Energy reform brings winds of change and some sunshine to SA’s energy market

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Energy reform brings winds of change and some sunshine to SA’s energy market

SA is blessed with an abundance of sunshine and wind. But does this mean that renewable energy is the most efficient solution to load-shedding?
Energy Reform Brings Winds of Change
Muhammed Munshi

Muhammed Munshi

Portfolio Manager, STANLIB Infrastructure Investments

Key takeouts
  • Restrictive regulation has proved a significant barrier for private energy suppliers in helping to resolve SA’s electricity challenges.
  • A recent regulatory amendment  represents an exciting reform, allowing businesses involved in electricity generation to operate more easily and unlocking a significant opportunity for economic growth.
  • STANLIB Infrastructure Investments is already seeing a number of promising investment opportunities which enable it to diversify its investment into South African renewable energy.
  • Most importantly, while this means we are better able to provide stable, long-term returns for investors in our funds, we are also making a tangible difference to the country’s energy transition and economic growth.

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Restrictive regulation: a significant barrier to private energy Generation 

 

SA’s electricity challenges are well documented. Escalating costs and load-shedding are a regular feature of  South African life. This is largely due to the declining reliability of Eskom’s aging fleet of coal-fired power plants. Eskom itself expects load-shedding to continue for the next five years as it deals with an electricity supply shortfall of approximately 4 000 megawatts (MW). 

 

Unsurprisingly, in a 2020 World Bank Enterprise Survey on South African firms, 55% of those interviewed cited electricity as the most significant of 15 business environment obstacles. 

 

SA is blessed with an abundance of sunshine and wind, making renewable energy the most efficient solution to load-shedding. In addition to supporting the longevity of our environment, solar PV and wind already  represent the least-cost option for the electricity sector. 

 

By 2025 the global weighted average cost of electricity from solar PV could fall by as much as 59% and onshore wind could see cost declines of 26%. 

 

South African commercial and industrial players have long expressed interest in investing in self-generation to achieve reliable and cost-efficient energy supply through cleaner sources of energy. However, regulations and red tape in the sector have presented barriers. 

 

The Electricity Regulation Act (“ERA”) sets out the licensing, registration and operating requirements of the National Energy 

Regulator of South Africa (NERSA) that enable businesses to generate and sell power in SA. The Act is too restrictive and contains burdensome licensing requirements for small projects. This made self-generation by private businesses largely unfeasible. To promote private generation of any scale and unlock sustainable economic growth opportunities, changes to the regulatory environment and an amendment to the Act were critical. 

 

June 2021: a major energy reform was announced 

In a major step to reform SA’s energy supply, the President announced proposed amendments to Schedule 2 of the ERA on 10 June 2021. These included exemptions for all embedded generation projects with a capacity of up to 100MW from having to be licensed by NERSA. This applies whether they are connected to the grid or not and means that industry participants will experience significant improvements to their ease of doing business in the sector. 

 

Another important amendment includes allowing businesses that generate electricity to wheel (or transmit) electricity through the transmission gridsubject to wheeling charges and connection agreements with Eskom and relevant municipalities. A simple example of the benefits of access to wheeling could be an independent power producer based in the Northern Cape, wheeling its solar-generated energy to a mine in the North West Province using Eskom’s transmission network. 

 

All power is carried on the long-haul transmission system and the local distribution system before it reaches the point of delivery to end-users. SA’s distribution network includes municipal networks in towns and cities and Eskom’s network in towns and rural areas. Municipalities and Eskom will have the discretion to approve grid connection applications in their distribution networks (based on an assessment of the impact on their grid). This may remain a bottleneck in some municipalities, while others have stated their intention to support and promote this evolution. 

 

Unlocking opportunities for economic growth 

The reform of the sector plays a key role in unlocking investment in energy projects, driving much-needed power supply to domestic business and a developing economy. 

 

We expect there will be a significant increase in investment into embedded generation projects as companies in energy intensive sectors such as mining and manufacturing are able to develop their own power projects. Mining companies are considering spending as much as R40 billion to construct 2 000MW of power generation capacity. 

 

Independent power producers (IPPs) are likely to have more confidence in investing in larger-scale commercial and industrial projects. The risk and uncertainty of obtaining a generation licence, after incurring significant upfront development costs, is largely removed5. In addition, the ability to wheel power across the national grid allows power to be produced in a separate location from where it is consumed. 

 

This is significant, as not all large energy users have the physical capacity or effective location to generate power on-site. 

This liberalisation of SA’s energy market is expected to add about 15GW to the electricity system over the next five to seven years, amounting to around R100 billion of investment. More importantly, the positive sentiment created by this key reform will attract further interest from international investors. Increased investment in SA’s energy infrastructure will have multiplier effects on the economy, like ripples across a pond, by creating much-needed employment and skills development. 

 

Due to the staggering reduction in the cost of solar and wind energy, coupled with SA’s abundance of renewable energy sources, it is expected that these newly-unlocked embedded generation projects will mostly be sourced from green energy. 

This is hugely beneficial in reducing the carbon footprint of South African industry, which is crucial to maintaining global demand for South African products. The European Union, for example, is considering imposing carbon border tax on some imported goods, which could impact SA’s participation in global trade. It also means that, as a signatory to the Paris Agreement, the country is aligning to these global objectives and will be in a position to secure international funding for “low carbon” growth. 

 

Not without challenges 

While the proposed amendments to the ERA are a significant and positive step for the sector, there are several factors that pose challenges to a successful outcome. 

 

The amendments to the ERA now mean that projects below 100MW only need to be registered with NERSA and not licensed, so they avoid the complex licensing process. To ensure the successful roll-out of this new reform, the NERSA registration process needs to be transparent and have set guidelines and clear timelines. 

 

An important enabling factor in wheeling energy from key solar resource areas (such as the Northern Cape) to commercial 

hubs requires Eskom to make a significant investment in SA’s distribution network. Based on Eskom’s network requirements for sustainability, over 8 200km of power lines will have to be built at a cost of approximately R130 billion over the next 10 years. 

 

While the amendments to the ERA allow generators to wheel (or transmit) electricity through the transmission grid, to ensure practical implementation, it is critical to establish wheeling agreement frameworks for municipalities and wheeling tariffs. Currently only a few municipalities clearly stipulate their wheeling tariffs. Policy and regulatory certainty is required to unlock the full investment potential of this reform. 

 

Municipalities rely on a surcharge on the cost of power they carry over their distribution networks, which forms a significant part of their funding base. It is expected that, with a lower rate and a smaller tax base, most municipalities will look to wheeling as an additional source of revenue. There is always the risk that this layering of costs at municipal level will undo some of the expected benefits for power producers and consumers. 

 

More renewable energy investment opportunities 

The additional direct investment opportunities created by the liberalisation of the sector are largely project-based for private investment, meaning retail investors have access through their pension funds. However, it is important to consider the broader impact on the local economy: a cascade of more investment opportunities across all businesses and sectors and an investment opportunity in the country. 

 

STANLIB Infrastructure Investments manages funds that specialise in investing in renewable energy generation projects. 

These funds are currently invested in a diversified portfolio of 20 individual renewable energy projects, which in total make up investments in approximately 20% of SA’s current procured renewable energy projects. 

 

We are already seeing a number of promising opportunities that will allow us to further diversify our investments in South African renewable energy. 

 

Importantly, while this means we are better able to provide stable, long-term returns for investors in our funds, we are also helping to make a tangible difference to SA’s energy transition and economic growth. 

This article appears in the Q4 November 2021 edition of our StandPoint publication. Click here to download a copy of the full publication.

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