The Future of Eskom Single Buyer Office (SBO)

Introduction

South Africa’s Renewable Energy Independent Power Producer’s (REIPPP) programme has been heralded as a successful landmark initiative in the boosting of the economy through expansion of private and institutional investment into the renewable energy market. The RE market, through the REIPPPP, has seen the development and award of tenders for solar, onshore wind, biomass, landfill gas and hydro technologies. Since its inception in 2011, 6.3 GW of RE has been procured by Department of Energy (DoE) IPP Project Office, representing approximately 15% of the South African installed power generation capacity. At the end of 2015, 2.2 GW of the 6.3 GW procured had been installed, connected to the grid and commissioned [1].

Built on lessons learnt from an earlier unsuccessful effort to kick start local investment in renewable energy, based on feed-in tariffs, the REIPPP framework provided an incentive for private sector participation and has enabled a fast effective roll out of new generating capacity with multiple bid winners.

The DOE, through section 35(4) of the Electricity Regulation Act no. 4 of 2006, developed and updated the Integrated Resource Plan (IRP) providing the official policy position from which the generation procurement needs for the country are determined. Through the REIPPPP, which is aligned with the IRP, the DOE facilitates the procurement of renewable energy from IPPs who submit their project proposals in a competitive bid process, by state-owned power utility, Eskom as the off-taker or single buyer. In South Africa government recognizes IPPs as privately financed Greenfield generation plants, with support of non-recourse or limited recourse loans, backed by long-term Power Purchase Agreements (PPAs) signed with Eskom [1] [2]. These PPAs are approved by National Energy Regulator of South Africa (NERSA), and the framework allows Eskom to pass the associated reasonably incurred costs of these PPAs through to retail customers.

In the current market the core electricity network operator and market functions are performed by Eskom. In addition to providing the majority of South Africa’s generation capacity, Eskom is also the single buyer of power, and the main distributor of power to municipalities, direct large customers, smaller customers in certain municipalities, and in the majority of rural areas. To support the IPP market, and in accordance with the single buyer model outlined in South Africa’s electricity policy, Eskom established the Single Buyer Office (SBO) as the purchasing arm of Eskom responsible for PPAs between Eskom and IPPs as illustrated on the left in Figure 1 below. The Eskom SBO is accountable for all of the following IPP programmes – REIPPPP, Small Renewable IPP programme, Medium Term Power Purchase Programme (MTPPP), and the Open Cycle Gas Turbine (OCGT) programme as well as Municipality generation and short term contracts for security of supply. The Eskom SBO has been very active in the REIPPPP and is currently working to conclude PPAs for preferred projects selected under the expedited round 4.5 [3].

Figure 1: Current Single Buyer model (left). State-owned ISMO power market model (right)

In July 2016, Eskom announced that a decision had been taken by the board not to sign any further power purchase agreements with IPPs beyond the preferred projects selected under the expedited round 4.5. In light of the changed demand/supply conditions, refurbishment of its generation assets and commercial operation of its newly installed plants, Eskom forecasts that it will be in a surplus position by 2022 without increasing the renewable energy capacity and is therefore reluctant to commit to more PPAs [4]. This stance has thrown the future of the REIPPPP into question and created uncertainty in the market, possibly undermining future investment into the sector.

It is widely acknowledged that Eskom plays and will continue to play a key role in the effective operation of the existing generation fleet of predominately thermal power stations in South Africa. Furthermore, Eskom has also played a significant role in supporting the influx and growth of IPPs through its bankable SBO as the power off-taker. It can however be said that there is a need to further optimize the electricity market system to allow the continued growth of IPPs to provide healthy competition for Eskom to the benefit of South Africa.

Electricity market structure

The 1998 Energy Policy White Paper [5] publication prompted Cabinet’s acceptance of a 70-30 generation split between Eskom and the private sector, and consequently the commencement of work towards the increased participation of the private sector in the electricity supply industry. In addition, it called for open and non-discriminatory access to the grid for all generators of power and soon after an Independent System and Market Operator (ISMO) Bill was drafted to implement some of the polices set out in the White Paper. However, the then impending generation shortages saw the prospective wholesale market idea abandoned in favour of Eskom as the off-taker in the existing single buyer model [1], and the ISMO Bill was watered down and then abandoned entirely.

The choice of a single buyer model was due to various technical, economic and institutional factors, and is in fact a popular model still implemented in many Asian, African and Eastern European countries today. The single buyer model facilitates the balancing and matching of electricity supply and demand given that Eskom is responsible for real time dispatch, as well as the exclusive right, to buy from IPPs or generators and to sell to distributors. Other merits include the simplification of price regulation by maintaining a unified wholesale price, protection of IPP lenders from market risk thereby making projects more commercially viable and bankable through PPAs, and preservation of the key role of the DoE in decisions on investment in generation capacity [6]. The Eskom SBO has allowed the DoE to procure both capacity and energy cost effectively, in alignment with the IRP. In addition to renewable energy, the SBO has enabled the procurement of more expensive peaking and mid-merit dispatched plant generation to cover fluctuations in renewable energy production.

