Cablegate: Electricity - Economy's Driver or Achilles Heel?

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RR RUEHBZ RUEHDU RUEHGI RUEHJO RUEHMA RUEHMR RUEHPA RUEHRN RUEHTRO
DE RUEHSA #2166/01 2961422
ZNR UUUUU ZZH
R 231422Z OCT 09
FM AMEMBASSY PRETORIA
TO RUEHC/SECSTATE WASHDC 9966
INFO RUCPDC/DEPT OF COMMERCE WASHINGTON DC
RHEBAAA/DEPT OF ENERGY WASHINGTON DC
RUCNSAD/SOUTHERN AF DEVELOPMENT COMMUNITY COLLECTIVE
RUEHZO/AFRICAN UNION COLLECTIVE

UNCLAS SECTION 01 OF 04 PRETORIA 002166

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STATE PLEASE PASS USGS
DEPT FOR AF/S, ISN, EEB/ESC and CBA, and OES/EGC
DOE FOR T.SPERL, G.PERSON, A.BIENAWSKI, M.SCOTT, L.PARKER
DOC FOR ITA/DIEMOND

E.O. 12958: N/A
TAGS: ENRG EPET EMIN EINV ETRD ECON SENV SF
SUBJECT: Electricity - Economy's Driver or Achilles Heel?

REF: A) 09 Pretoria 1762; B) 09 Pretoria 179
C) 08 Pretoria 2654
D) 08 Pretoria 2403 and previous

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distribution.

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Summary
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1. (SBU) South African power utility Eskom is struggling belatedly
to increase capacity to meet demand, while working to engage the
private sector, secure financing, and correct its pricing to reflect
market realities. The utility suffered an electricity supply
emergency, resulting in rolling blackouts and repeated load
shedding, from January through April 2008. While failure to meet
demand with supply had a significantly negative effect on the
economy, the global slow-down has given Eskom a temporary
demand-side reprieve. As owner and operator of the national
electricity grid, Eskom is the designated "gatekeeper" for all
potential market entrants and independent power producers (IPPs).
Following the 2008 crisis, the utility has announced that it will
require a capital outlay of $52 billion for new generation capacity
and an ambitious and controversial tariff increase of about 45
percent yearly through 2012 to service this capital. 90 percent of
Eskom's electricity is currently derived from coal combustion. To
date, the utility has made little progress in integrating
alternative sources of nuclear and renewable energy. Challenges
include: a shortage of coal, increasing demand related to global
economic recovery, energy intensity in key industries such as
mining, and the need to mitigate the increasing carbon load of
coal-fired electricity. End Summary.

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Eskom's Monopoly
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2. (U) South African State utility Eskom dominates electricity
generation. It supplies some 95 percent of South Africa's, and
about 45 percent of Africa's, electric power. It also owns and
operates the national electricity grid. If and when South Africa
attracts independent power producers (IPPs), Eskom is also the
designated purchaser of electricity. Eskom is among the world's top
seven in generating capacity, and among the top nine in terms of
sales. Coal-fired power stations generate 90 percent of South
Africa's electricity. A 1800 MW nuclear station at Koeberg near
Cape Town accounts for 4 percent, and hydroelectric, pumped storage,
and gas/kerosene-fired plants provide the remaining 6 percent.

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Electricity Crisis of 2008
--------------------------

