INVESTMENTLight at the end of the tunnel: energy crisis will soon be a thing of the past
The ideological resistance to private sector participation in energy generation has now crumbledIf there is a single topic that occupies the minds and dinner table conversations of all South Africans, it is load-shedding. From businesses and households to political parties and the average person on the street, none of us is spared the devastating effects of rolling electricity blackouts, which seem to get worse with each passing year.
Some clients regularly question how we can continue to invest in JSE-listed shares with material exposure to the crumbling SA economy amid load-shedding. To respond we should first consider the reasons Eskom is failing, and what has changed that makes us say there might be light at the end of the tunnel (pun intended).
Why are we here? Years of mismanagement and corruption have resulted in a precipitous plunge in Eskom’s ability to generate power. The energy available factor (EAF) is the amount of power available for production, represented as a percentage of Eskom’s total installed capacity. The deteriorating trend depicts how the winter of 2022 marked the beginning of intense and destabilising blackouts across SA, when electricity supply could no longer meet demand.
Most people tend to take current trends and assume they will simply persist. However, our job is to conduct research to form a view about the future and figure out the most likely potential outcomes. Our team has done substantial research on this topic as it is the primary variable in the outlook for the SA economy and the SA companies we invest in.
In short, our "belief" is supported by powerful incentives, a credible plan and cold, hard facts. We are convinced that the power shortages will moderate significantly over the coming 12 months and that the energy crisis as we know it will be a thing of the past within the next two years.
From a political perspective, we have national government elections taking place in 2024. Polling data suggests that load-shedding is the single biggest factor in determining how voters will cast their ballots. As the biggest potential "loser", the ANC recognises this risk to its political supremacy. Private sector companies in turn understand that electricity supply is their primary existential threat.
This is not lost on labour leaders, who also understand the devastating consequences for workers if the energy crisis is not resolved. The ideological resistance to private sector participation in energy generation has now crumbled, as the ANC-led government has realised that it has neither the funds nor the internal capacity to resolve the energy crisis on its own. The incentives are finally aligned — the government, businesses and individuals all want to resolve the issue.
However, even such powerful incentives will ultimately prove worthless without an actionable plan. We are pleased to report that such a plan exists, and that some major potential impediments to the required structural reforms have already been resolved. While Eskom’s internal plans to improve plant performance and procure additional supply are most welcome (and are likely to deliver short-term relief), it is the legislative amendment passed in December 2022 to remove the cap on how much private electricity can be produced by projects that will make a major difference over the medium term.
This seemingly small change will unleash private sector capital and expertise to generate power for own use, which will materially improve aggregate electricity supplies and establish a more durable and diversified generation fleet for the long run.
Plans are meaningless unless they are supported by efficient and timely execution that delivers tangible results. It is time for us to evaluate some cold, hard facts.
Eskom has about 50GW of installed generation capacity, which accounts for 90% of electricity generation in SA. But it produces only 26GW-27GW of reliable supply. Aggregate peak demand in the country is about 33GW, so we had a 5GW-6GW shortfall on any given day during peak load-shedding periods in the first half of 2023.
While capacity is clearly constrained, there are three major sources of supply that will materially reduce load-shedding in the short run:
Eskom expects multiple units at Medupi and Kusile to return to service from November to July, and the second unit at Koeberg by June 2024, resulting in the return of 4.5GW of baseload power to the grid over the next 12 months;
Rooftop solar installations are likely to add 2GW-3GW to the grid in 2023, as per data from the presidency; and
Large-scale private sector projects are likely to add 1.3GW of new supply in 2023 and 3.1GW in 2024, and this pipeline will grow in 2025/26.
Over and above these major drivers there are additional shorter-term wins available: three Karpowerships could provide 1.2GW per year over a five-year period to resolve some short-term stress. SA has concluded negotiations for a 1GW a year power purchase agreement with Mozambique using gas-fired power plants.
In the longer run, legislative reforms to establish a competitive electricity market, and the unbundling and subsequent investment in the transmission network, are likely to unleash hundreds of billions of rand in private sector investment in electricity generation. There have been numbers thrown out as high as 66GW as per a recent Eskom survey. While we don’t say all of this will be commissioned, it is more than enough to permanently resolve the load-shedding situation, and it is this fact that supports our confidence in the longer-term earnings trajectory of SA businesses.
The graph indicates our forecasts of electricity supply and demand. The key uncertainty to the picture is the EAF of the current fleet. We believe we are being conservative in our forecast, but the end result could still be above or below our estimate. Even if Eskom’s performance is somewhat worse, we believe the private sector investments will simply increase to offset this. The research we have done leaves us in a position where we believe this major stumbling block to SA growth and investor confidence will be resolved.
A better outlook for electricity supply doesn’t mean the SA economy reverts straight back to the 3%-5% growth that we enjoyed under the Thabo Mbeki administration.
Significant impediments remain before the true economic potential of our country can be unleashed. Electricity transmission and distribution, water infrastructure, municipal governance, the inability to tackle crime and corruption, and the systemic and treasonous sabotage of our infrastructure are likely to persist over the medium term unless there is profound and positive political change.
However, the potential resolution of the electricity crisis over a reasonably short period by the government and the private sector working together could provide a playbook to resolve many of the other challenges facing our country.
By resolving the electricity crisis and restoring a semblance of stability to the economy, businesses can once more focus their time and effort on running their operations. Once stability has been restored it will become clearer what the true earning power of listed businesses is, and how cheap some of the underlying valuations are.
Msimango is an investment analyst at Peregrine Capital.