South Africa’s “National Energy Emergency”
March 10, 2008
“This puts us in exactly the same position as other developing countries.” That was South Africa’s Minister of Public Enterprises Alec Erwin announcing in early February that the country’s sudden shortage of electric power, the “national energy emergency,” required rationing. Households must reduce usage by 10%, business by 15%, and hotels and shopping centers by 20%. The shortage will cut economic growth in the short- and most likely the medium-term. That will have a social and political downside. In the longer-term the current crisis will result in new power plants being built and diversification of energy sources from coal to solar, wind and biofuels, all of which will be good for the economy and the environment. In the meantime there will be pain. The question is how much and for how long and who will take the blame politically.
The shortages were shocking because for many years South Africa has had reliable and cheap electric power. For the moment new industrial projects may be put on hold, unemployment may increase, and the country’s ambitious plan for sustained growth of 6% by 2014 has been thrown in doubt. The government has, however, given assurances that the 2010 soccer World Cup competition will go forward as planned.
What are the causes of the power shortage? By what means and how quickly can it be resolved? How can the consequences for commerce, economic growth and unemployment be minimized? What are the political consequences?
South Africa has benefited from an abundant and cheap supply of electricity since the founding of the monopoly public utility, the Electricity Supply Commission, or Eskom, in 1928. The act establishing the monopoly mandated that electricity be sold at cost. Artificially low labor costs under apartheid, combined with South Africa’s large reserves of coal, enabled Eskom in effect to subsidize industrial development and to become a surplus producer, ultimately exporting electricity to neighboring countries. The low cost of South Africa’s electricity has deterred foreign power companies from entering the market. As a result, Eskom supplies 95% of the country’s power. The African National Congress governments since 1994 have expanded service to rural areas and townships and successfully pursued policies to increase GDP growth. There were warning signs a decade ago that demand would exceed supply at about the time that this in fact happened.
On January 9, 2008, a power shortage shut down South Africa’s critical mining sector for five days. Subsequently, the mines were operated at 90% capacity, but on March 5, the government announced they would begin operating at 95%. Also in January, service to the general public became subject to “load shedding,” cutting service to customers on a rotating basis. Telephone and Internet service for businesses and other customers became unreliable; the periodic absence of street and traffic lights worsened traffic; private security systems switched to generators, which work only for a limited time; and a man died on the operating table because the power failed as “rolling blackouts” interrupted power supply for homes, businesses, shopping centers and public utilities. On February 29, Eskom announced that power in Johannesburg would be cut for several hours two to three days a week.
The proximate cause of this was a shortage of coal at Eskom’s power stations and a very wet rainy season that had flooded coal mines and impeded transport. In 2000, Eskom had 61 days of coal stockpiled. By this January coal stockpiles averaged only 10 days, and in some places only two days, resulting in an inability to cope with increased demand. Several factors lay behind the shortages. In 2000, Eskom began to reduce coal stockpiles to better manage operating costs. Meanwhile, South Africa’s Black Economic Empowerment (BEE) policy was favoring small and new suppliers, so that plants cancelled long-term bulk contracts to switch to short-term deals with black suppliers. Suppliers were no longer selected by proximity to plants, and BEE-compliant transportation was required, which meant that coal was increasingly carried by trucks traveling poor roads. As a result, coal supply was compromised and Eskom was burning more coal than it bought.
\South Africa’s robust economic growth was also an underlying cause. Rapid growth has been the government’s intention and its ardently desired outcome, and the fact that growth contributed to a power shortage explains why President Mbeki said the crisis had arisen from positive factors. One of the great achievements of the African National Congress (ANC) governments since 1994 has been the doubling of the population served by electricity. Eskom’s 1.2 million customers in 1990 grew to 4 million in 2007. At the same time the government decided not to build more power plants and even mothballed two existing plants, reducing generating capacity from 45,000 megawatts to 37,000-40,000 megawatts.
In 1999, Eskom recommended expanding capacity, but the government decided against doing so, preferring to open up to private companies to become independent power producers. Unfortunately, the private sector did not take up the opportunity due to low profit margins resulting in part from Eskom’s dominant market position. The shortage also resulted from a continued reliance on coal power, coal transportation bottlenecks; and a shortage of project engineers resulting from a post-1994 brain drain What is the impact on the economy?
In his February 21 budget presentation, “Weathering the Storm” (referring to global trends), Finance Minister Trevor Manuel projected a decline in GDP growth from 4.5% to 4% during 2008, but some private economists estimate growth may fall to 3%, the lowest rate of growth since democratic elections in 1994. The projected decline is in part due to the power shortage. In January, Eskom’s finance director suggested that no new major industrial projects be started until 2012 when new power plants will be on line.