3. (SBU) Long-term underinvestment in power supply, exacerbated by
cheap prices and an unwillingness or inability to engage/attract
private investors, culminated in a sudden and severe power crisis in
early 2008 in South Africa and the region. Shortage of supply was
so dire on January 25, 2008 that the system was at risk of total
blackout. An alarming admission from Eskom: a system-wide blackout
of the national grid could require three weeks to restore power. In
January, South Africa's critical mining sector was shut down for
five days and reopened at a mandated 90 percent provision of power.
Eskom imposed rationing, rolling blackouts, and repeated daily load
shedding -- a last-resort measure of interrupting load to certain
customers, undertaken to maintain the stability of the grid and
prevent a system-wide blackout -- between January and April 2008.
Qprevent a system-wide blackout -- between January and April 2008.
The immediate cause of the emergency was that a large percentage of
Eskom's existing capacity was unavailable for supply, due to planned
maintenance, unplanned breakdowns, and reduced output linked to coal
supply problems. Together these factors contributed to a situation
in which some 20 percent of the country's generation capacity was
out of service at one time. As South Africa's surplus electricity
capacity had been depleted, and Eskom's reserve margin - the spare
power plant available when the highest demand of the year is
recorded - had fallen to 5-7 percent, the electricity utility was
unable to meet demand. The internationally accepted standard
reserve margin for a country is between 15 and 20 percent. At the
same time that the South African Government and Eskom failed to
increase investment in supply, they had the political mandate to
increase access to the population since 1994.

4. (SBU) Since the power outages and economic disruptions of early

PRETORIA 00002166 002 OF 004

2008, electricity supply has become more stable. Eskom has recently
described the electricity system as "tight but manageable". The
utility has increased its coal stockpiles at power stations from
less than 12 days' supply to greater than 40 days' supply, brought
on new capacity of 4,450 MW since January 2008 (a combination of
"de-mothballed" older plants and some new gas-fired generation), and
expanded the reserve margin to just under 10 percent. Nonetheless,
other contributors to the crisis, such as policy uncertainty,
planning confusion, delayed investment in new generating plants, and
regulatory impediments to attracting private investment, continue to
contribute to a restricted supply.

5. (SBU) Officials are concerned that South Africa, which is
hosting the 2010 football World Cup, may not have enough electricity
to go around. The capacity-stressed situation has forced Eskom into
a planned spend of R385 billion (52 billion U.S. dollars) over the
next five years to increase capacity from 40,000 MW up to 70,000 MW.
The planned program includes the development of new capacity, the
continued recommissioning of mothballed capacity, and the
refurbishment of existing operating capacity, across a range of
generation platforms. The company's new project pipeline comprises
primarily immense coal-fired baseload facilities. Some more modest
gas-fired and pumped storage peaking facilities, renewable
facilities, and the refurbishment of existing plants are also
included. 9,600 MW of new baseload capacity is planned from two new
coal-fired power stations - Medupi and Kusile. Medupi, situated
near Lephalale in South Africa's Limpopo province, will be a
six-unit power station. Kusile, to be situated near Eskom's
existing Kendal power station in the Mpumalanga province, will be a
six-unit mine-mouth power plant. Each of these power stations will
have an output of about 4,800 MW. Medupi and Kusile are planned to
be fully commissioned and operational by 2016 and 2017,
respectively, but some units will come on stream as early as
2012-13, intended to abate the power crisis, while increasing
dependence on coal.

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From Cheap to Costly
--------------------

6. (SBU) Eskom is striving to implement controversial and
significant tariff increases to cover operational and capital costs.
In order to fund its capital program, it has already implemented
27.5 and 31.3 percent increases in 2008 and in July 2009,
respectively. In October 2009, the utility applied to the National
Energy Regulator of South Africa (NERSA) for further increases of 45
percent per year for the next three years. It is not clear how
long-term contracts with mining and other interests, often linked to
commodity prices and locking in prices well below the proposed rates
over time, will be handled.

7. (U) It is unlikely that consumers and interest groups will
accept price hikes graciously. One journalist commented, "Has the
power giant gone stark raving mad?" According to parliamentary
testimony by Eskom CEO Jacob Maroga on October 6, Eskom proposed an
increase in the allocation of free basic electricity (FBE) in their
tariff increase application as a way of shielding the poor from
substantial hikes in electricity prices. Under the FBE
Qsubstantial hikes in electricity prices. Under the FBE
intervention, 50 kWh/m of free electricity would be provided to
households with an income of less than R800 ($111) per month.

