By Hügo Krüger
In South Africa, the consumer price of electricity is not set by Eskom, but rather determined by the National Energy Regulator of South Africa (Nersa) whose intention is presumably “to protect the consumers” against high electricity prices. It is this mandate that deserves scrutiny from the wider public, because it, along with various licensing laws, led to the creation of the incentive structure that allowed for load shedding to have occurred in the first place.
Load shedding, which is a shortage in electricity supply, is from an economist's perspective, not an engineering or technical challenge, but rather a failure of the electricity tariff to accurately reflect the shortage. In fact, one of the most well-established principles in economics is that price controls, set below the market equilibrium price, will inevitably lead to supply shortages.
During a shortage, if prices are not allowed to temporarily increase, they simply cannot revert to a lower level, because absence of sufficient profit margins discourages investment in new generation capacity.
Moreover, if investors encounter obstacles due to burdensome government regulations such as licensing laws, then the cost of remedying the crisis becomes prohibitively high, ultimately harming the consumer with load shedding.
While this theory is economically rigorous, the idea of “letting prices float'' is unfortunately unpopular, which is why few politicians in South Africa, including the Democratic Alliance, would be hesitant to point to Nersa’s ability to set and structure electricity tariffs as a root cause of load shedding. This is understandable from their perspective, because high fuel prices, for example, have sparked social unrest in various countries worldwide, sometimes leading to the downfall of several governments.
However, load shedding could have been ended, years ago, for good, if Eskom’s price was allowed to go higher to reflect the shortage in electricity supply, and if there were no licensing laws that prohibited new competitors from entering the market.
Incidentally, if Eskom were to price electricity too high, then the market would punish it. Customers would simply not use electricity if they cannot afford it, or they will slowly pivot to the various partial off-grid solutions that are being offered by various competitors to Eskom.
This was pointed out when load shedding hit South Africa in 2008, the Free Market Foundation was the only institution to point to Nersa’s regulations, rightfully, as the reason why we have blackouts.
Nersa’s failure to regulate electricity unfortunately does not end here. In fact, it is the view of several analysts that electricity supply in SA is already privatised through the backdoor (irrespective of whether or not the unbundling process gets traction). Nersa with the recent increase in electricity prices has been systematically pricing Eskom out of the market to the extent that Eskom sells less volumes today than in 2008 when rolling blackouts first emerged in South Africa.
The decline in sales can be attributed to Eskom’s customers finding it more convenient to shift to various alternatives such as domestic cooking, rooftop solar installations, diesel generation, or even reducing electricity usage altogether to evade Eskom's influence on the economy. The drop in sales indicates that the electricity price might now be so high that Eskom is pricing itself out of the market. This spectacular failure should raise questions about Nersa's capacity, as a central planner, to accurately determine the appropriate electricity prices. Pricing boards have a long history of failure and Nersa is no exception to it.
This obvious fact that South Africa’s supply and demand is in price disequilibrium seems to escape many commentators on Eskom. It's particularly frustrating to witness it from the free market advocates who argue that Eskom’s tariff was too high, while obfuscating the fact that the regulator has been forcing it to sell at the bare bone with our industrial tariffs being some of the lowest in the world.
Eskom's tariff was kept too low due to government policy and now it is struggling to recapitalise as there are alternatives in the market. This root cause of the problem dates back to the late 1980s when Eskom decided to price electricity close to the marginal cost of generation, aiming to attract heavy industry to set up factories in South Africa. The practice was enforced and largely kept in place even after Nersa came into being through the Electricity regulation Act 4 of 2006.
At that moment Eskom’s ability to set its own tariff was removed and handed over to government bureaucrats and in effect the price of electricity became captive to the political process. The subsequent disasters, including load shedding and the cost overruns at the Medupi and Kusile power stations, can be traced back to this ill conceived policy.
It unfortunately doesn’t end here, because government intervention with price signals often leads to unintended consequences, including the accumulating municipal debt and South Africa’s inefficient electricity usage that is expressed by the fact that South Africa’s economic energy intensity is some of the lowest in the developing world. This is despite the fact that our industrial users often have electricity tariffs that are competitive with large industrial nations such as China or the United States of America. Although the critics might point out Eskom’s lack of cost-reflective pricing due to corruption and inefficiencies, the reality is that South African electricity tariffs were kept too cheap compared to similar economies. Corruption was a wrong justification used by Nersa for keeping electricity prices too low. The artificially low electricity tariff was what Andre de Ruyter referred to when he said that “power is too cheap, so we waste it”.
To add insult to Eskom’s injury, in 2017 it became more affordable to install private solar installations than to draw electricity from Eskom while others such as David Lipschitz suggested that we might have hit “grid” parity with batteries in Cape Town as far back as 2012.
Whatever conclusion is drawn it is clear that Nersa uses a poor formula to determine Eskom’s tariff and that whereas in the past it underpriced electricity, it is now pricing Eskom out of the market. Consequently the municipalities have been left with a shortfall in revenue as more users move to partial off-grid solutions.
Another reason for Nersa’s failure is that the tariff is structured in fixed terms and effectively the bulk users are chased away, because they can afford the long term returns and hedge against Eskom. Because electricity prices in SA do not have a fixed component, the bulk users are effectively offsetting the cost to service the transmission and distribution system and therefore pushing their insurance costs onto the poorer households. Additionally, Eskom’s performance has exaggerated the new “missing money problem” where partial off-grid users are not paying the full service cost to the end users. A quick way to remedy it would be to introduce a time of usage tariff where during periods of low solar or wind activity Eskom can charge diesel prices to its off-grid users.
In any other sphere of the economy, optimal value of a particular product is communicated through the market price mechanism, which signals the supply and demand equilibrium. The market sets the price, because what constitutes an optimal price is subjective, and because the value of electricity changes between day and night, and between winter and summer it is impossible to argue that their production cost is the same all year round. There are thousands of units of electricity that are consumed on a daily basis, and not all kWhs are the same, and nor do they have the same value or quality.
The fairest pricing model, whether capacity, variable, or time-of-usage has to be determined between Eskom and its various customers. The regulator should not get involved. Discretion is required as not all electricity generators or consumers will agree on it. Solar and wind consumers for example would prefer time of usage tariffs, while large dispatchable generators such as coal and nuclear would prefer to sell through the grid with power purchase agreements, and municipalities would like fixed prices so that their cost to service the distribution system is not dependent on electricity usage. There is no objective way to determine what “the best price structure would be”, but it is clear that Nersa’s ability to intervene is going to exaggerate the situation.
Nersa should be stripped of the ability to set and structure prices, because they will inevitably cause load shedding in the future. The regulator at best should only be able to monitor prices, but they should not be able to determine the price or the price structure at all. That should be a matter between customers and suppliers.
Rather, South Africa should move towards pricing electricity in a similar fashion to cellphone contracts, where various users are given various options for their own profile. If we are serious about establishing a competitive market, then we should allow for the price of electricity to be free.
It will help end load shedding for good.
Hügo Krüger, MSc in Civil Nuclear Engineering and Sdumo Hlope, BSc (Physics and Chemistry), MSc in Engineering Management, with input provided by Tisaenergy.
* The views in this column are independent of Business Report and Independent Media.
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