Is energy the silver bullet we need exit the low growth scenario?

By Nedgroup Investments

JP Landman is a consultant to Nedbank Private Wealth and an independent political commentator.

He focuses on political trends and economics with an emphasis on emerging economies, specifically South Africa. JP reflects on the potential of the energy sector to get South Africa out of the current low growth scenario.

6-year ‘demographic’ recession
Economic growth has to be looked at in comparison to population growth. Statistics show that from the middle of the 70’s to the mid 90’s, South Africa got poorer by a margin of about 11% after inflation. From the mid 90’s to 2014, we had a good recovery with the country getting wealthier by 33% after inflation. From 2015 to 2019, the economy stagnated and per capita incomes declined by about 3%. We’re expecting the ‘train smash’ to come in 2020 where we expect the economy to contract by 9.5% and our population to grow by 1.5%. By the end of the year, per capita incomes will probably be about 11% [1] lower than December 2019, the most serious number since 1921.

‘Safe’ consequences of the pandemic
COVID-19 served to aggravate our pre-pandemic problems by a wide margin and there is little doubt that it is going to cause a huge debt crisis. The -19 crisis has, however, considerably strengthened President Ramaphosa’s position and there is an urgency and cohesion around the need for urgent economic growth, evidenced by the ANC’s recent release of a strategy for economic reconstruction as well as speeches by the President and Minister of Finance. Despite our downgrade by Moody’s in March and being kicked out of the world global bond index in April, we have not gone to the IMF and have survived both the downgrade and COVID-19, which is testament to the stability, strength and depth of the South African financial markets. Our long rates are virtually back to where they were before the downgrade. While the currency is still weaker, this is to be expected.

How to exit a low growth scenario
In view of more fiscal and monetary stimulation not being an option, we need to maintain a stable and predictable macro-economic policy framework. This is evidenced by the R500 billion COVID-19 relief package announced by the President of which only R90 billion extra has to be borrowed from the IMF, World Bank, BRICS Bank and the African Development Bank. Structural reform in the economy, i.e. any action that increases or improves productivity, is needed to get us out of the low growth rut that we’re in. The Treasury’s paper on structural reform identifies five key growth reform areas in the economy to increase productivity. These are lowering barriers to entry, enhancing competition and promoting small business; prioritising growth in labour intensive sectors like agriculture and tourism; re-imagining focused and flexible industrial and trade policies; promoting export competitiveness and regional growth; and modernising network industries, i.e. energy/electricity, telecommunications (spectrum release), transport and water.

What’s in store for the energy sector in South Africa?
The ANC, government and the unions are aligned when it comes to the energy sector with good progress being made in comparison to some of the other growth reform areas. Two documents were released in October 2019. The first dealt with South Africa’s Integrated Resource Plan (IRP) and how energy will be developed over the next ten to 30 years and the second with Eskom. The IRP states that between 2019 and 2030, 30 000 MW of new electricity capacity must be installed from wind (48%), solar (20%), gas (10%), hydro (8%), storage (7%) and coal (5%) and that 11 000 MW of coal-powered station have to be decommissioned over the next few years for economic and environmental reasons. A massive change is coming for the energy industry. We’re moving from a scenario where 95% of our electricity, derived from coal, is provided by Eskom to a situation in 2030 where less than 60% will come from Eskom. The balance will be derived from renewable sources (25%), hydro (8%), nuclear (4.5%) and storage (1%). I expect the gas industry in 10 – 15 years’ time to be much bigger than it is today. I doubt that the two new power stations included in the IRP will be built due to financial constraints and environmental concerns.

How will the new electricity landscape influence growth?
The IRP assumes an energy availability factor (EAF) of 75% whereas Eskom has been running at an EAF of below 68% for the better part of a year. I don’t believe Eskom will get back to 75%, perhaps 70% at the most. This means that more than 30 000 MW will have to be installed. To date, 6 000 MW of renewable energy has brought in R220 billion in investment, of which 42% was foreign investment, indicating huge appetite for energy investment from both local and foreign companies. 30 000 MW will therefore need an investment of at least R1 trillion, which will not come from government or Eskom, but rather from private investors. This works out to about R100 billion a year for ten years. South Africa’s net investment over the last two years was below R200 billion a year, so this will be an almost 50% increase in South Africa’s net investment.

To get out of this low growth scenario, we need to restructure Eskom and more importantly the energy industry by continuing to implement the IRP. COVID-19 is forcing the economy onto the agenda and forcing structural adjustment. The lowest hanging fruit in structural adjustment are spectrum release and electricity which will always be in demand. I believe this is where the economy will get a kick start on the back of real investment and holds the potential to take the economy back to a 2% – 3% growth rate, almost double the population growth and an end to the 6-year ‘demographic recession’.

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 1] Bureau of Economic Research, Stellenbosch