Rejuvenating South Africa's economy - The role of the energy sector

INCLUSIVE SOCIETY INSTITUTE

Rejuvenating South Africa’s Economy – The Role of the Energy Sector March 2022

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DISCLAIMER Views expressed in this report do not necessarily represent the views of the Inclusive Society Institute or those of their respective Board or Council members. All records and findings included in this report, originate from a panel discussion on developing a new economic blueprint for South Africa, which took place in February 2022

Author: Mariaan Webb, Creamer Media Writer Edited by: Daryl Swanepoel

Contents Abbreviations & acronyms...........................................................4 Introduction...................................................................................5 Identifying weaknesses...............................................................7 • Bureaucratic impediments ........................................................................................7 • Central planning shortcomings.................................................................................7 • Education, training and skills development............................................................7 • Energy pricing and regulation....................................................................................7 • Infrastructure backlog ...............................................................................................8 • Restricted local opportunities...................................................................................8 • Stagnant refining sector............................................................................................9 • Sustainability of IPP model........................................................................................9 • Uncertainty about end-state of energy..................................................................10

Suggestions for fostering growth .......................................... 11 Conclusion.................................................................................. 13 References.................................................................................. 14

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Abbreviations & acronyms

CSIR........................................................................Council for Scientific and Industrial Research IPP.........................................................................................................independent power producer ISI............................................................................................................. Inclusive Society Institute Nersa............................................................................ National Energy Regulator of South Africa REIPPPP..............Renewable Energy Independent Power Producer Procurement Programme

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Introduction South Africa’s well-documented electricity crisis is a binding constraint on economic growth and solving power supply challenges is one of the key interventions needed for faster, more sustainable and inclusive economic growth.

Ageing power stations and underinvestment in maintenance, compounded by years of corruption and maladministration at State-owned power utility Eskom, have weakened the electricity system, resulting in debilitating load-shedding that has become the default in managing grid stability when demand exceeds supply. Plant availability, as evidenced by the energy availability factor has fallen to 62%, against a target of 70% (Eskom, 2022). At the same time, electricity prices have increased by 175% over the past decade, which, combined with unreliable supply, has constrained economic growth as customers lower their demand and adopt alternative sources of power (Nersa, 2021).

The Council for Scientific and Industrial Research (CSIR) has published data that show 2020 and 2021 were the worst years on record for load-shedding. According to a 2020 report by the CSIR, load-shedding is estimated to have cost the economy between R60-billion and R120-billion in 2019, when the country experienced 530 hours of outages, amounting to 1 353 GWh. The total economic impact of load-shedding over the past ten years could be as high as R338-billion (Wright & Calitz, 2020).

Government acknowledges that power constraints must be addressed, with several policy interventions and new energy generation projects set to come on line over the next few years to close a capacity shortfall that is estimated to be between 4 000 MW and 6 000 MW.

New energy generation projects to come on line: • M ore than 500 MW from the remaining projects in Bid Window 4 of the Renewable Energy Independent Power Producer Procurement Programme (REIPPPP), which are, for the most part, complete.

• 2 600 MW from Bid Window 5 of the REIPPPP, for which the preferred bidders were announced in 2021.

• U p to 800 MW from the Risk Mitigation Independent Power Producer Procurement Programme projects that are ready to proceed.

• 2 600 MW from the soon-to-be-opened Bid Window 6 of the REIPPPP. • 3 000 MW of gas power and 500 MW of battery storage, for which requests for proposals will be released in 2022.

• A n estimated 4 000 MW from embedded generation projects in the mining sector.

• A bout 1 400 MW currently in the process of being secured by various municipalities.

Source: Ramaphosa, 2022

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Introduction Business Leadership South Africa has called for the accelerated procurement of additional electricity from independent power producers (IPPs), potentially doing away with ‘bid windows’ in favour of procuring “on an ongoing basis as the situation demands” (BLSA, 2021).

While stakeholders agree that there are no simple solutions to South Africa’s energy crisis, there is a need to identify creative, short-term measures to help better manage and stabilise the situation, while simultaneously advancing South Africa’s low-carbon, clean energy transition. South Africa has secured an initial offer of $8.50-billion (about R131-billion) to fund a just-transition to a low-carbon economy by investing in renewable energy, green hydrogen and electric vehicles (European Union, 2021).

Stabilising electricity supply will help improve business confidence, improving sentiment towards South Africa and making it more attractive to foreign and domestic investors.

The Inclusive Society Institute (ISI) met with energy experts in February 2022 to gather sectoral insight for a broader research project that will culminate in a new blueprint for economic growth and development. This report is a summary of discussions with industry participants, whose expertise pertain mostly the electricity sector, as opposed to the energy sector.

