There is an urban legend that the word “tariff” was named after the port city of Tarifa that was regularly raided by Portuguese Pirates during the Spanish Empire, but the origin of the word comes from the 12th century when Baghdad was the capital of the Islamic World and at the centre of scientific advancement.
The term translates from Arabic loosely as “information” and when it comes to electricity tariffs, regulators have to make sure that the information reflects the true cost of electricity to the consumers.
In the days of vertically integrated utilities, and when fixed prices were set by a regulator, electricity was always cross subsidised, leading to the false assumption that electricity costs were the same during the day and night and carried the same value to consumers during those periods. The various generating technologies were compared to one another, using a simplistic discounted cash-flow model, called the Levelized “lying” Cost of Electricity (LCOE), and electricity to the end users was priced in dollars or rand per kilowatt-hour. The LCOE is determined by dividing the entire cost of the electrical plant in net present value by the amount of electricity that it will generate over its lifetime.
The unfortunate consequence of the tradition is that it gave policy makers the wrong paradigm about electricity, which was to regard it as a commodity and not as a service (EOS). The metric is used today by salespeople, but few experts inside the energy sector take it seriously, because it does not account for the full cost to guarantee the end user a security of supply.
Partial off-grid users still get their security of supply from Eskom, either when there are low energy outputs from the energy devices or when their local security of supply (battery) runs out.Users who claim to be partially off-grid because they have installed solar, or wind power, are effectively using Eskom as free insurance.
When the Sun does not shine, or there is little available, like when it rains; or when the wind does not blow; or when the installed battery goes flat; they rely on Eskom for emergency power. The current system of pricing in kilowatt-hours alone does not adequately price this essential service.
The consequence is that partial off-grid solutions (such as a solar panel on a residential household that draws electricity from Eskom at night) might appear more affordable than they might otherwise be, because the consumers can get away with passing their service costs onto the poorer households.
As more residential customers use only the power utility at night and solar panels during the day, the lack of revenue will result in Eskom’s death-spiral if the tariff does not carry the full cost of having the utility act as a battery at night. Inevitably, government bailouts will continue under the current framework.
There is no agreement among economists about which metric is to be used, but there is an agreement that LCOE has various shortcomings and, notably, that it cannot compare dispatchable and non-dispatchable technologies, does not take into account the integration cost, the cost of ancillary services, back-up, and that it is not value reflective.
In addition, reliance on the LCOE by policymakers creates bad market incentives that favours intermittent sources at the cost of baseload capacity, and therefore there has been various attempts to replace it by other metrics such as the Value adjusted Levelized Cost of Electricity, the Full Cost of Electricity and the Relative Cost of Electricity.
With Treasury having to absorb Eskom’s debt, and municipalities having a shortfall in revenue due to the widespread expansion of rooftop solar, South Africa now has the unique opportunity to become pioneers in enacting legislation that can settle the LCOE debate by selling electricity as a service (EOS) as opposed to selling Electricity as a Commodity (EOC) only.
The shift in mindset will allow for electricity suppliers (Eskom or private) to charge a fixed rate for the connection that accounts for the services, such as peak capacity, dispatched ramping, grid balancing, synchronous power, system strength, frequency- and voltage stability, while having a variable market for the fuel cost.
In the latter market, intermittent sources will compete with thermal plants for the fuel source on a cost per cost basis and, in the former, batteries can compete with traditional methods for power system stability. Customers should be allowed to avoid the fixed cost only if they are completely off grid.
Such a policy framework would incentivise the correct electricity mix in terms of baseload, mid-merit, and peak generation, as well as create a market for pumped hydro, battery storage and partial off grid solutions. The change would also prevent Eskom’s death spirals through cost-reflective fixed costs. The electricity suppliers would, in addition, have the correct incentive to help consumers individualise their demand curve by offering them energy efficient solutions or by helping them move partially or fully off grid.
The government should even add an additional fee that cross subsidises electricity to poorer households fairly and equitably.
With the upcoming parliamentary debate regarding Eskom’s debt relief, the National Energy Regulator of South Africa should be encouraged to adopt an EOS framework where consumers will be charged a fixed price for a single or three phase connection (priced in rands per amp), and in addition have a variable fuel price (priced in rand per kwh).
Such a framework will prevent future Eskom bailouts through cost reflective tariffs.
Hügo Krüger is a YouTube podcaster, writer and civil nuclear engineer who has worked on a variety of energy-related infrastructure projects, ranging from Nuclear Power, LNG and Renewable Technologies.
* The views in this column are independent of Business Report and Independent Media.