be funded. This additional cost should be netted off from the net proceeds in their results. We estimate the remaining capex plus financing cost for Medupi and for Kusile to be in the region of R85-billion.

Retrofits

The calculations appear to exclude the cost of the environmental retrofits required at each station in order to comply with South Africa’s legislated environmental standards. These costs are expected to be substantial. Depending on the retrofit scenario assumed, Eskom has quoted figures of between R63 and R300-billion for these costs. While the new private sector owners can be expected to fund these investments these costs have to be netted of from the gross sales proceeds in the same way the authors have netted off the rehabilitation costs.

Discount rate and cost of tax

We assume that the discount rate used of 8% real is an after-tax figure as is the convention (and is as used in the IRP and the CSIR’s modeling). The authors’ calculation therefore appear to exclude the cost of taxation that the new owners will have to incur. Reflecting this cost will further reduce the net proceeds that can be earned from selling the stations.

Dr. Grove Steyn

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Source: EE plublishers

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