Opposition to Eskom's World Bank Loan is hot air

Environmentalists vent frustration but ignore bigger picture
by Galen Sher

If you haven't heard already, Eskom has applied to the World Bank for a $3.75bn loan to cover some of its enormous financing gap. The majority of the loan ($3bn) will go towards the 4,800 MW Medupi coal-fired power station in Limpopo. Understandably, environmentalists in South Africa and abroad are concerned that the World Bank should not finance power generation based on fossil fuels. While it is good that people around the world are concerned about the environmental consequences of World Bank investments, much of the opposition is principle-based and lacks a broader perspective.

1. Medupi will be constructed regardless of the outcome of the World Bank loan

Construction of Medupi began in 2007 and has slowed since financing became more expensive. However, the project is going ahead with a coal-supply agreement recently confirmed. Opposition to the World Bank loan often ignores the fact that construction of Medupi will continue regardless of the outcome of the loan application.

2. There will be severe regional consequences if Medupi does not go ahead

South Africa supplies "60 percent of all electricity produced in sub-Saharan Africa and our neighbors Botswana, Lesotho, Namibia, Swaziland and Zimbabwe all rely on Eskom for their electricity."

Eskom would have to redirect funding from other projects (including renewable energy projects) to finance Medupi. Failing this redirection, Eskom will have to apply for further electricity price increases to finance Medupi.

Medupi will also generate job opportunities for workers in Limpopo.

3. The World Bank loan will also fund renewable energy projects

The balance of the loan, some "$745 million, will be invested in wind and concentrated solar power projects, each generating 100 MW, and in various efficiency improvements". Pravin Gordhan

4. The construction of Medupi must be seen in the context of South Africa's national climate change policy

South Africa is pursuing reductions in carbon emmissions of "34% by 2020 and 43% by 2025" (Pravin Gordhan). As long as the construction of Medupi and other coal-fired power plants in South Africa are compatible with these reduction targets, it is debatable whether construction of these power plants should be opposed at all.

Eskom has also undertaken efficiency improvements at Medupi to reduce coal and water consumption at the power station. The construction has also passed its environmental impact assessment through the Department of Trade and Energy. These are at least a small comfort.

Now, instead of getting frustrated with the environmental implications of such coal-fired power stations, the public should be more concerned with the potential corruption in the award of the contract to Hitachi to construct Medupi and Kusile - contracts valued at some R39bn!

The benefits of aluminium smelters and Eskom's risky contracts

By Galen Sher

The context
At Creamer Media's Engineering News, Matthew Hill has discussed a 2008 Econometrix report, which says the South Africa enjoys "enormous" benefits from its controversial aluminium smelters.

The report was commissioned in 2008 by BHP Billiton. Southern Africa has three aluminium smelters, two in Richards Bay and one in Maputo, all drawing their power from Eskom. They are part of Eskom's controversial undisclosed deals, obtaining power at much-reduced rates. The smelters have been criticised because:

1. They use large amounts of electricity - as much as 5% of South Africa's total electricity consumption.


2. They obtain their electricity at low cost, which is seen as inequitable.


3. They are a capital (machinery)-intensive use of resources, rather than a labour-intensive use of resources, and hence they do not meet South Africa's employment generation objectives.

Risky contracts
None of this is new. However, the article makes a striking observation:

Under the terms of its contract with Eskom, BHP Billiton pays less for power when the aluminium price falls and more when it climbs. For Eskom, the economic crisis of 2007 and 2008, which led to precipitous declines in commodity prices, including the price of aluminium, blew in the perfect storm, with large chunks of power reportedly supplied to the smelters at below cost. [emphasis added]

Any actuary would immediately spot these contract terms as being extremely risky for Eskom. The cost to Eskom of providing electricity has virtually no relationship to the aluminium price. Therefore, these contract terms effectively place Eskom in a position where it has taken an outright bet on the aluminium price. Specifically, when the contracts were signed Eskom effectively took a wager that the aluminium price would continue to rise at least as fast as inflation.

The aluminium price graph below (Source: London Metals Exchange) shows the aluminium price hovering between $2500/t and $3000/t until late 2008 when the financial crisis broke in earnest, after which the price drops to some $1300/t in March 2009. Today the price has recovered only to some $2200/t. Therefore, from March 2009 to today Eskom has been forced to provide the smelters with low-cost electricity at a time when the utility could least afford it. This situation has arisen through Eskom's own folly in entering into such risky contracts and failing to provide adequately for the risk.



The benefits of smelters
Notwithstanding the costs incurred through providing them with cheap electricity, Southern Africa's smelters have given the region substantial economic benefits, according to the unreleased Econometrix report:

1. The smelters employed more than 3 200 employees and 2 800 contractors when the report was written


2. contributing R1,3-billion in corporate tax to the South African and Mozambique governments


3. it was estimated that about 100 000 South African citizens depended on the Bayside and Hillside smelters for their livelihoods


4. Foreign currency earned from exports... [were] more than R21-billion. [Net of imports, the smelters earned the region R12 billion in foreign exchange.]


