Independent power producers are a solution to Eskom’s woes, not a cause

Is it true that independent power producers (IPPs) are “draining and collapsing” Eskom, as Cosatu claimed last week during its strike over a proposed restructuring of Eskom?

Let us consider the facts. Eskom buys the IPPs’ electricity at prices that are agreed to in the rounds of auctions that award IPP projects. So if you know nothing more, it seems as if Eskom is having to pay IPPs at prices that are out of its control out of its own resources.

But the reality is far different. First, IPPs are treated separately when Eskom’s tariff applications are considered by the National Energy Regulator of SA (Nersa). All payments to IPPs get a full pass-through cost into the tariff. So if there were no IPPs, Eskom simply wouldn’t get that element of the tariff. For Eskom’s cash flows, IPPs are therefore entirely neutral the cost to the utility is perfectly offset by the tariff.

There is one small cost to Eskom: the infrastructure cost it bears to connect IPPs to its grid. IPPs pay to get the energy to the connection point, but Eskom then hooks them up. This cost is a good reason we should have an independent grid company, so that connection costs can be managed equally across Eskom and the IPPs. Whether IPP or Eskom plant is being connected shouldn’t make a difference.

Second, the marginal cost of IPP production is far below Eskom’s. The cost of new Eskom builds Medupi and Kusile has been a matter of contention. In 2016 electricity from Medupi and Kusile were estimated by the Council for Scientific Industrial Research (CSIR) to cost R1.05/kWh and R1.16/kWh respectively. But that was before further delays and the revelations of serious design problems at both stations. When the ash settles, the cost of power will be significantly more, perhaps two to three times the 2016 estimates.

In comparison, in the fourth round of the IPP auctions concluded in April 2015, bidders averaged R0.92/kWh. So even an optimistic reading of Medupi and Kusile’s electricity cost is higher than the more recent IPP prices. This fact is often muddied in the debate by reference to the earlier IPP round prices, particularly round one. These averaged R2.79/kWh. That was high because the renewable energy programme was new and the risks were poorly understood, also because solar panels and wind turbines cost much more. That price should be seen as an investment that kicked off a pricing race that reduced renewable costs below that of Eskom’s power. Consider also that there are no cost risks prices are fixed (subject to inflation adjustments) for a full 20 years. So delays or design failures don’t mean any extra costs to Eskom.

Of course, the prices ignore the indirect environmental costs of Eskom’s coal-based production. According to Eskom’s own estimates in a parliamentary submission in 2018, emissions from 13 of its coal-powered stations cause 333 premature deaths per year, with a health cost of R17.6bn.

Independent experts have put the number of deaths at more than 2,200 per year. If Eskom were to get its existing fleet to comply with current minimum emission standards, it would have to spend R187bn. The Centre for Environmental Rights has estimated that Eskom exceeded emissions standards 3,200 times over a 21-month period, each of which is a criminal offence. The IPPs have zero emissions.

But one doesn’t even need to factor in these indirect costs to see that IPPs benefit Eskom’s financial position. With the marginal cost of IPP production below the marginal cost of Eskom’s own production (not even considering the huge cost of running its diesel-burning peaking plants), every additional kWh that Eskom buys from IPPs is more profitable to sell than its own production.

So Cosatu’s claim that IPP’s are “draining” Eskom is doubly wrong not only are the costs of IPPs explicitly covered by the tariff, but Eskom earns bigger margins on new IPP generation than its own new fleet. IPPs are a solution to Eskom’s financial distress, not a cause of it.

The future looks even more profitable. The auctions system was pioneered by SA, and some held elsewhere in the world show prices can fall further.

In December 2017, Mexico ran an auction that was won at 2.1 US cents per kWh, currently equivalent to 29.6c/kWh. That’s at least a quarter, and probably far less, of the cost of Medupi and Kusile. When SA runs its next IPP auctions, the pressure will be on for projects to come close to that level of pricing.

The IPP programme has 112 approved projects, of which 62 have been connected to the grid so far. Those are producing electricity equivalent to 66% of Medupi’s design capacity.

The National Union of Metalworkers of SA’s head Irvin Jim says Eskom must be allowed to produce renewable energy. Well, it can. When the next IPP auction rounds happen, let an unbundled generation arm of Eskom bid for the projects.

If it is able to bid at competitive prices, there is no reason why Eskom can’t be a renewables producer.