Eskom has, and continues to play a significant role in the development of a private electricity sector through the SBO. However, there have been some noteworthy shortcomings in the SBO model, potentially hindering the continued progress of the IPP sector. Now that the grid system has regained some stability, Eskom is backing away from long term PPAs at prices which, once agreed, are non-negotiable for 20 years. Competition in the REIPPPP has seen renewable energy tariffs fall since its inception, thereby posing a threat to Eskom’s money making generation business. Eskom’s generation plants and installed capacity are the largest component on Eskom’s balance sheet [7]. As supply to the grid meets and exceeds the demand, contrary to what was envisioned in the 1998 Energy Policy White Paper, Eskom’s monopoly over the entire value chain of transmission and to an extent, distribution systems creates a conflict of interest in an electricity market based on the single buyer model. This suggests that the fate of the private sector (IPPs) hinges on Eskom’s fortunes and does not align with the best interests of the power sector and country as a whole and that is might be time to reconsider some form of ISMO.

Restructuring for success – The future of the Eskom SBO

Several authors [1] [6] [8] suggest the single buyer model can be seen as a transitional arrangement in place before the conditions for a more liberalised power sector are satisfied. In the case of South Africa, this is true; the Eskom SBO has indeed supported the development of the private sector by offering a bankable off-taker for the capacity produced. Furthermore, the REIPPPP, and other IPP programmes have provided the necessary building blocks for an ultimately diversified buyer/seller market. As the power market and REIPPPP participants have become more familiar with the process and framework, there is need to shift the focus from “establishing the market” through Eskom’s SBO to improving the electricity supply market and process [8]. The creation of a state owned ISMO, as illustrated on the right hand side of Figure 1, with Eskom generation, transmission and distribution as separate entities is an important next step in further optimizing the electricity market system and process. A state-owned ISMO eliminates Eskom’s conflict of interest and avoids the costs and possible disruption associated with privatisation of the process while maintaining a bankable off-taker for IPP investment. In addition, the creation of a well thought out state owned ISMO would create a truly competitive electricity supply market, fostering the evolution of the power sector in South Africa.

Conclusions

Although it is widely acknowledged that the IRP is now out of date and REIPPPP has had some challenges along the way, it is difficult to argue the success of the programme or the model which has since been adapted for similar programmes for the procurement of IPP co-generation, gas, and coal.

The successful implementation of the REIPPPP so far demonstrates the potential for growth and evolution of the South African power sector, however without Eskom’s support, there may be limited room for further growth of the private sector in the electricity supply market. Eskom’s recent decision not to sign further PPAs with IPPs beyond the current round of preferred projects has created uncertainty in the market and threatens these programmes and future investment in IPP projects.

Until recently Eskom as a single buyer has been an effective model for the procurement of power from independent producers as, in a capacity-constrained market, it has been in Eskom’s interest to work with the DoE to procure additional generation capacity. With a less constrained grid, new, independent, low cost generation could be viewed as competing with Eskom’s own generation fleet, the income generating arm of the business, and thus creates a conflict for Eskom as both single buyer and generator.

A state-owned ISMO power market model, although really just a more advanced form of the single buyer model, could provide the necessary push for a more competitive and liberalised power market for the good of South Africa.

References

[1] A. Eberhard, J. Kolker and J. Leigland. South Africa’s Renewable Energy IPP Procurement Program: Success Factors and Lessons. World Bank Group, 2014.
[2] R. Smit. “A holistic view on grid integration of renewable energy generation.” Energize, 2015.
[3] Eskom Holdings SOC Ltd, “Guide to Independent Power Producer (IPP) processes,” Internet: http://www.eskom.co.za/Whatweredoing/Pages/GuideIPP.aspx, June 2016. [October 2016].
[4] P. Carol. “Eskom cuts off private power,” Internet: http://www.bdlive.co.za/business/energy/2016/07/21/eskom-cuts-off-private-power, July 2016 [September 2016].
[5] Department of Minerals and Energy. White Paper on the Energy Policy of the Republic of South Africa. 1998.
[6] L. Lovei. The Single Buyer Model – A Dangerous Path toward Competitive Electricity Markets. The World Bank Group, 2000.
[7] Eskom Holdings SOC Ltd, “Annual financial statements,” 2016.
[8] P. Papapetrou. Enabling Renewable Energy in South Africa: Assessing the Renewable Energy Independent Power Producer Procurement Programme. 2014.