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Identifying weaknesses Bureaucratic impediments Bureaucracy and overregulation are considered as structural impediments that make it difficult for South Africa to achieve meaningful economic growth. Officials are sometimes fixated on compliance requirements, instead of seeing the ‘bigger picture’. More rules and regulations are therefore not seen as the answer to subvert fraud and corruption, instead inhibiting delivery. Concern about the level of compliance necessary in undertaking the procurement involved in systemic power system maintenance has recently been expressed by top management of Eskom.

Central planning shortcomings The energy sector lacks a centralised, coordinated approach to synergies in the value chain.

For example, a lack of coordination in the energy value chain, made worse by security weaknesses, led to a situation where the Richards Bay Coal Terminal’s export volumes in 2021 dropped to the lowest level since 1996. That, at a time when global coal prices were at record levels, resulting in a missed opportunity for the country.

Education, training and skills development The quality of South Africa’s education and training system has been highlighted as an area of concern. The basic education system is considered flawed, with poorly performing teachers, poor work ethic, a lack of community and parental support, and poor control by education authorities, all exacerbated by low levels of accountability. The result is learners that lack discipline, high levels of absenteeism and poor performance in essential areas of mathematics and literacy (Mouton et al, 2012). As the basic education system informs the tertiary sector, its shortcomings are widely felt.

While there is an opportunity to draw South Africa’s unemployed youth into the energy sector, there is a risk that the country may not be able to fully transition into a new technological model and sophisticated value chains, if it does not have the requisite domestic capabilities.

There is a view that South Africa is not imparting its youth with the correct skills for the transitioning energy sector.

Energy pricing and regulation The entire regulatory regime needs to be rethought to consider the purpose it serves, the value that it adds and the capabilities it unleashes. The point was made that the National Energy Regulator of South Africa (Nersa), which sets and approves tariffs, must review its

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Identifying weaknesses policies. Nersa’s determinations and tariff approvals could potentially have major implications for the fiscus and mispricing has been a major cause of Eskom’s unsustainable debt problem. Nersa released a consultation paper in September 2021 to develop a new price determination methodology, arguing that the revenue-based methodology has fallen short in providing stable prices.

Infrastructure backlog There is a significant backlog in infrastructure investment, which is vital to economic recovery and growth (World Bank, 2022). The deficit cuts across many different sectors, including energy, water and sanitation, transport, digital infrastructure and housing, among others. The National Development Plan envisions the ratio of gross fixed-capital formation to gross domestic product to be between 25% and 30%. Currently, the ratio is estimated at 14% to 16%.

While the deficit can be attributed to a shortage of funding, participants have noted that the issues run deeper. It is argued that, often funding, in a variety of forms, is available, but projects are not well planned, implemented or completed.

“. . . often funding . . . is available, but projects are not well planned, implemented or completed”

Tenders are another area of concern, mirroring an issue that was raised by the construction sector during a previous ISI workshop. It is argued that the time that it takes to award a tender is too long and that the ratio of tenders that are awarded is too low. The tender process

has been described as onerous and complicated, while political influence also plays a role. There is also a lack of people with the required skills and competency, especially at municipal level, to handle tenders effectively and to manage infrastructure throughout its life cycle. At municipal level, many people with valuable skills and experience are either leaving municipalities or are not in the right positions to make critical decisions that are needed for economic development.

Restricted local opportunities South Africa does not focus enough on creating local opportunities and developing local supply chains. Too much work is outsourced to foreign contractors or companies, instead of using local expertise or accumulating the required skills and expertise. Eskom’s flagship Battery Energy Storage Systems project, which involves the development of a 360 MW storage system at a substation in Vredendal, in the Western Cape, has been cited as an example of a missed opportunity to develop the local supply chain. According to a participant in the ISI discussion, project criteria, in many instances, were not conducive to South African companies taking part.

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Identifying weaknesses Competitiveness is a serious constraint to local manufacturing, with the country struggling to compete, for instance, with the cost of solar panel manufacturing in China, or other Asian manufacturing hubs. Powering up a competitive manufacturing landscape in which products that are used not only domestically, but also have export potential, are produced will be key to establishing local supply chains.

Stagnant refining sector The crude oil refining industry has for years struggled with financial viability, ageing infrastructure, power interruptions and the need for massive capital investment to produce cleaner fuel. Many refineries have closed in recent years, including the Engen refinery in eThekwini, in December 2020, and the Astron Energy refinery in Milnerton, in mid-2020. The Engen refinery will now reopen as a fuel-storage facility, while the Astron refinery may restart “at some point” this year (Business Report, 2022). Sapref, South Africa’s biggest crude oil refinery, jointly owned and operated by BP South Africa and Shell Refining South Africa, is the latest to announce that it will “pause” refinery operations from the end of March 2022, for an “indefinite period”. Concerns have been raised about the refining industry’s preparedness for the future, especially in preparation for the roll-out of more electric vehicles in the country.

