Energy17.12.2014

Scary future of power outages in South Africa

To quantify the cost of the electricity crisis is not easy but, with major manufacturing role players stating that it’s cost the industry R6 billion so far, it’s clear that the power shortage is causing trauma in the economy.

South Africa is very likely to have electricity shortages for the next three to five years and possibly longer for big projects. The costs are enormous: in money, direct economic growth and perceptions too. Technology innovations will also be affected.

The negative economic effects

1: While the whole economy will be affected, the two major industries where growth will decline are energy-hungry manufacturing and mining.

For example, the whole local heavy industry and especially the smelters or refineries of chrome, gold, platinum, steel and aluminium will no longer be a viable option for new or supplementary investment without energy saving. This industry was a great earner and part and parcel of the government beneficiation policy which is now no longer possible – probably for the next decade.

Electricity and manufacturing both going nowhere fast

Electricity and manufacturing (source: Economist.co.za)

Lost sales in retail, restaurants and motor trade will probably mean that retailers have to work harder for similar sales, although there may be opportunities when customers have to replace electronic items. Constant outages are a double-edged sword for the electronic sector: more items break, but the consumer will likely hold back on buying newer durable electronic consumer items – such as TVs, game consoles and entertainment systems – for fear of losses.

Even services such as advertising will suffer as viewer and listener numbers will decline on many popular programmes.

Some economists have calculated that SA has already lost 10% of GDP. The problem is that the future also loses more and more. Already growth prospects have declined from just over 4% potential to 2.5%. Every year the GDP loses another 1.5% of value added to the economy and it builds up over time. So within five years South Africa will probably lose at least 7.5% of GDP or more and likely another 10% or more of potential GDP.

2: Fewer investors, local and foreign, will invest in a country which already has high effective corporate taxes and huge administrative requirements without the added costs around power shortages, such as generators or lost time and customers.

Investors compare risk and returns with weak growth, which indicates that returns will be under pressure. Outages and intermittent supply increases the risk of doing business here. Along with strikes, [power supply] is the factor mentioned most by investors I’ve spoken to in the last few years.

Having a stable supply of both electricity and water is a necessity in every modern economy. One cannot invest millions or billions and not have proper power supply.

3: Productivity will be affected by time lost on factory and retail floors as well as in extra traffic congestion. There’s also likely to be more breakages and a longer reaction time to them.

Service industries such as banking, transport and communication will all have extra costs for no extra returns. Profit margin will be squeezed and investments in both machines and people will be realigned to account for productivity loss.

Productivity declines will make it harder for local firms to compete with foreign firms here and abroad. The rest of the world is increasing its productivity a little faster than South Africa already so the further slowdown in productivity will be hard on our competitiveness.

4: Employment opportunities will be depleted; the current 8.5 million people who would work if given the opportunity today will grow to over 10 million in the next decade. This is the human element of the tragedy that should not have happened. The lack of power has probably already cost over one million job opportunities over the last seven years. This will worsen as growth falters and some companies actually close sections or are just not able to produce and therefore pay employees.

5: Our current account with the rest of the world will remain far in the red as Eskom needs to import capital equipment and South African producers cannot make goods to take to the international market. The recent apricot production is a case in point where producers could not pulp their fruit and freeze it for export.

Furthermore the whole production process is getting more expensive as generators or stoppages add to costs, making South African producers more expensive relative to others, maintaining the market share difficult and production timelines more difficult to manage.

Exports haven’t risen in volume terms for some years already and are now more likely to decline, which will harm South African earnings. The situation is so serious that many exporters are actively looking to replace SA production with other countries’ production.

6: Inflation will rise quicker than would otherwise be the case. Firstly electricity prices will increase above the 6% inflation target for many years, as Eskom will struggle to keep the lights on without using expensive gas turbines which cost over R2.50 a kilowatt hour (kWh) to produce, while Eskom only gets about 65 cents for the average power price.

The graph below shows how electricity price increases have beat inflation thus far:

Inflation index vs electricity & water indices

Electricity and inflation

Selling less electricity makes the cost per kWh higher and Nersa is likely to boost the 8% increases per year by quite a fair margin every year. We expect about a 10-12% price increase in electricity on average per year for the next five years. There’s even a good chance that increases could average above 14% – which would mean a doubling in kWh prices in less than five years.

With intermittent electricity outages, costs of South African production and services rise and this too will feed into inflation. Inflation will now decline because energy prices are declining but we will remain about 100 to 200 basis points higher than we need to be: ie if inflation was to be 4% it’s more likely to be between 5% and 6%.

6: Government finances and its deficit are likely to remain larger than expected. With less retail sales VAT will decline and with higher industry costs corporate tax collections will be under pressure again (lower growth will impact the growth of employee tax growth and other taxes eg customs and excise).

The government debt-to-GDP ratio and the net debt situation will now worsen as government sells assets to help fund Eskom. Also, many government guarantees will have to be met by government as even other State-owned enterprises will now struggle to meet revenue targets.

Societal problems

But there are other problems for society as a whole.

1: Longer traffic delays – already noticeable – with economic and social effects. Many parents will have to leave earlier for work and arrive home later, making them more tired and angry at missing out on family events such as children playing sport.

The frustration will also lead to more road rage

People will use more fuel to get to their destinations which will hurt the pockets of the households (30%) who have a car. Commuters will be frustrated when they are stuck in a train with no power or busses stuck in traffic jams.

2: Insurance costs are likely to rise as more electronic goods fail and crime levels increase as electric fences and alarms cannot cope with long periods of outages. Crime and overall claims are likely to rise and many people will feel that security costs just have to rise.

3: South Africans will feel more helpless as traffic delays, crime and job security worsens. This will result in a confidence decline and durable good sales will also feel the impact.

4: The political shifts now probably underway will likely get quicker and the ruling party will have to work hard to win back voters’ trust. The longer power outages continue the bigger the effects on ordinary South Africans’ voting intentions.

But perhaps the biggest effect is that outages will form part of South Africans’ lives for at least the next two years. That in itself will be a very big talking point and something everyone has to plan for.

When the ANC blames Eskom it’s clear that the ruling party has learned from e-tolls and is trying to put distance between it and Eskom –although it is the ruler that allowed this situation to develop.

This crisis however has one simple silver lining. We will see a greater willingness to talk across our divides, whether it be colour/income or government/business/unions. That is the one thing that could bring us all together in getting things going. It could just lead to us talking about what really needs to happen and what business needs and even to the end of the state monopoly Eskom.

Let’s all hope that this crisis is not wasted.

Mike Schussler is the owner of Economists.co.za – an economic consultancy.

Source: Moneyweb