EDITORIAL: Industrial policy gone wrong (South Africa Business Day Live Editorial – August 13, 2013)


REPORTS that Eskom stands to lose as much as R11.5bn in revenue as a result of its controversial preferential power agreement with BHP Billiton is a brutal lesson in the pitfalls of ill-conceived industrial policy. It will also hopefully provide a learning opportunity for Eskom as it completes the process of negotiating the present round of renewable energy agreements.

In its annual report last week, Eskom said it expected its liability as a result of an agreement signed in 1992 to provide cut-price electricity to BHP Billiton’s aluminium smelters, Mozal and Hillside, to more than double from the R5.9bn reported in last year’s financial statement. While the potential for revenue losses as a result of the agreement is regrettable, the biggest error in the agreement was failing to build in a stop-loss clause. The extent of the liability is calculated as the opportunity cost of supplying electricity to BHP Billiton on the present special pricing formula compared with the revenue that would be generated if it was to sell that power at regular industrial customer tariffs.

When the agreement was signed in 1992, it was hoped it would serve the dual purpose of utilising the power utility’s excess capacity and developing South Africa’s industrial capacity. However, during the first decade of democracy in particular, economic growth and Eskom’s failure to invest sufficiently in new capacity has meant that excess capacity has been eroded, to the point where there are now other industrial users willing to pay more than BHP Billiton — hence the potential for loss.

In anticipation of having insufficient capacity to honour the contract with BHP Billiton, Eskom has tried unsuccessfully to renegotiate the terms of the agreement — specifically its duration. This is the policy’s biggest failure.

To attract investors to large-scale projects such as aluminium production and ensure their financial viability over the long term, it was essential for the government to provide a sweetener to the deal, such as discounted electricity supply. However, the degree to which risk is shared between investor and benefactor needs to be re-evaluated.

In Eskom’s defence, the original deal does include a clause that permits the utility to disrupt the power supply to BHP Billiton’s smelters in the event that household demand exceeds the grid’s capacity — a right Eskom invoked earlier this year. However, this is an extreme measure that, on balance, could be even more costly to BHP Billiton than a renegotiated agreement.

For the rest of this editorial, click here: http://www.bdlive.co.za/opinion/editorials/2013/08/13/editorial-industrial-policy-gone-wrong