The South African energy sector is facing a major dilemma. While international trends are pointing towards a privatised multi-player energy landscape with renewable energy making up a larger portion of the mix, South Africa has an energy system that is 80% dependent on fossil fuels and is a large employer in the country.
In order to meet its commitments to the Paris Climate Agreement signed in 2016, SA has to reduce its carbon emissions by just less than half by 2030. This is the context within which the South African government recently signed 27 new independent power producer (IPP) contracts, after three years of delays, and announced the implementation of a carbon tax from January 2019.
Deloitte carbon tax expert Gerhard Bolt says the world is moving towards “micro-grid” energy-generation markets. “It’s inevitable,” he comments. A microgrid is a localised group of electricity sources that are connected to a centralised electricity grid, known as the macrogrid, but which are also able to function autonomously.
This transition means potential job losses for many working at fossil-fuel-based companies.
Not surprising, then, that many union officials see the Renewable Energy Independent Power Producer Procurement Programme (REIPPPP) as the vehicle that will deliver the privatisation of SA’s energy sector – and subsequent job losses. The REIPPPP was launched in 2011, and all the projects commissioned have pre-approved tariffs for the next 20 years.
Jesse Burton, a faculty member at the University of Cape Town’s Energy Research Centre, says reductions in renewable energy costs mean that contracts overseas are being signed at below the operating cost of Eskom’s more expensive coal-fired power plants.
“One thing no one talks about is that SA needs a plan for the phasing out of coal over the next 30 years,” she comments.
It is imperative that workers and communities who face upheaval from unplanned coal-plant closures are protected, Burton believes. She argues that what SA needs is the new, least-cost Integrated Resource Plan (IRP) to take care of the emissions from the electricity sector, as this was the cheapest way to reduce emissions.
Luc Koechlin, managing director of EDF South Africa, said energy companies such as EDF need to know where the country wants to go.
“How is the country going to tackle unemployment in the coal sector and climate change?” he asks. “Investors want to put their money where there is policy certainty.”
Speaking at the recent Africa Power Roundtable conference in Sandton, department of energy (DoE) director-general Thabane Zulu said there had been a long period of policy uncertainty and that the recent signing of the 27 IPP contracts represented the “gearing towards policy certainty”.
“Policy certainty is key going forward,” he said. “No more stop-start.”
The consequences of government’s stop-start policy position were evident in the tale of one manufacturer, who said he had to retrench 220 people. “I have to come to events like these to get my voice heard,” he said.
Zulu admitted that the DoE had learnt from its mistakes and would make sure not to repeat them. “We’re building from those lessons,” he said, suggesting that bid windows five and six of the IPP would see changes implemented.
Zulu said the DoE was finalising the new IRP and promised “the dawn of a new era” in the energy space. He added that there was ongoing engagement between Cabinet and the DoE over the IRP, and this was the department’s priority. No timeline is yet available. He said the new IRP would guide all future energy procurement, so South Africa has a “well-managed” energy sector.
The rise of renewables
According to Burton, the recent signing of the 27 IPP contracts has created a much more positive sentiment in the sector after three years of delays: “I think that we have seen a renewed vigour in the space. The interest has never really gone away, but developers didn’t have anything to do for several years.
“The challenge now is to maintain the momentum, so that South Africa can continue to take advantage of the cost reductions we’ve seen globally,” she adds.
Peter Baird, head of African private equity at Investec Asset Management, says that with solar- and wind-energy-generation prices having fallen significantly, these technologies can no longer be ignored: “It’s not tree-hugging, save-the-planet stuff – it’s cold, hard economics.”
He believes that renewables will emerge as a bankable, wealth-creating industry, but right now there is still a lot of risk.
Baird warns that investors should “tread carefully” at the moment.
“We are witnessing a profound change,” he says. “There is a lot of money to be made, but also a lot of money to be lost.”
It’s a little early for retail investors to get involved in renewables, with mostly institutional investors and a few venture capital firms in the market currently, he adds.
“But there is a lot coming,” Baird says. “Over the next five years, renewable energy is coming to equity markets.”
According to Corneleo Keevy, head of credit risk management at Ashburton Investments, local investors have very limited ways of getting exposure to the renewable energy market in SA at the moment.
One option is to invest in infrastructure investment holding companies such as GAIA Infrastructure Capital and Hulisani, which are listed on the JSE, and the AltX-listed Renergen, he says.
