Eskom IPP IRP 2018

Eskom, tariffs, bailouts and IPPs – let’s cut throu…

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 A South African engineer and technician work on the Helio 100 Concentrating Solar Power pilot facility at Mariendahl experimental farm of the University of Stellenbosh, South Africa, 02 September 2015. EPA/NIC BOTHMA  Less

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Almost every South African knows that Eskom is in a dire state and that its parlous financials threaten to drag the country down with it. On a very basic level, there are only two ways out of the immediate problem – much higher than inflation tariff increases or a very large bailout by the taxpayer. What we will get is a combination of both. There is no other way out of this awful situation.

As a vertically integrated monopoly that has operated without any oversight, it appears nobody, including the government shareholder via the Department of Public Enterprises, really understands what has gone wrong or why it has gone wrong. The result has been metastasising cancer in a critical part of the economy upon which each of us living in this country depends.

For some time, the ability of Eskom’s management to raise ever more debt, based on government guarantees, was celebrated as some sort of achievement. Well, the indebtedness at over R440-billion (about R7,700 for every South African) is so high that Eskom’s operational profits are insufficient to service its debt. That is not all. Eskom’s own view is that it needs to raise another R160-billion just to complete existing capital projects.

Because nobody really knows exactly what ails Eskom, it becomes an opportunity for those with an agenda to go out and misrepresent the position. One of the reasons punted by the profoundly corrupt former management of Eskom is that the utility woes are a result of renewable Independent Power Producers (IPPs) with which Eskom has Power Purchase Agreements. Opportunistic political parties and organised labour appear to have lined up behind this claim.

There are many, many contributing factors to where Eskom is now and they include gross mismanagement, corruption, a far too big and expensive staff complement with the wrong skill sets, ill-advised efforts to get rid of people with the relevant skills, very poor coal procurement policies, and many others. They all contribute to where Eskom now finds itself, but the real problem has been Eskom’s new power station builds known as Medupi and Kusile. Had it not been for them, Eskom, with all its other problems, would be in a completely different place.

But what about the claims that renewable IPPs have played a role in the demise of Eskom, that expanding them threatens our electricity system? For now, renewable energy plays such a small part in our electricity system that these claims cannot be taken seriously. But imagine if our renewable programme, under the REIPPPP, had to expand so that it would be equal in scale to Medupi itself. How would that play out?

The table below sets out an approximation of how this would have looked at the outset, both of them, Medupi and REIPPP side by side:

Medupi

REIPPPP

Technology

Super-critical dry coal

Mainly solar PV, onshore wind

Plant Availability

92%

30.50%

Name plate capacity

4,800MWe

14,479MWp1

Annual Output to spec

38.71TWh

38.71TWh

Form of procurement

Six independent units of 800MW each linked by common infrastructure.

Bidding rounds of roughly 1,600MWp each – requiring 9/10 bidding windows.

Private sector component of construction

100%

100%

Method of funding

100% debt

75% debt and 25% equity held by underlying private sector project owners

Establishment Date

2007

2010

Scheduled Completion Date

2014

2025 based on one bidding round every 18 months, the last one being in 2023

Stand-alone Tariff

Uncertain. Medupi commissioned without a final design or funding model, but initial capital expenditure was R69.1 billion raised to R81 billion in 2009. Typically, capital expenditure represents 50-60% of the costs of electricity generated by a coal fired power station over its lifespan.

Depends on outcome of competitive bidding rounds which are disclosed upfront after each bidding rounds.

Medupi, since it is new and part of Eskom, will supply all of the electricity it can produce to the grid. Its daily operational costs ought to be lower than older power stations nearing retirement. Similarly, the projects under REIPPPP sell all the electricity they produce in terms of the standard form PPA they have with Eskom.

Although the actual construction of Medupi and all renewable power plants uses engineering and components procured entirely from the private sector, one significant distinction between them is the 25% equity contribution for renewables. Senior lenders to renewables don’t want to take construction risk. If anything goes wrong, the investors lose their investment first and the lenders remain whole – they can step in and secure their interest income.

Having equity at risk is not a bad thing. It incentivises delivery on budget, on specification and on time. If Medupi had been ringfenced and had some investment (even if a direct government equity injection), losing it would have raised alarms and possibly remedial action before it was too late.

Medupi, as we now know, has turned out to be a catastrophe. Poor project conception, design and dodgy procurement have dogged the construction of the project from the start. The scale of the disaster at Medupi is emerging. Just four generating units are operational, the first unit, unit 6, became commercially operational in August 2015, the second unit, units 5, in April 2017, the third, unit 4, on November 28 and the fourth, unit 3, reached the first synchronisation in April 2018. Against the initial targeted completion date of 2014, completion is now only expected in 2020/1. The total budget to completion is now R145-billion (excluding interest expenses) when all six units are completed in 2021. Thereafter Medupi will undergo an extensive process of repairs to failed equipment on the first four units.

In a detailed analysis showing all assumptions and calculations and adding capitalised interest during construction, Chris Yelland showed in 2016 that Medupi’s cost of generating electricity would be R1,05kWh. With the new projected budget to completion, adjustments, this figure rises to about R1,17/kWh. That’s if everything goes right.

This presents an existential problem for Eskom. The all-in cost of Medupi, including interest during construction, will be well over R200-billion. On current and indeed projected allowable tariffs, Medupi will run at a loss. Nersa, for its part, sets Eskom’s tariff based on a calculation of the value of its asset base. Medupi’s costs to construct is far higher than its economic value. This is why has already Eskom received a R86-billion bailout in 2015 and are the main reason for the bail-outs and massive tariff increases to come.