Sustainability of IPP model The sustainability of the IPP model has been questioned, given that it is predicated on insulating the investor, to a large extent, by providing guarantees. Although it may be politically attractive, as private-sector funding is mobilised to shift green infrastructure investment off the national balance sheet, it has been argued that guarantees create mounting financial risks to the fiscus. The National Treasury contends that contingent liability risks for IPPs represent a low risk to the fiscus, although it is considering a reduction or elimination of guarantees to

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Identifying weaknesses reduce the stock of contingent liabilities. Treasury states in the 2022 Budget Review that a government study is under way to explore alternative support for the REIPPPP. The value of signed IPP projects, which represents government’s exposure, is expected to amount to R177-billion by the end of March 2022, decreasing to R156.60-billion in 2022/23, R137.80-billion in 2023/24 and R120.80-billion in 2024/25 (National Treasury, 2022).

Electricity produced by REIPPPP projects is bought by Eskom, which is the designated single buyer, after government has entered into power purchase agreements with the IPPs. The purchases are funded through a revenue allocation in the Eskom tariff, which is determined by Nersa.

The IPP model is also considered to offer limited participation for local entities, because foreign investors tend to be selective about with whom they work, an industry participant argued, stating that the programme’s true impact on broad-based black economic empowerment must be further interrogated.

REIPPPP Bid Window 5 economic development targets As with all the independent power producer (IPP) procurement programmes to date, Bid Window 5 set out a number of key economic development targets to be achieved by the bidders. In this regard, the 25 preferred bidder projects: • a chieved South African entity participation of 49.20%; • a chieved a total of 34.70% shareholding by black people in IPPs; • c ommitted to 25% black participation in companies building the projects; and • u ndertook to spend 41% of their committed budgets on purchasing locally produced products that meet the requirement local content.

Source: Department of Mineral Resources and Energy, 2021

Uncertainty about end-state of energy There is too much uncertainty about the vision for the end-state of the electricity sector, with political, economic, technical and regulatory challenges reported. For instance, South Africa previously pursued a now-abandoned model to separate the distribution division from Eskom and to merge it with the electricity departments of municipalities to form a number of financially viable regional electricity distributors. Instead, Eskom is now being restructured, set to be split into three divisions – generation, transmission and distribution. The legal separation of the transmission unit along these lines has started and will help open the grid to private suppliers.

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Suggestions for fostering growth Quick wins to accelerate growth

Establish pilots

Instead of pursuing ‘grand plans’, South Africa must consider smaller, more focused projects to increase chances of success. Pilot projects can help establish the feasibility of producing different technologies, such as batteries, photovoltaic panels or inverters. Currently, these items are imported, when they could be manufactured locally, and potentially exported.

Demonstrating the different technologies’ success through pilot projects will create an enabling environment to fast-track development and help develop local supply chains, which can be considered in the procurement process.

Priority items

Import qualifications

Select two or three priority items that would provide the biggest benefit to the energy sector and focus on the entire value chain of those items.

Put together a team that will concentrate on the full project life cycle, from the feasibility studies to getting funding and implementing the project.

Rather than importing skills, South Africa should consider importing qualifications. It is a complicated, arduous, long process to develop a curriculum and learning material. Importing qualifications or learning programmes will reduce the lag between South Africa’s skills planning and implementation of projects.

This is also an opportunity for skills transfer to ensure that local academics and universities are well informed.

Plan for skills

Develop a skills plan, in tandem with new policies, to align the delivery of skills with the implementation of such policies. The skills plan must deal with all the support systems, such as education and accreditation requirements.

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Suggestions for fostering growth Suggestions to enhance investor confidence – continued

Seize climate opportunities

While often discussed as a major risk, climate change is also an opportunity. The low-carbon transition is creating opportunities for firstmovers willing to innovate, whether that be in adaption or mitigation projects across different segments in the economy.

The opportunities will require careful consideration to select the right projects, create enabling policy and legislation, as well as introduce the legislative mechanisms that give impetus to these projects.

Establish dedicated units

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Emulate the model of the IPP Office, which is a dedicated unit with the mandate to manage the procurement of electricity from the private sector. Dedicated units can be established to successfully navigate public–private partnerships.

Conclusion South Africa’s electricity crisis is a great threat to economic and social progress, thus resolving the supply shortfall and reducing the risk of outages is one of the most important interventions that will revive economic growth.

President Cyril Ramaphosa has committed to reforms to transform the industry, including lifting the threshold for electricity generation projects for which a licence is not required for projects up to 100 MW, and bolstering energy supply with the ongoing massive procurement of utility-scale power.

