Power & Energy Part 1: Philip Copeman's Sclerotic Monopoly
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South Africa is a peculiar country, to say the least. Over the last 13 years, the country has experienced a rolling blackout in the form of mandated load-shedding of the electrical grid by the country’s State-Owned Energy company, Eskom. It gets very tough when it rains & the whole country, from individual households to large organisations, hold their breath that coal is not wet.
In part 1 we will tackle the history of Eskom & why Philip Copeman’s calls it Sclerotic Monopoly. This piece goes from a high-level overview then into the microeconomics of Eskom.
Elektrisiteitsvoorsieningskommissie (EVKOM)
The Electricity Supply Commission (Eskom) was founded in 1922 through a Parliamentary act called the Electricity act of 1922. The act served to govern the mandate of Eskom, which was to sell electricity at cost & be exempt from tax. The first power stations were built & completed in 1928. Like all startups, Eskom had early adopters who ended up being power users — these came in the form of mining companies. One of the first power stations in Witbank, Mpumalanga was created to power the mining industry. The early boom years of Eskom were crippled post World War 2 when South Africa started having power shortages (sounds familiar).
During the Apartheid years Eskom, with the backing of its government continued to grow, adding more coal-fired power plants. The state-owned company (soc) added a nuclear plant in 1974, establishing the intentions of the Apartheid government to move into nuclear power production
. These expansion strategies were expensive, resulting in a restructure of Eskom’s mandate to a for-profit soc so it could raise institutional funding — backed by the treasury.
Fun Fact: South Africa built 6 nuclear bombs in the 1980s (shaking my head)
By early 1984 Eskom was in another crisis, this time the first of many financial scandals when an assistant financial accountant embezzled R8 million (~R140 million in today’s money)
When democratic South Africa came into effect in 1994, President Mandela sought to increase access to electricity to the neglected population of South Africa. The National Electricity Regulator (NER) was established, this came from a 1993 talk shop called the National Electrification Forum (NELF). The Electricity act was amended in 1995
John Maree & Allen Morgan, as Eskom Chairman & CEO respectively were tasked to increase access to electricity to 1.75 million households by Y2K. The NER had several blunders in the late 1990s, in a period that saw Eskom’s debt increase:
1994, Eskom was owed R920 million in arrears, and by 1999, Eskom’s customer arrears (which included individual customers as well as municipalities) stood at R2 billion. It would take some years to sort out the problem and help municipalities reverse the tide of non-payment. To this day, there is controversy around the distribution of electricity and the levies municipalities put on electricity charges.
John Maree retired in 1997 & was replaced by astute businessman Reuel Khoza, the first black chairman of Eskom. The target of 1.75 million households was reached in 1999. Khoza & Allen worked very well together. The organisation committed to helping its staff buy homes & Eskom Finance Company loaned out R2.2 billion to home buyers. With Khoza & Allen at the helm Eskom continued to reform:
By the end of 1999, almost half of all managerial, supervisory, and professional staff were black, coloured, or Indian. In 1995 alone, the organisation created 500 small, medium, and micro enterprises (SMMEs), and in 1999, it spent almost R1 billion on black-empowered companies. On the training front, Eskom dramatically increased the literacy of its workers and supported thousands of bursars and trainees (for example, there were 480 black bursars and trainees who graduated in 1999).
The 2000s was a decade of increased demand and under-investment of the electrical grid by the government. Infrastructure spending was neglected in favour of social spending. By 2004, 7.8 million households had access to electricity even more demanding it. The country started to clap & President Mbeki in his 2004 SONA created a policy goal of universal access by 2012.
(These days we want smart cities, how the times have changed)
By 2007 Eskom had begun to deteriorate, President Mbeki had been debt cautious & declined the request to build new Power Stations. The age of the rolling blackouts began. This was compounded by the financial crisis in 2008 & the changing political landscape in 2009. The demand for more Megawatts increased as more households required power. Mbeki’s target of universal access by 2012 was not met (access as a % of households was 83%).
Brian Dames was at the helm of Eskom from 2010 - 2014, that’s when the restructuring at Eskom happened. It seemed like a coordinated attack on the parastatal, from the top, continuous changes in ministers & the board. From the bottom, experienced personnel leaving the organisation & finally, Dames himself left in 2014, replaced in 2015 by the infamous Brian Molefe — not a bad guy, just had friends. From 2015 to 2018, Eskom experienced another series of crises’; maladministration, nefarious activity & an economic crushing pursuit of nuclear energy. This was in conjunction with failing infrastructure in the form of 2 power stations; Medupi & Kusile. Then came calls of privatisation & to break up Eskom.
All this, In its almost 100 years of existence, Eskom has never faced competition. It has always operated as a State monopoly.
Philip Copeman’s Sclerotic Monopoly
Image source: Bloomberg
There’s that saying “To Whom much is given, much will be required” argh what am I saying it’s a passage in the Bible, Luke 12:48.
"But the one who does not know & does things deserving punishment will be beaten with few blows. From everyone who has been given much, much will be demanded; and from the one who has been entrusted with much, much more will be asked.”
This passage reminds me of Eskom. Much has been entrusted to Eskom, much has been asked & they seem not to know what they are doing. Yet the nation persists with them — it. Eskom is what you call a state monopoly. There are 3 types of monopolies;
1. a Natural monopoly - think Google & the search engine, no direct government involvement, significant market share in one area that was reinforced by a key component that made it far superior to the next competitor in the market;
2. a State monopoly - these are industries where the state has full ownership of the entire industry. Think Aramco & Saudi Arabia, the Post Office & money supply within a country.