At present, R113-billion has been spent on Medupi (77% of the projected R145-billion and just 4 units (two-thirds) are in operation. This suggests a tariff of about R1,301/kWh for the units now in operation. However, plant availability (uptime) is not anywhere near the expected 92% and instead stands at just 70%. That brings the tariff for the four operational units to around R1,70/Kwh.

One can safely assume that all the above-mentioned problems are being replicated at Medupi’s twin power station, Kusile.

The REIPPPP programme is not perfect, but it has been very transparent. It works on an open competitive bidding process which means one can see exactly what is going on. Bidders are required to submit their financial models that support their underlying tariff bids. Included within these are the expected equity returns. In addition, the competitive pressures of multiple bidding projects serve to compress the available returns to owners. There is no place for rentier-type profits. Perhaps that explains some of the opposition to the programme from some quarters.

Moreover, since there are multiple underlying projects in each bidding round, if one project fails (none have done so yet), it doesn’t make too much of a difference and can easily be put back into the pot and be made up in a subsequent round.

The first round of bidding in 2010 was unfamiliar territory for everyone. One could call it the R&D round. The result was very expensive tariffs, particularly for solar PV. Nevertheless, the completion of the first round on exactly the rules attracted the interest of more developers from around the world. The second round of bidding in 2013 saw a massive drop in prices bid in and they continued to fall in the third round of bidding. Significantly, every project selected came in on time and on budget – if not better.

Significantly, developers around the world started to pile into South Africa. The rules are adhered to, even when it looks like the pioneers in the early rounds have done much better than expected. Contracts in the form of PPAs have been respected. The result is that participants are prepared to reduce their required return on investment and that adds to the competitive pressure reducing prices even further. In the background, global renewable expansion sees enormous falls in the cost of equipment. Wrights’ Law or the experience curve in renewables see electricity from solar power dropping by 25-30% for every doubling in scale and wind power dropping by 15-20% for every such doubling. It is the fortuitous dramatic falls in equipment prices during the build phase of these projects that have given their equity holders significantly better results than their financial models predicted. Better resourced (sun and wind) than modelled provided an additional kicker for them.

Like so much else, the unchecked corruption and mismanagement of Eskom impacted on further progress in the REIPPP programme. The fourth round of bidding was concluded in 2015 but it took a change of president to finally get these projects signed off. The almost three-year delay resulted in the lost potential of almost two additional bidding rounds. The real damage was to the hard-won international reputation of South Africa’s renewable energy profile. The potential to localise more manufacturing in South Africa has suffered a huge setback. Serious developers, having set up shop, have decided to focus their energies in other countries, leaving watching briefs in South Africa.

But let’s look at the actual performance of the REIPPPP projects in solar PV and onshore wind so far (other renewable technologies are a very small part of it). The solar PV tariff in round 1 at R2,67/kWh is, with hindsight, extremely expensive but the fall in prices is equally impressive. In the last bidding round, round 4, solar PV had fallen to just 79c/KWh. Onshore wind shows a relentless downward trend in price, starting at R1,14 in round 1 to 66c/KWh just five years later.

Now, the renewable projects don’t have any impact on Eskom’s financial performance. Their tariffs are a pass-through and added on top of the tariff secured by Eskom in its own right. But what is renewable energy costing South Africans? More interestingly, what is the likely answer to the question posed at the beginning of this article? If REIPPPP continued so that renewables produced the same energy as Medupi’s specs, how much would we pay then?

The table below sets out where we are. After round 4, renewable energy amounting to 5,647MWp is costing us exactly R1/kWh.

Now, assuming another 8,832MWp were to be split equally between solar PV and onshore wind we would need an idea of the price of these technologies. UCT’s Energy Research Centre projects that by 2030, solar PV will be as low as 38c/kWh and wind at 58c/kWh. A reasonable assumption is that the average tariff for each technology is the average of the Round 4 tariffs bid in 2015 and the projected 2030 cost. It gives us a solar PV tariff of 58.5c/kWh and onshore wind a tariff of 58c/kWh. The all-in result is a tariff of 79c/kWh.

Tariff

R/kWh

kWp Allocation

Cumulative Tariff

R/kWh

Round 1

Solar PV 625MWp

2.67

625

2.67

Onshore Wind 649MWp

1.14

649

1.14

Round 2

Solar PV 417MWp

1.65

417

2.26

Onshore Wind 559MWp

0.9

559

1.03

Round 3

Solar PV 435MWp

0.99

435

1.89

Onshore Wind 787MWp

0.74

787

0.81

Round 4

Solar PV 813MWp

0.79

813

1.50

Onshore Wind 1,362MWp

0.62

1362

0.66

Total Cumulative Round 1-4 Solar PV and Onshore Wind

1.00

Projected Rounds 5-9

PV

0.585

4416

0.90

Wind

0.58

4416

0.67

Total Cumulative All In

0.78

Needless to say, the result will provoke a whole new debate about comparative system costs and the issue of variable loads, the need for filler capacity, storage batteries and demand response mechanisms. The outcome of those debates might result in an adjustment of the renewable energy tariffs upwards, even substantially so. It doesn’t really matter any more. Adding renewable energy is so much cheaper than anything else and it’s going to get a lot cheaper.

It is hard to accept the claim that renewables are part of the problem when any rational analysis shows that they are part of the solution. DM

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