While these reforms will take time to bear fruit, implementing some of the ‘quick wins’ that the ISI energy sector roundtable discussion identified, could have immediate positive impacts and provide the economy with breathing space to catalyse some of the more complex opportunities that are presenting themselves.

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References Business Leadership South Africa. 2021. Press release: The impact of loadshedding, November 15, 2021. [Online]. Available at: https://hub.blsa.org.za/energy/press-release-theimpact-of-load-shedding/ [accessed: February 22, 2022].

Business Report. 2022. South Africa’s biggest oil refinery to ‘pause’ operations for an undetermined period, February 11, 2022. [Online]. Available at: https://www.iol.co.za/ business-report/companies/south-africas-biggest-oil-refinery-to-pause-operations-foran-undetermined-period-88a6b8b6-a3c7-4247-8426-f4702f313af0 [accessed: February 24, 2022].

Department of Mineral Resources and Energy. 2021. Renewable Energy IPP Procurement Programme Bid Window 5 announcement of preferred bidders, October 28, 2021. [Online].

Available at: https://ipp-projects.co.za/PressCentre [accessed: February 25, 2022].

Engineering News. 2022. Mantashe confirms some RMIPPPP projects won’t close, outlines six-monthly renewables procurement tempo, February 15, 2022. [Online]. Available at: https://www.engineeringnews.co.za/article/mantashe-confirms-some-rmipppp-projectswont-close-outlines-six-monthly-renewables-procurement-tempo-2022-02-15 [accessed: February 22, 22].

Eskom. 2022. Media statement: Eskom makes major strides in its operational recovery process, cautions the path to sustainability will be long and hard, January 27, 2022. [Online].

Available at: https://www.eskom.co.za/eskom-makes-major-strides-in-its-operationalrecovery-process-cautions-the-path-to-sustainability-will-be-long-and-hard/ [accessed: February 22, 2022].

European Union. 2021. Press release: France, Germany, UK, US and EU launch ground-breaking Just Energy Transition Partnership with South Africa, November 2, 2021. [Online]. Available at: https://ec.europa.eu/commission/presscorner/detail/en/IP_21_5768 [accessed: February 24, 22].

Mouton, N., Louw, G.P. & Strydom, G. 2012. Critical challenges of the South African school systems, December 2012. [Online]. Available at: https://www.researchgate. net/publication/297722032_Critical_Challenges_Of_The_South_African_School_ System#:~:text=When%20analysing%20the%20school%20system,very%20low%20 levels%20of%20accountability [accessed: February 24, 2022].

National Energy Regulator of South Africa. 2021. A consultation paper to determine a new pricing methodology, October 2021. [Online]. Available at: https://www.nersa.org.za/ wp-content/uploads/bsk-pdf-manager/2021/09/Consultation-paper-to-determine-a-newprice-determination-methodology.pdf [accessed February 24, 2022].

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National Treasury. 2022. Budget Review 2022, February 23, 2022. [Online]. Available at: http://www.treasury.gov.za/documents/national%20budget/2022/review/FullBR.pdf [accessed February 25, 2022].

Ramaphosa, C. 2022. 2022 State of the Nation Address, February 10, 2022. [Online].

Available at: https://www.gov.za/speeches/president-cyril-ramaphosa-2022-state-nationaddress-10-feb-2022-0000 [accessed: February 24, 2022].

World Bank. 2022. Databank: Gross-fixed capital formation as a percentage of GDP, 2020.

[Online]. Available at: https://data.worldbank.org/indicator/NE.GDI.FTOT.ZS [accessed: February 24, 2022].

Wright, J.G. & Calitz, J.R. 2020. Setting up for the 2020s: Addressing South Africa’s electricity crises and getting ready for the next decade, January 2020. [Online]. Available at: http://researchspace.csir.co.za/dspace/handle/10204/11282?show=full [accessed: February 22, 2022].

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This report has been published by the Inclusive Society Institute The Inclusive Society Institute (ISI) is an autonomous and independent institution that functions separately from any other entity. It is founded for the purpose of supporting and further deepening multi-party democracy.

The ISI’s work is motivated by its desire to achieve nonracialism, nonsexism, social justice and cohesion, economic development and equality in South Africa, through a value system that embodies the social and national democratic principles associated with a developmental State. It recognises that a well-functioning democracy requires well-functioning political formations that are suitably equipped and capacitated. It further acknowledges that South Africa is inextricably linked to the ever transforming and interdependent global world, which necessitates international and multilateral cooperation. As such, the ISI also seeks to achieve its ideals at a global level through cooperation with like-minded parties and organs of civil society who share its basic values. www.inclusivesociety.org.za