It’s not just us – the cost of (electric) power

South Africans have been lamenting the state of our power infrastructure and Eskom’s inability to keep infrastructure up with demand.  Now there’s plenty of useful debate left there (so many of the points I hear made are irrelevant and serve to distract everyone from the real issues.

Past sins

For example, why are so few people pointing to the previous Eskom tariff increases – the requested increases haven’t been granted in recent history (my quick search confirms this for several years, but my search wasn’t exhaustive). In general, the increaes have been below CPI, CPIX, PPI and, recently anyway, the actual cost of generating electricty given operating costs and the rising costs of the fossil fuels required.

The problems revolve around three factors:

  1. The tariff increases granted have been officially based on a regulator-approved return for Eskom.
  2. Eskom has been reducing its debt as a direct result of the reduced capital investment. The increased cash generation has been used to reduce debt levels. How this reduction in debt has been figured into the required return for Eskom (allowing for the reduced gearing usually implying a lower required return), or their operating costs (interest payments included in required return calculations or not) is not clear.
  3. Presumably the required return calculations made some allowance for either depreciation or future capital replacement costs (let alone the capital required for future capital required for new infrastructure investments, because there is a strong argument that in a truly market-based economy future projects should be met with future revenues – this is not the only option). Given the apparent lack of apreciation for replacement, renewal and reinvestment costs it seems possible that all these careful calculations of the required return are, quite simply, wrong.

The problems in demand do not come from a sudden and completely unexpected increase in economic growth. Until as recently as last year, there was no discussion of the impact that increased economic activity was having on the demand for electricity, and Eksom was granted a particularly low increase (although my reference for this and the exact number temporarily evade me). Lack of appreciation of the underlying economics, a flawed calculation of the required return and the actual return generated allowing for non-cash items have come back to haunt us.

Other sources of enlightenment

Slashdot has a post “California Utilities to Control Thermostats?” covering a NY Times article on teh same topic. Interesting to read the comments and links to a variety of similar problems and a range of possible solutions. These solutions include WW2 technology used to operate air raid alert sirens and sensors that operate automatically on a decrease in the frequency indicated by strains in load.

The increased interest in nuclear power generation (and perhaps, more importantly, a decreased reluctance to go down the nuclear path) is also clear. A word of caution though: the readers and contributors to slashdot are not necessarily representative of the US population as a whole!

Tragedy of the Commons

What I found encouraging is how many people stated that prices should be increased – as much as nobody likes to pay more for something, the economic reality that Somebody does need to pay for something that has a cost seems more firmly entrenched in that society than our own. Makes me remember the age-old (well, since 1833 anyway and revisited thoroughly truth of the Tragedy of the Commons where finite resources shared by several with inappropriate incentives to moderate consumption are destined to overexploitation.

Financial and risk implications for Eskom and taxpayers

Engineering News has a story: S&P’s may cut Eskom’s ratings outling how Eskom’s planned capital investment, financed mostly with debt (rather than an equity injection from the state) and through long overdue, and lower than required tariff increases, has reduced their capital strength and likelihood of needing a fresh injection of capital in future. The credit rating of a parastal like Eskom is always interesting, since as South African citizens and residents it is difficult to contemplate Eskom defaulting on its obligations to foreign investors without indicating a financial meltdown of the country’s finances as a whole. However, regardless of the quality of Treasury’s implicit guarantee of Eskom’s debt, the “credit watch negative” has clear implications for the future finances and tariff increases in future.

The rolling blackouts will continue. Under the name of load-shedding or less spin-friendly terms.

Published by David Kirk

The opinions expressed on this site are those of the author and other commenters and are not necessarily those of his employer or any other organisation. David Kirk runs Milliman’s actuarial consulting practice in Africa. He is an actuary and is the creator of New Business Margin on Revenue. He specialises in risk and capital management, regulatory change and insurance strategy . He also has extensive experience in embedded value reporting, insurance-related IFRS and share option valuation.

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