Hulisani, which listed on the JSE in April 2016, is an African energy-investment company that plays in the coal, gas, solar, wind, hydro and biomass sectors, while Renergen is an alternative-energy company that listed on AltX in 2015.
Prudence Lebina, GAIA Infrastructure Capital’s CEO, says that the company operates in the secondary market, purchasing infrastructure assets in the energy, transport, water and sanitation sectors when they are almost completely built and operational. The company looks for operational returns of at least CPI plus six percentage points.
Keevy points out that it is important for investors to understand what type of investment they are making in these companies.
“These are essentially yield vehicles in a secondary market,” he explains. “You are not investing in the projects at an early stage; they are being acquired once constructed.”
As these projects have an agreed 20-year tariff plan, they should provide steady and predictable revenue. “They are not a growth story,” says Keevy. “More a yield story, so they have limited appeal.”
How will carbon tax work?
South Africa’s carbon tax was first mooted by Treasury in 2010 but has been subject to multiple delays since then. It was finally adopted by Cabinet in August 2017 and is set to be implemented from January 2019.
The tax is set at R120 per tonne of carbon?dioxide equivalent. The first phase, which will run from 2019 to 2022, will offer tax breaks that can reduce the tax to as little as R6 per tonne. South Africa is among the top 20 carbon dioxide emitters in the world, with total emissions from the consumption of energy at 461.29m metric tonnes in 2011, according to the latest available data from the US Energy Information Agency. China, which ranked top, had total emissions of 8.7bn tonnes the same year.
Many stakeholders whom finweek spoke to feel that the carbon tax is not the appropriate tool to use to cut emissions.
Jarredine Morris, a representative of the Industry Task Team on Climate Change, a non-governmental organisation whose members include many of SA’s biggest carbon emitters and high-energy users, says the carbon tax is set too low to really effect change and it will be costly for businesses to comply with and implement.
“We support South Africa’s efforts to address climate change, but the carbon tax is not suitable,” he states. Morris says that SA is within range of where it needs to be to meet its Paris Agreement commitments and is likely to be within that range until some time between 2022 and 2025, making a carbon tax premature.
Most countries choose between a carbon tax and a carbon-budget approach, which allocates a “tolerable quantity of greenhouse-gas emissions that can be emitted in total over a specified time”, according to the World Wide Fund for Nature.
SA has decided to implement both a carbon tax and a carbon budget.
The current carbon-budgeting regime, launched in 2016, is run on a voluntary basis. Companies approach the department of environmental affairs and apply for a carbon budget, which effectively gives them an allowable quantity of greenhouse-gas emissions that may be emitted in total over a specified period. According to Morris, this process will be mandatory from 2020.
After the first phase of the carbon tax, there is a scheduled review process that will look to align the carbon-tax and carbon-budget regimes. But the first phase of the carbon tax runs until 2022, resulting in a two-year overlap between the two systems.
This will be onerous for business, cautions Morris. It will effectively cause a “double penalty”, where companies are forced to cut emissions and pay tax on them.
It’s also difficult for industry to calculate its total exposure to the carbon tax, as regulations are still required on some of the tax breaks, says Deloitte carbon-tax expert Gerhard Bolt.
Technical work to figure out what those regulations will be is also still being undertaken. After the regulations are in place, there still has to be a period of public comment, Morris says, pointing out that Treasury is running out of time.
Bolt says companies in sectors such as petrochemicals, cement and metals are big carbon emitters, and they can’t do that much about it, which means a carbon tax will do little to reduce their emissions. On the other hand, companies that burn fossil fuels have more flexibility, as they can look into alternative energy sources, such as renewables, to cut emissions.
Both Bolt and Morris argue that the socio-economic impact assessment for the carbon tax is not comprehensive and fails to take into account the real potential job losses and economic impact of the tax.
Bradley Preston, head of listed investments at Mergence Investment Managers, says that it is quite difficult to tell what the impact of the carbon tax will be on companies, as the rebate system is complex. Investors need to look at what a company’s potential exposure to carbon tax is, what percentage of its margin that equates to and the company’s ability to pass on that carbon tax to consumers, he advises.
Investors will also need to understand companies’ production practices. Sephaku Cement, for example, has a much newer collection of cement plants and claims it produce far fewer emissions than rival PPC, Preston says. Similarly, companies operating deep-level mines will have a higher carbon footprint than those with open-cast mines.
This article originally appeared in the 10 May edition of finweek. Buy and download the magazine here, or sign up for our weekly newsletter here.