3. The third one is an Unnatural monopoly - this is a combination of 1 & 2. Where a private company creates a product that gets given preferential treatment by the government to fast track its production & market share therefore artificially creating a monopoly. Think Pizer vaccine (too soon?).
But Eskom is another kind of demon. Eskom is what is Phillip Copeman calls a Sclerotic Monopoly.
"A sclerotic monopoly takes the pure monopoly analysis further and examines what happens when society encourages or allows the monopolist further powers to effect legislation that disallows competing technologies with substitute potentials from other sectors, from entering the market. There is a multiplier, choking effect on intermediary uses of the industry output that has a particularly damaging effect on aggregate output.”
Natural monopolies or otherwise known as pure monopolies exist to maximize profits. In doing so they earn what is called super-normal profits, if you did econ 101 you will know that in a competitive market normal profits = 0, so super-normal profits are profits above normal, in excess of 0.
If you look at the graph above, for a monopolist to sell more units, they need to decrease the price due to the downward sloping demand curve. Because demand only increases as the price goes down, the marginal revenue derived from selling one additional unit will always be lower than the price of that unit. The monopolist will have to sell all its units at a lower price as shown in the middle graph above. As the quantity increases the marginal revenue derived will continue to go down until it reaches zero. Monopolies are monopolies for a reason so they always restrict output & price at a higher clearing price relative to the competitive price (P-Mon vs P-Comp above & output A' vs D').
In the power supply market, Eskom eats into the consumer surplus & creates an area of economic waste (D'-A'- B'). Philip Copeman says this causes a problem for business consumers;
The monopolist is restricting output and ensuring a higher clearing price. The consumer pays more – Pmon and uses less - Q2. Output drops from Q1 to Q2 and prices rise from Pcomp to Pmon.
The consumer surplus is now divided up. The monopolist takes the area Pmon- D'- B'- Pcomp. The consumer gets less surplus H'- D'- Pmon. Then the area D'-A'- B' is economic waste. Business consumers that have lost because they have been excluded from the market and are unable to use the inputs at the monopolists prices and were thus forced to restrict their own output. The economic waste and the multiplier there of is the reason that most economists will recommend that societies do not allow monopolies to form, even if that monopoly is owned by the state or the citizens.
In a Sclerotic Monopoly, the monopolist not only controls output but can also control the production of substitutes through legislation.
Eskom restricts municipalities from procuring from Independent Power Providers (IPPs).
I (Philip Copeman) give it the name sclerotic, because the monopolist uses legislation to intentionally choke the the production of intermediary goods, thus triggering sclerosis down all industries that use intermediaries. In the case of electricity it effects all sectors.
Eskom has a monopoly in the production, distribution and supply of power. Because they use fossil fuels, In the short to medium term their supply is a perfectly inelastic supply curve, there’s a finite constraint on supply. Eskom also takes a monopolistic right over the production, distribution & sale of solar electricity. Solar is a separate good with a separate supply curve. It’s cheaper to produce but can only cater to a market that accepts interrupted supply.
Philip further explains this:
In the short run, ESKOM cannot change the supply of electricity. It has to take the supply and maximize the revenue. Fortunately for ESKOM at this full supply price Demand is also inelastic. Further because of power brownouts, it is better to supply less than full capacity. This causes ESKOM to supply at Q2 at a price of Pmon instead of Full Output of Q1 at a price of Pcomp. ESKOM has little need for solar in a fossil mix as it does not focus on selling to customers who accept interrupted supply. However, the opportunity does exist to sell solar electricity to users at prices P3 and extend the output of solar buy Q3-Q2. The sclerotic monopoly destroys F''- E''- Q3- Q2 in GDP right there.
The sclerosis is worse as it has a multiplier. Because the output of electricity is used in production, The demand for solar increases even further from H''- E'' to J''- G''. This increases the price of solar and in fact with the multiplier the area Q2-C''- G''- Q4 is lost. Ah there's the rub! Under the Sclerotic Monopoly, ESKOM (Our company) still collects a monopoly tax of Pmon- D''- B''- Pcomp but the Government (Our Government) gives up 25% tax of the lost GDP Q2- C''- G''- Q4. By freeing the solar market and placing it into a Competitive Market, ESKOM does not change its revenue downwards, so much as the Government revenue increases. (it will take a full input-output analysis to calculate the exact benefit). The key understanding is that there is not a perfect substitution between solar and fossil. The interrupted supply problems exclude the majority of fossil buyers from using solar. There is also a multiplier in that solar users increase demand on all other producers, increase further demand on solar AND fossil generated electricity.
Eskom is a dying dinosaur. After all, it deems solar unnecessary in its supply mix because it is not in the business of selling to customers who accept interrupted supply. Philip Copeman argues that the opportunity exists for the government to free up the supply of solar by allowing IPPs to focus on the private sector which would result in the boom of solar production and a multiplier effect in the expansion of GDP.
The problem isn’t really on the private consumer side. Since 1992 individual households have been installing photovoltaic systems. The problem is on the municipal side (& maybe big business).
A comparative analysis of the coverage of the South African electrical energy crisis during the period 2005-2010 by Cape Town newspapers by Jacobus Petrus Holtzhausen
PageRank (PR) is an algorithm used by Google Search to rank web pages in their search engine results. PageRank patents expired on the 24th of September 2019.
In October 2020 municipalities were given the green light to procure from IPPs through amendments to the Electricity Regulations on Generation Capacity.
So good, thanks.