8. (U) Eskom ranked as one of the four cheapest electricity
producers in the world until the July increase. The requested
increases would take the power utility from an electricity price of
4.47 (U.S.) cents per KWh in 2007 to around 7.80 cents per KWh in
2010. This would put the price in the same range as developed
countries like Canada and Sweden. The electricity cost in the
United States in 2010 is likely to be above 10 cents per KWh.

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Low Prices, High Environmental Cost
-----------------------------------

9. (SBU) Coal-fired power may be historically cheap, but it has
high environmental costs in terms of carbon emissions, particulates
(air quality), and the need to use scarce water supplies for
cooling. These costs do not appear to have been taken into account
by policy makers or by Eskom. Nonetheless, investment in
alternatives could be spurred once pricing is adjusted.

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Post Recession Demand Spike?
----------------------------

PRETORIA 00002166 003 OF 004

10. (SBU) The global recession has alleviated power demand
temporarily. In particular, many energy-intensive smelters have
shut down in response to a drop in world demand for metals and
alloys. Prior to the recession, Eskom had based its supply and
demand projections on a robust power-demand growth of 4 percent a
year and annual economic growth of 6 percent. This would have
required doubling of the generation system to nearly 80,000 MW by
2025 to keep pace with demand and build an acceptable reserve margin
of at least 15 percent. The recession, however, has caused a number
of Eskom's key industrial customers to adjust their outputs (or shut
down), and as a consequence, Eskom has re-assessed its demand
scenarios. The utility is currently assuming "marginal" to zero
growth in electricity demand for 2009 and 2010. Eskom now expects
the system will need a 60,000 to 70,000 MW capacity by 2025. A more
rapid market recovery, and related revival of mine production, could
cause renewed shortages and force further planning revisions.

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Not Enough Coal to Burn
-----------------------

11. (SBU) Coal shortage is a serious threat to SA electricity
supply. South Africa currently produces about 250 million tons of
coal a year. 48 million tons of capacity a year will be lost in the
next ten years, as mines reach the end of their productive lives.
Eskom's coal consultant Johan Dempers is quoted as saying that South
Africa will need to commission as many as 40 new coal mines at a
cost of some R110 billion (15 billion U.S. dollars) in order to meet
the country's electricity needs by 2020.

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Independent Power Suppliers' Role
---------------------------------

12. (SBU) The South African Government (SAG) has called for the
private sector to play a greater role in power generation, but it
and Eskom have been unable to deliver on this policy. IPPs are
intended to generate 30 percent of the additional power capacity;
doubts have been raised as to whether such a target will be met. As
reported in Ref A, IPPs must have capacity of at least one Megawatt
for renewable sources; reverse-metering by households and
enterprises that have invested in solar panels or other renewable
sources are not permitted or encouraged under current regulations.
Individual IPPs proposing large power generation projects have been
struggling to finalize purchase agreements with Eskom, including the
large coal-fired Mmamabula project in Botswana that cannot be
financed without an Eskom off-take agreement. Under current
legislation, all power generated by IPPs has to be sold to Eskom.
The power utility appears to have made little progress in
encouraging or introducing additional players and to date has not
negotiated any new Power Purchase Agreements (PPAs). In fact, Eskom
has not signed a PPA since 1976, when the Cahora Bassa Dam
hydroelectric project in Mozambique came on stream.

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Impact on South Africa's Neighbors
-----------------------------------

