The critical role of energy revealed in the medium term budget
The developments again raise the question of the wisdom of mega-energy projects built on the government’s balance sheet with only goodwill on the part of the national utility as the doorkeeper against near-bottomless cost overruns and delays. The Eskom Medupi power station is now more than three years late and will ultimately be between ZAR 50 billion and ZAR 100 billion over budget. There is the direct cost of the over-run, the interest during construction running at something like ZAR 30 million per day, the economic opportunity cost of not having sufficient energy to support the national development plan, plus the cost of either load shedding or running the Open Cycle Gas Turbines to keep the lights on. In the past financial year, the latter cost ZAR 11 billion. When finally it is fully commissioned, the cost over-run at Medupi will have an inflationary effect on the economy for decades beyond as the electricity consumer pays more in order to recoup the cost. Whatever it ultimately costs, the country will have to pay.
To contextualise, consider the following data:
- While keeping distinct sets of financial accounts in mind, the cost over-runs at Medupi will nevertheless equal the entire proceeds of the tax increase for between 3 and 6 years;
- The annual saving the treasury intends to effect in the government’s use of outside consultants (about ZAR 370 million per annum) reflects less than 15 days of interest during construction at Medupi (more than three years late now);
- The diesel consumed in the open cycle gas turbines, running as hard as they do because of the delays at Medupi, annually equals two thirds of the likely tax increase.
It is clear that one mega-project gone awry can have dramatic impacts on the economy. Everything is on the balance sheet of “SA Inc”, and we pay for building the asset as we go, then for the energy it produces. If Eskom were to build smaller projects with shorter construction times and lower capex, far less could go wrong and an occasional hiccup would likely be offset by other successes. Renewable energy projects like their prospective wind farm at Sere would be an example of such an approach.
Risk can be lowered further. Consider the situation where an independent power producer (“IPP”) builds a power plant, as has been happening with great success under the Renewable Energy Independent Power Producer Procurement Programme (“REIPPPP”). Eskom pays only for the electricity, at an agreed price with an agreed escalation, for a twenty year period. Any cost over-runs are for the account of the IPP. Delays can cause the government to cancel the agreement. The money, both debt and equity, is sourced entirely from the private sector, including from abroad, boosting Foreign Direct Investment. The amount it would have cost had it been built like Medupi stays available for investment into other priorities: healthcare, infrastructure or something else. The only impact for the government is that it under-writes the Power Purchase Agreement that Eskom signs as the buyer. As the contract winds down, the potential liability drops. Risk is circumscribed and determinable at any point.
The advantages are self-evident and can be further enhanced by promoting bilateral power purchase agreements directly between producers and large consumers. This would remove or significantly decrease the need for an under-writing of the Power Purchase Agreement and free up the national balance sheet.
In summary, the world has become a far more dynamic and volatile place than ever before. This in and of itself should be sufficient to suggest an energy sector that is built out with maximum flexibility, not locking the country into any big decisions that may soon show themselves to have been erroneous. Technology and geo-political realities are changing faster than ever before. Imagine ordering today’s state of the art mobile phone and being told it would be delivered in ten to twelve years. The sense that intervening, technological innovation would render it entirely redundant at delivery would be strong, yet this is what a mega-energy project essentially does. The dramatic and irreversible impact of these mega- projects on the economy and the tax payer clearly provides an even more pressing reason to build a multitude of small energy plants. Renewable energy is well placed to do this, and wind power is the most mature and cheapest of those that are available in bulk in the country.
The wind industry seems highly likely to reach the target size of 8,400 MW installed well before the target date of 2030, and then grow well beyond that into a truly significant contributor to the national energy mix.