Cutting power in the mining sector will reduce gold, platinum, and diamond production, as well as coal exports. The most immediate result has been layoffs in a country with severe unemployment. For example, Gold Fields, Africa’s second largest gold producer, announced on February 24 that it might have to eliminate 7,000 jobs, or 13% of its work force, to match the electricity available to it, and that production would fall 20-25% in the first quarter.
Impact on Trade and Foreign Investment
Cheap and reliable electric power has always been an asset in attracting foreign direct investment to South Africa. Indeed Eskom provides cut-rate power to foreign investors as an incentive. So it was jarring in mid-February when Rio Tinto Alcan announced it would put on hold a planned smelter at the Coega industrial development complex until new power plants are built. Shortages of electricity may further depress the already anemic interest of U.S. companies in new direct investment in South Africa. At the same time, U.S. and other foreign power companies are now investing in South Africa’s generation capacity.
The trade picture is murkier. Despite Minister Erwin’s assurance that “the growth of South Africa’s economy at the current healthy levels can continue,” there are macroeconomic risks. Reduced GDP growth and plant closings will reduce domestic demand and exacerbate unemployment. Decreased gold, diamond and platinum production will likely reduce export volumes, although price increases in global markets may compensate in part. A devalued rand would worsen South Africa’s chronic current account deficit. That in turn could reduce the appetite of foreign investors for South African equities. Since the current account deficit has been financed by robust portfolio investment, the currency could be at further risk, adding to inflationary pressures. In short, if the power crisis results in a reduction of capital inflows or, indeed, outflows from South African equities markets, causing the rand to fall precipitously, the result could be increased inflation and economic contraction.
What is the remedy?
There is little prospect of adding significantly to power generating capacity in the short-term because of the lead-time for new power plants. Minister Erwin has announced that a plan will be ready by mid-2008 which may include electricity price increases, saying “we must not create any sense of false security. We are not safe.” He went on to predict that the shortage will be overcome within six months. A variety of short-term measures are being taken to address the proximate cause of the crisis. Minister Manuel has cited emergency task teams dealing with the coal-mining industry and fast-tracked gas turbine projects. The government plans to buy 45 million tons of coal to replenish depleted stockpiles. Eskom has announced it would “buy back” power from industrial customers, and may target international aluminum smelters such as BHP Billiton. A complete power supply buy-back from aluminum smelters could effectively shut them down for the rest of the year.
Longer-term plans are taking shape to increase capacity and mandate conservation. Minister Manuel announced plans to lend Eskom $7.6 billion of the $43 billion cost of new power plants over the next five years. The government also proposes increasing solar and wind power. Eskom has invited tenders for new power plants to be operational by June 2012. Foreign companies can have a role here. AES Corporation, headquartered in Arlington, Virginia, will build two plants by next year, one of which is at Moatize, Mozambique, that will supply about 1,000 megawatts and General Electric may also invest in increased generation capacity in South Africa.
The energy crisis arrived at a sensitive time in South African politics, coming as it did less than three weeks after Jacob Zuma defeated President Mbeki for the ANC presidency, further battering the president’s legacy. The Sunday Independent newspaper ran a headline “President Is Major Casualty of Power Crisis.” Mbeki’s successor will be elected in April 2009, and there are predictions that the ANC may lose middle class voters of all ethnic groups over the crisis. Critics accuse the government as a whole of minimizing the seriousness of the crisis and point to the fact that no one has been held accountable or resigned office. (Minister Erwin, the cabinet official under whom Eskom falls, will likely leave office with Mbeki.) The crisis has fed scapegoating, with politicians and pundits blaming everything from nefarious foreign capitalists to affirmative action policies. Given South Africa’s dependence on foreign capital flows, the highly publicized power failure combined with uncertainty about future political leadership as well as a global economic downturn, could make for a rough economic ride in the near term. The ANC may pay a political price for this.
On the other hand if the government can muddle through until new capacity comes on line, the crisis can provide the stimulus for an expanded, more efficient and diversified electrical power generation capacity. If the government spends millions to upgrade and build new power stations and private enterprise starts to generate and source its own electricity supplies, the current difficulties may have stimulated a sounder basis for economic expansion. The crisis may also create important new export and investment opportunities for U.S. companies.
Daniel O’Flaherty leads the U.S.-South Africa Business Council at the Corporate Council on Africa.
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