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Awarding prizes for non-innovation

By Rutger-Jan van Spaandonk

On 6 December of last year, Eskom received the Financial Times Global Energy award for Power Company of the Year 2001 because, according to FT: “Eskom has proved its ability to provide the world’s lowest cost electricity to its customers while developing economical, efficient and safe methods of combustion of very poor quality of coal“.

This remarkable feat has not received much attention, but now that Eskom is using the cost advantage in its advertising campaign, the time has come to examine its claims – and the basis for FT’s decision – in more detail.

In its advertisements, Eskom proudly compares the price of a unit of energy (kWH) in South Africa to that in other countries, concluding that South Africa has the lowest electricity prices in the world. To share their data with you: South Africa – 2.43 US$ cents, Finland – 3.52 US$ cents, Italy – 7.92 US$ cents and the USA – 7.54 US$ cents.

However, if you look at Purchasing Power Parity (PPP is a measure of the relative purchasing power of different currencies; it is measured by the price of the same goods in different countries, translated by the exchange rate of that country’s currency against a “base currency”, the int$) the story looks rather different: South Africa – 6.45 Int$ cents, Finland – 3.52 Int$ cents, Italy – 10.85 Int$ cents and the USA – 7.54 Int$ cents. All of a sudden, South Africa’s electricity is 80% more expensive than in Finland, the lowest cost country.

But is it fair to use PPP numbers, you might ask. Yes, it is. Especially since Eskom in its latest annual report indicates in another, more outdated comparison of electricity prices, that “relative purchasing power of the respective currencies is not reflected in these values”. You would not put in this disclaimer if you felt that it did not matter.

It is questionable whether the so-called lower prices are the result of Eskom’s strategy or competences. The Deputy Minerals and Energy Minister Susan Shabangu has admitted herself that the low prices are the result of cheap coal, previous exemption from tax (Eskom started paying taxes in 2000) and dividends, and the fact that there is overcapacity and the existing capacity has been depreciated already. Other sources claim that the low return on assets of around 11% – which should be closer to 16% to attract foreign investors – also contributes to the electricity prices being lower than they ‘should be’.

So, we should expect the prices to rise when Eskom has to start adding capacity, or attract private capital. Bear in mind that Eskom already asked for a 7.4% increase (2% points above inflation) to be allowed at the end of last year, although the NER only approved 6.2%.

The second claim to fame pertains to Eskom’s skill at combusting coal. Eskom generates 95% of electricity consumed in South Africa (the rest is imported) of which 92.5% is generated by coal-fired power stations.

The last time I checked, scientists were still convinced that the global climate is changing due to the increase of greenhouse gases in the atmosphere, which is largely caused by using carbon-based fuels, and of which coal seems to be the most polluting.

This is the reason why governments, utilities, oil companies, car manufacturers and the likes are looking for alternative energy sources. To foster innovation and encourage these attempts, prizes should be awarded for advances in the field of fuel cells, solar and wind energy, or even nuclear power (such as Eskom’s pebble-bed modular reactor project) – not for better burning of coal.

Clayton Christensen showed very convincingly in his seminal 1995 book “The Innovator’s Dilemma” the difference between firms that focus on sustaining technological change versus the ones that do disruptive technological change. Companies in the first category incrementally improve the technology that form the basis of their business model (such as using coal as fuel in power stations), whereas truly innovative firms break the mould by using completely new, paradigm shifting technologies, and over time ‘creatively destruct’ the businesses in the first category.

What is more, the author shows that the performance of disruptive technologies in the beginning under performs the existing technologies (think solar energy), and that they are only applicable in small and emerging markets (think fuel cells), and thus not attractive to incumbent companies and their customers. Therefore, a company’s decision not to invest in disruptive technology often seems very rational!

All in all, electricity in South Africa is not as cheap as we are led to believe, and we should brace ourselves for substantial increases. Furthermore, Eskom needs to be careful not to fall in the trappings of sustaining technological change. But if they ever do, they will have a trophy from the Financial Times to show for it.

Rutger-Jan van Spaandonk is the founding director of FutureForesight Group, a boutique strategy consultancy. He can be reached via mailto:rj@futureforesight.com.

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The Big Change is a business strategy blog and newsletter published by Arthur Goldstuck, managing director of World Wide Worx, a leading technology research organisation based in Johannesburg, South Africa.

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