Eskom: The making of an electricity crisis

Gerhard van Onselen writes on the roots of the underlying problem


The electricity crisis in South Africa certainly is no secret. Load shedding, maintenance outages, and lately, planned power cuts of bulk supply to defaulting municipalities mean no one’s, not even paying electricity consumers, are really certain about electricity supply nowadays.

State-owned power utility Eskom is at the root of the problem and, evidently, problems at Eskom are numerous. For instance, in its recently released financial statements for FY2018, Eskom reported a net loss of around R2,3 billion.

Serious “liquidity issues” were noted – a bookkeeper’s way of saying Eskom is struggling to pay its day-to-day bills. Compared to the previous year, revenues remained flat at R177 billion. Special initiatives supposedly to “stimulate demand” apparently fell on the wayside.

(Reading about such measures may be surprising, especially if one considers that, in the not too distant past, Eskom issued proverbial ‘Defcon 3’ amber alerts on television to dissuade South Africans from using too much of their product.)

Liquidity troubles, funding difficulties, irregular expenditure, municipal and other arrear debt, and short-term insolvencies present sizable difficulties for Eskom’s status as a going concern.

In addition to doubtful hopes at squeezing more sales from a badgered consumer base, Eskom plans to allay liquidity issues through reduced investment and attempted “costs-containment measures”. Furthermore, Eskom continues to lobby Nersa for price increases to cover its bloated costs, though it was disappointed with the recent rulings.

Moreover, Eskom recently also applied for three so-called “revenue recoveries” on the questionable regulatory clearing account (RCA) mechanism; a longwinded way of asking government regulators for permission to lean more on paying electricity consumers for revenue shortfalls on the multi-year price determination (MYPD).

Unfortunately for Eskom (and the rest of us), cost containment measures are sure to face off with union activism, while any extravagant tariff increases imposed by means of the MYPD and RCA mechanisms, given current conditions, are likely to depress sales. Whereas, Eskom and Nersa, in their twisted, convoluted and anti-market coven, are free to dictate prices, they aren’t able to dictate how consumers will respond to those increases. (If only economics had something to say about this.)  

Reasons stated for the continuing electricity crisis are many. Pundits, government and Eskom itself have weighed in suggesting numerous culprits. These include corruption and state capture, poor planning, political interference, an oversized workforce, the Gupta capture racket and many more.

The solution, the popular thinking goes, is better boards, better CEOs, less Gupta-capture, more auditing oversight, McKinsey paying back the money, stricter enforcement of the municipal finance act and so forth. Yet, these proposed solutions merely scrape the surface of the problem. Getting to the root of the problem requires us to dig a little bit deeper.

A pertinent question, perhaps, is asking how exactly did Eskom manage to turn itself into the systemically risky balance sheet monstrosity it now is in the first place? To answer this question requires us to delve a little into mainstream economic assumption on power utilities.

Eskom, SA’s largest power utility, is regulated in accordance with the thinking on so-called ‘natural monopolies’. Not to go into a lengthy and unnecessary technical discussion on the matter, natural monopoly theorists reason that power utilities are too costly, too big, too problematic, or too complex for the private sector to undertake on its own. For these reasons, these theorists maintain, government-led public investment is needed to build power stations.

However, it’s argued further, such power utilities would naturally fleece consumers through a monopolistic market position, which owing to economic complexities cannot realistically be challenged by market competitors. From this theory it’s typically recommended that governments regulate electricity prices, which is effectively what Nersa does with Eskom.

Those critical of this line of reasoning may argue, correctly I think, that no regulator is perfect and perfectly knowledgeable on future conditions. In theory though, regulating electricity prices is said to be a relatively simple matter. Allegedly a number of calculations and perhaps some economic graphs will help regulators, such as Nersa, to set the ‘correct’ price for electricity. In practice, however, setting prices is no simple matter.

The supposedly objective price considerations, soon become fuzzy and evidently increasingly unworkable as stated or unstated political pressure and, locally, the state’s basic service mandates with regard to electricity enter into the calculus.

Regulators working outside the realm of market prices and in control of systemically critical centralised services, such as power grids, inherently have smaller margins for error. Highly centralized electricity provision, as is the case with Eskom, evidently would have much less resilience than would be the case had we had numerous private sector providers. The result? If something big goes wrong with Eskom the results, clearly, would be disastrous.

Notions of grid-down disasters aside, anticipating future capital expansion, determining the correct mix of infrastructure and proper and most efficient resource allocation is very difficult, some would say impossible, without responsive free market prices to convey proper planning signals.

In addition to the fallibility of regulators, other arguments challenge natural monopoly theory. One challenge is simply asking for examples of natural monopolies existing outside supportive special regulatory arrangements.

While even some free market economists are sympathetic to the possibility of natural monopolies – although regarding them as rare – there’s simply no excuse when special regulatory measures aimed at controlling monopolies in itself endows monopoly-like legal privileges to the detriment of free competition.

Stated more simply, it is one thing to suppose that since natural competitors won’t arise on the free market a power utility requires price regulation. It is quite another thing completely when regulation itself greatly hampers free competition from occurring in any case. If electricity monopolies are indeed “natural”, “unavoidable” or free market alternatives impossible, then it shouldn’t really make any difference allowing for the possibility of free competition.

The electricity crisis in South Africa may be attributed to a central planner’s catch-22 where laudable intentions are overrun by a mounting range of predictable perverse incentives and chaotic economic calculation.

In seeking solutions outside the market economy the South African state gave municipalities a constitutional charter to oversee certain basic services – including electricity. Eskom is sustained through licensing and regulations as South Africa’s largest power utility. This means in effect that many consumers have to buy electricity from municipalities and many municipalities have to buy from Eskom.

This licensed privilege allows Eskom to apply regulated prices, which, according to the tariff principles outlined in the electricity regulation act, “must enable an efficient licensee to recover the full cost of its licensed activities, including a reasonable margin or return.”

Arguably, no single policy is more disastrous to keeping costs down than guaranteed cost-plus arrangements of this sort. While the Act does specify “efficient licensees”, efficiency is hard to measure outside true market prices and free competition, especially if Eskom would act more or less as its own local benchmark.

Free market provision of electricity in South Africa is hampered by a number of anti-free market interventions. These include licensing, municipal reticulation authority and non-market price regulation and other legal restraints to free entry, all of these serve to keep free competition out of the market for electricity.

If we add thereto government secured lending and the productivity-poison of legally mandated cost-plus arrangements, the table is set for bulging costs. Within this context it is no surprise that Eskom grew into a sizable and expensive fiscal risk. Solutions to the ‘Eskom question’ may require substantial rethinking outside of the regulatory status quo.

Gerhard van Onselen, senior researcher, Sakeliga.