13. (SBU) South Africa values its relationships with and potential
imports from other countries in the region. Eskom exports 5.7
percent of the power it generates to neighboring countries and has
honored contracts and relationships with its neighbors despite the
Qhonored contracts and relationships with its neighbors despite the
power crisis. Eskom imports 3.9 percent of its power from countries
like Mozambique and the Democratic Republic of Congo (DRC) and owns
subsidiaries in various African countries. Of these numbers, Eskom
imports 1200-1500 MW annually from the Mozambique Cahora Bassa dam,
but re-exports up to 900 MW transmitted on the Eskom grid back to
the Mozal aluminum smelter in Mozambique, under the terms of a
longstanding contract. The utility currently sells about 3,000 MW
to Botswana, Mozambique, Namibia, Zimbabwe, Lesotho, Swaziland, and
Zambia each year. Eskom has reported that its electricity supply
accounts for 45 percent of Africa's power. It has pointed out that
current and future imports could be severely jeopardized if exports
of electricity from South Africa are restricted. To prevent any
future crises, particularly during the 2010 World Cup, members of
the Southern African Power Pool (SAPP) have agreed to provide
support, although it is not clear how much they could help. These
members include Mozambique, Angola, Botswana, Malawi, Namibia, the
DRC, Swaziland, Tanzania, Zambia, and Zimbabwe.

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Increasing Nuclear Power
------------------------

PRETORIA 00002166 004 OF 004

14. (SBU) Eskom cancelled its tender for new conventional nuclear
power plants in December 2008, but the SAG reaffirmed its commitment
to expanding nuclear power with government playing a greater role.
The SAG is still formulating its nuclear power plant policy and
plans, but they will be reduced from its ambitious policy of 2007
that targeted a fleet of up to 20,000 MW over 20 years.

15. (SBU) The Embassy has been advocating for Westinghouse as a
supplier of new nuclear plants. Areva of France is the main
competition. Another component of South Africa's nuclear strategy
is the development of pebble-bed modular reactor (PBMR) technology -
a reactor technology developed in Germany that uses graphite pebbles
and very high temperatures to generate energy - as an option for
future nuclear power generation. Construction of a demonstration
PBMR at the Koeberg site,initially due to start in 2007, has been
delayed. The estimated cost for the project is R14.5 billion ($2
billion). To date the SAG has spent more than R8 billion ($1.1
billion U.S.) on research and development. The U.S. Nuclear
Regulatory Commission is working with South Africa on pre-licensing
of the new fourth-generation technology, and the USDOE is working
with PBMR in a number of multilateral research fora.

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Opportunity for Renewable Sources?
----------------------------------

16. (SBU) South Africa has been relatively slow to initiate
renewable energy projects, despite the SAG pursuing a renewable
energy target of 10,000 GWh by 2013. The National Energy Regulator
Nersa's recent finalization of source-specific, preferential,
renewable energy feed-in tariffs (Refit) may stimulate new
investment in renewable energy projects. Eskom's managing director
for corporate services Steve Lennon reports that the company is
designing a R6 billion ($830 million) pilot solar capture thermal
plant in the Northern Cape and has restarted procurement for the
construction of a wind farm. Each of these sources will be designed
to contribute 100 MW to the grid.

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Comment
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17. (SBU) As South Africa struggles with the impact of limited
electricity supply and looming price escalation, the country is
presented with a watershed opportunity to transform its power
industry. This transformation could include: reducing reliance on
coal, integrating new private IPP's, increasing the number of green
suppliers and renewable sources, correcting the price structure, and
reducing the carbon load. Getting the prices right will not be
easy; it is not clear to what extent Eskom's prodigious tariff
increase requests will survive economic and political hurdles. In
this time of protests over service delivery, the inflation impact on
the poor and on the economy will be significant. In the short term,
the utility will have to deal with emissions issues at a time when
the SAG is committing to mitigating its carbon footprint. The
country's abandonment of luring industrial users with cheap
electricity may impede its ability to fulfill its goal of greater
in-country processing of mineral commodities to export at a higher
added value.

18. (U) Opportunities for greater US-SA cooperation in alternative
energy (nuclear and renewable) may become more attractive as Eskom
Qenergy (nuclear and renewable) may become more attractive as Eskom
tries to find different ways of securing future supply. There will
also be opportunities for bilateral cooperation and advice as Eskom
strives to finalize Power Purchase Agreements with IPPs, balancing
build versus buy and cost and timing implications.

Gips

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