“Electricity supply throughout the world is undergoing a revolution. This is being caused mainly, but not solely, by electricity utilities having to meet new pressures resulting from global markets and governments opening up their countries to foreign investors to help fund power sector expansion and development. As a result, utilities are having to see themselves as businesses, and act accordingly. South Africa is not immune from these forces, and will have to move broadly in line with developments taking place in the rest of the world, while also ensuring that the industry evolution meets South Africa’s special requirements. However, in South Africa the main drivers for change are potential economic efficiency gains, and technological change (e.g. different economies of scale in power plant construction and new information and control technologies).” _Source: White Paper on the Energy Policy of the Republic of South Africa_ , 1998.<sup>1</sup>

# **I. Introduction and Preliminary Observations**

The primary objective of this report is to examine the structure of the South African electricity supply industry and to analyze public policies designed to improve its performance. Our focus on the electricity industry is motivated by its critical role for sustained economic growth, poverty alleviation, and international competitiveness. South Africa’s electricity sector has played a particularly important role in the country’s industrialization and economic development. The origins of the sector at the beginning of the twentieth century, for example, were driven primarily by the requirements of the booming mining industry.<sup>2</sup> With its abundance of coal reserves, South Africa has a distinct comparative advantage in energy supply that has contributed to growth opportunities for the economy as a whole. Indeed, low-priced electricity generated from coal-fired stations has been one of the country’s key competitive advantages.

The sector’s main operating entity, Eskom, appears to be an efficient and wellfunctioning utility even when judged by advanced industrial country standards. Eskom has: (i) been generating some of the lowest-priced electricity in the world (in 2005, for example, the average electricity tariffs in South Africa for both domestic and industrial customers were the lowest among the countries surveyed by the International Energy Agency); (ii) managed to meet and in some years actually exceed the government’s ambitious electrification targets with significant cost reducing innovations—within a decade (starting in the early 1990s), the number of domestic electricity customers more than doubled making South Africa’s recorded electrification rates the highest in world while at the same time dramatic reductions in the capital investment costs of rural connections were achieved through careful network planning and significant technological innovation (between 1995 and 2001, the average cost of rural electrification declined by 40 percent in real terms); and (iii) at the same time, the utility exhibited robust financial and operational performance—during the past twenty years Eskom has earned between 8 and 12 percent pre-tax rate of return on its assets, its debt/equity ratio declined from 2.06 in 1980, 1.6 in 1995, 0.3 in 2003, and to a record low of 0.18 in 2005, while during most of the same period the utility reduced its prices in real terms (since the late 1980s, Eskom’s average tariff increases have been consistently below inflation until

> 1 http://www.dme.gov.za/publications/wp_ene/whitepaper1998.htm

> 2 Spalding-Fecher, R. 2002. “Energy and Energy Policies in South Africa: An Overview”. _NER Quarterly Journal_ 1: 1-18.

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