Global Insight Perspective
Significance	A continued loss of production in the mining sector could negatively impact on employment investment and exports.
Implications	Should the current situation continue, growth could be seriously compromised.
Outlook	Growth could be at least 0.3% lower than projected for 2008.

Eskom’s key customers include 138 major industrials, factories, and gold and platinum mines. Following Eskom’s request on Friday (25 January) to cut consumption to “survival levels”, gold and platinum producers AngloGold Ashanti, Gold Fields, Harmony, Anglo Platinum and Impala Platinum subsequently suspended production at all of their mines as they cannot guarantee the safety of their miners in such conditions. However, a continued loss of production will have severe economic implications.

Background

A combination of planned and unplanned maintenance and wet weather resulted in an electricity shortfall of around 3,000MW daily in January 2008. Eskom then embarked on an acute load-shedding schedule that, until now, has been met with annoyance and resulted in large costs to businesses from hastily having to buy generators and alternative power sources in order to stay open. However, with the forced closedown of factories and mines, the situation has now turned into what Public Enterprises Minister Alec Erwin has declared a "national emergency".

The government has officially taken the blame for a lack of planning for future energy usage, as it emerged that a white paper drawn up by the Energy Ministry in 1998 predicted that electricity would be in short supply after 2007 should expansion plans not be implemented. Favourable global conditions led to the country subsequently registering growth in excess of 4% per annum over the past seven years, leading to electricity demand far exceeding the 2.3% per annum initially forecast. In 2007 alone, electricity demand grew by 4.9% and is forecast to grow even faster as the economy approaches the government’s target of 6% sustainable economic growth by 2014.

Handling the Crisis

Eskom’s long-term expansion plans total around 150 billion rand (US$21.4 billion) up until 2012, the price tag of which could double as costs escalate. Eskom is planning to add 50% more capacity in the next 10 years—all in all, new generating capacity of 40,000MW is to be added by 2025, estimated to cost around 1 trillion rand (US$142 billion). The projects include returning old power stations to service, upgrades to existing power stations, new coal-fired power stations, new gas turbines, and the building of up to 20,000MW of nuclear power stations. However, most of these projects will only come online from 2009 onwards.

Medium-term solutions include the government’s National Electricity Emergency Programme, which is an extension of the current demand-side management plan. The programme includes:

• encouraging the use of compact fluorescent light (CFL) fittings.
• the installation of 1 million solar water-heaters, with a subsidy of between 20% and 30% per unit.
• the implementation of "smart metering" in residential houses to help match generation and consumption.
• encouraging fuel switching, thus persuading households to use more liquid petroleum gas (LPG), resulting in the implementation of price regulation on LPG.
• converting all traffic and public lighting to solar power.
• raising tariffs.

Over the short term, a power-rationing programme will be introduced, but no detail on this is currently available.

Economic Impact

Up until 25 January 2008, load-shedding resulted mainly in frustration and costs to small and medium businesses, as well as consumers. However, the lost production capacity and sales were mitigated to an extent by extra (unplanned) spending on emergency power sources. The problem now, though, is that the closure of South Africa’s largest gold and platinum producers, which could last for another four weeks, has increased the risk to growth considerably. South Africa’s mining industry is a key contributor to the economy through exports, investment and employment. The direct share of mining and quarrying stands at 6.5% of GDP, but is significantly more if all the indirect links to the economy are taken into account. Around 400,000 people are directly employed in this sector. Mining and quarrying exports totalled 150 billion rand (US$21.4 billion) in 2006, contributing 38% to total merchandise exports. In 2006, mineral sales alone reached 193 billion rand (US$27.6), with platinum at 65 billion rand (US$9.3 billion), coal at 38 billion rand (US$5.4 billion) and gold at 37 billion rand (5.3 billion). A spokesperson at Harmony Gold Mine indicated that the company would “lose 60 million rand (US$ 8.6 million) from Friday's suspended operations”. Data from Statistics SA on mineral sales indicates that up to 9 billion rand (US$1.3 billion) could be lost in gold and platinum sales, should all the gold and platinum mines come to a standstill for one month.

Furthermore, Eskom has the contractual right to call upon export-destined coal if there is a shortfall in the contracted tonnage of domestic coal. Excessive wet weather, on top of the power cuts to coal mines, has led to a short supply in coal for power generation. Thus, a loss in export revenue will not only stem from lower gold and platinum sales, but from coal as well, adding to the current-account woes, already suffering from an increased import demand for power generators and capital goods to satisfy infrastructure investment demand. The result would be depreciation in the rand, aggravated by a loss of foreign investor confidence in the economy. Resultant increased inflation, helped along by even higher electricity tariffs, would then keep interest rates higher for longer.

It must be acknowledged that an attempt to quantify the effect of the current electricity crisis in the country is extremely difficult as a number of counteracting forces are at play. However, as an illustrative exercise, Global Insight tested the sensitivity of lowering investment spending in the economy. Private-sector investment levels were lowered by 1% over five years, compared to the baseline, to incorporate current production losses by the mining and manufacturing sector, as well as the postponement and possible cancellation of future capital projects. Government and parastatal investment spending were kept at baseline levels, as these entities are already committed to spending the allocated amounts under the government’s growth initiative. Under the assumption of elevated domestic price levels to accommodate further electricity tariff increases and capacity shortages, as well as sustained high imports, the results indicated that, compared to the baseline, 0.3% could be shaved off GDP growth for 2008, while the target of 6% growth by 2014 could be missed by 0.4%. It must be stressed that, in the absence of clear indications on the likely outcome of the energy crisis, crude assumptions were made in this exercise. A number of factors, including likely increased government spending and the financing thereof, were not taken into consideration. The impact on investment and consumer spending will only be known as the year progresses and actual figures become available.

Outlook and Implications

Global Insight has found that growth could be seriously compromised if the current situation continues. Eskom, on the other hand, has repeatedly stressed that the situation currently represents an “energy shortage” rather than a “capacity shortage”, and that unplanned maintenance, coupled with planned maintenance, has led to the current crisis. However, this highlights another crucial capacity constraint in the economy—namely a lack of skills. A shortage of engineers and technicians has added to the absence of sufficient short-term planning and preventative maintenance, which in turn has aggravated the situation created by higher than expected economic growth. We are encouraged by the government’s engagement with business to resolve the situation, but stress that private-sector participation in the electricity sector, through which added skills and knowledge could be brought to the table, has become a necessity. Plans to emphasise the development of renewable energy are closely coupled with this. Even so, should the current situation continue, we expect GDP growth to be at least 0.3% lower than forecast.