5. The facilities comprised around 1% of gross regional product.

The report goes on to argue that South African investment in aluminium smelters should be increased, not reduced, at the time of writing. If only Engineering News, BHP Billiton or Parliament would release the full report to the public.

Patel Pursues Pensions 2

by Galen Sher

In our first blog post on this issue, Julian provides a great introduction, his view and the full bibliography. I chose to create a second blog post, rather than comment directly, because my response is too long for a comment. I strongly encourage the reader to view this short post and some of its bibliography before reading my instalment.

I am close to pensions and this issue is therefore compelling to me. I hope to provide a middle ground between the various commentators here and an actuarial perspective.

Patel is mooting that 5% of pension funds' assets be invested in government debt, potentially a special kind of 'developmental' government debt, with the intention that this policy would provide government with additional capital to finance public infrastructure.

The Pension Funds Act of 1956 and the FSB's Regulation 28 already encourage retirement savings vehicles to invest in government bonds. Government bonds also provide a good match for level pensions liabilities and provide diversification. For these three reasons, pension funds already invest, sometimes extensively, in government bonds.

If the 5% is viewed as a minimum allocation to government bonds, its impact would be negligible as the vast majority of funds already achieve this. Funds could also use structured products to circumvent this requirement.

If the 5% is viewed as an additional allocation to Dion George's "parallel system of government debt", then this policy could be viewed as Dawie Roodt's "nothing more than an additional tax" strictly when pension funds would otherwise not have invested in such debt. It would amount to an additional tax when markets are performing well, and a subsidy otherwise.

Mike Schussler points out that the real (pun intended) risk is that long-term inflation erodes the fixed returns earned on government bonds. Contrary to Dawie Roodt's skepticism, this problem could be overcome by issuing more inflation-linked government bonds, the demand for which is large in SA.

It is impossible to be decisive on this issue without more information. The proposal is both "workable" (Mike Schussler) and "flaky" (Dion George).

I have purposely ignored the moral issue of whether this level of government intervention is acceptable, or the philosophical-legal issue of whether it infringes on individuals' property rights, but these certainly merit discussion for another blog post.

The management of retirement savings is a sensitive subject because retirement savings constitute a substantial portion of an individual's wealth at retirement.

Gross Greek Government

Not even 2000-year-old ruins are safe from bad government:

Greek heritage crumbles - Mail & Guardian

Perhaps this shows that national monuments shouldn't necessarily be owned by national government.

Patel Pursues Pensions

So the state wants to "encourage" the trustees of private citizen's retirement savings to "invest" in "development projects". So much for private property rights.

Incidentally, this is why I oppose pension funds: they significantly reduce people's power over their (implicit) retirement savings. It's almost a Law of Nature that the less power you have over your money, the less of it you will have in the end.

Here are some relevant links:

Patel to tap pension funds - Times LIVE

Patel eyes pensions trillions for state fund - Free Market Foundation
"The unintended consequences of this action are entirely predictable - individuals will stop investing in retirement vehicles, thereby reducing the level of savings in the economy, resulting in less money for genuine investments that drive economic growth."

Patel's pension plan dangerous - DA - Politicsweb
"Under Apartheid, pension funds were utilised to fund the Apartheid regime through the implementation of prescribed assets."

Uasa opposes Patel's retirement fund plan - Times LIVE
"If the state were a business, we at Uasa certainly would not have invested our hard-earned retirement savings with them."

NUMSA backs Patel's pension funds proposals - Politicsweb

Patel's pension plan 'workable' - Fin24.com
Economist Dawie Roodt: "Politicians are not good at identifying winners and here we have the idea that pension funds be forced to invest 5% of their savings into a politically determined project."


Well, at least we're not Argentina:

Argentina Makes Grab for Pensions Amid Crisis - WSJ

Just a jump to the left (again)

Yesterday's feature article at Politicsweb by Dr Pierre Rabie (DA MP) provides an excellent response to Minister of Economic Development Ebrahim Patel's anticipated policies of import tariffs and company bail-outs (albeit with strict conditions).

Central to the argument is that:

• Protectionism (like company bail-outs and import tariffs) protect jobs for certain interest groups only
• But they force South African consumers to pay higher prices for the goods so produced.

This represents a direct wealth transfer from South African consumers to the workers who would otherwise lose their jobs. It's all well and good to say we should protect workers from losing their jobs, but at what cost? Should all South Africans have to pay higher prices because organised lobbying interest groups like Cosatu demand import tariffs?

In the South African context of extreme poverty, my opinion is no. Workers, however vulnerable, are nevertheless less vulnerable than the unemployed and poorest South Africans. Such workers should not be entitled to protect their interests at the expense of the poor and unemployed.

I thought this piece of the article was balanced:

"...the broader costs to society far outweigh the short term sliver of benefits to a narrow interest group. The ANC government needs to accept that the figureheads of its so-called developmental state, the parastatals, requires urgent attention by way of privatisation, and that labour market rigidities needs to be solved in order to make it easier to employ job-seekers. Until this is done, efforts to step up protectionism are at best attempts at distraction, and at worst interventions that would achieve the direct opposite of the sustainable, job-creating economic growth we need."