Is the growth path to Net Zero economically feasible?

At the begging of April, Eskom sounded an ominous warning informing the public that there may be up to 100 days of loadshedding in winter. As the cold weather swept across South Africa two weeks ago, Eskom lost significant generation capacity and was forced to upgrade its loadshedding from peak hours only to the whole day from 20 to 22 May.

The challenges that the utility faces to provide the only product that it produces are well documented, as is the need for South Africa to catch up with the world agenda regarding the migration towards a Net Zero economy. However, recent reports from PwC indicate that this may turn out to be a significant challenge for both South Africa as well as the rest of the continent.

South Africa’s precarious position

A recent PwC report points out that South Africa is starting on a high base when considering the carbon intensity of our major industrial and energy blocks and is currently ranked 95 out of 180 countries in the 2020 Environmental Performance Index.

We will continue to face major challenges due to heavy reliance on Eskom coal-fired power, which in addition to poor reliability (load-shedding in 2019 caused an estimated R59bn damage to the economy) has risen in cost by 300% over the past two decades (and will likely need to continue at above inflationary escalations).

The report adds that, over and above our internally driven risks, the Climate Policy Initiative has estimated transition risk to South Africa arising from international policy trends alone, to be around US$84bn.

What does this mean for business?

Although this Net Zero journey is largely driven by technology innovation, it will challenge every organisation’s strategy, agility and resilience in the face of rapidly changing market dynamics and regulatory trends.

The PwC report points out that IRENA has estimated the required investment to achieve global Net Zero by 2050 at USD130 trillion, probably making the energy transition the single biggest growth opportunity for winning organisations, but equally a significant disrupter, with the risk of major stranded assets. To remain relevant and sustainable in this future decarbonised world, all organisations will have to transform and invest as they navigate market disruption, pivot their asset base as well as restructure their workforce and capabilities.

PwC points out that a commitment to Net Zero needs to be at the heart of every winning organisation, bringing together strategy, technology, investment and compliance. As a global professional services firm, PwC is incorporating Net Zero into our own organisation and culture and have made a commitment to achieve global Net Zero by 2030.

Net Zero is here and it will change our lives.

World leaders, economies and organisations are acting now. Propelled by rapid technology innovation, deflationary costs and accelerating policy measures, the global Net Zero journey is well under way.

The report adds that the EU economic region can be considered the global Net Zero leader and gives us a glimpse of the road ahead for a developing economy such as South Africa. Some of the measures we can expect include: regulated emissions disclosure; banning of carbon intensive technologies; advanced taxation such as the Emissions Trading System (ETS) and the Carbon Border Adjustment Mechanism (carbon border tax), all backed by climate law. The European Climate Law legally obliges its 27 nations to collectively slash greenhouse emissions by 55% from 1990 levels by 2030; and to become a net-zero-emissions economic zone by 2050.

Despite the challenges of a highly carbon-intensive economy and the need for a Just Transition**, South Africa is accelerating commitments and actions along our own Net Zero pathway.

The PwC report points out that progress in South Africa includes: establishment of a South African presidential council on climate change; introduction of carbon taxes, which are set to become exponentially punitive after initial free allowances lapse; recognition of regulated carbon trading instruments; Eskom unbundling and reform; easing of embedded generation regulations; opening up of small scale embedded generation (SSEG) and municipal IPPs; focus on alternative fuels such as green hydrogen; an accelerated national renewable energy purchase programme (REIPPP); publishing of a South Africa Net Zero least cost energy model, and the recommendation by the Presidential Climate Commission to strengthen emissions targets contained in our National Determined Contribution (NDC) to be compatible with the 1.5 degree global target as per the Paris Agreement. This commitment will put South Africa on path to be a global leader in Climate Change.

Accepting that this transformation journey is inevitable, what is key to optimising the impact for the South African economy is to ensure an appropriate and capable State. This role should not only deliver the necessary technology and economic acceleration, but also incentivise and create space for private sector and business to flourish in order to develop a strong and diverse economic base.

Turning towards Africa

So how does Africa close the funding gap to achieve access to sustainable and affordable energy?

Another PwC report points out that it is widely acknowledged that governments and the public sector alone cannot meet Africa’s energy funding requirements. Except for a small handful, the vast majority of countries in Africa still have fully integrated utilities, often loss making and constraining market reform. Lack of cost-reflective revenue collection and investment into maintaining robust networks are commonplace. Governments are under further financial stress as they divert funds and resources in response to the COVID-19 pandemic.

Although there is significant private sector investment appetite for renewable generation, this is not achieving the required scale, and not translating into sufficient support for market reform or network upgrades. Donor communities continue to provide much-needed aid across Africa; however, it is predominantly directed towards generation, thus also leaving a ‘missing middle’ where access to a grid connection is unavailable and even if available, unsubsidised electricity is largely unaffordable.

The report points out that it would therefore seem that closing the energy funding gap for Africa hinges on the ability to attract blended investment across public and private sector as well as across the electricity value-chain. From analysis in our 2020 PwC Africa Oil and Gas review, it was evident that despite the vast majority of African countries having committed to a green economy, very few have well-defined national energy strategies, policies and regulatory frameworks necessary to attract such large-scale blended finance.

Key insights on the African position

The report points out that Eluma Obibuaku from AFC stated that, firstly, a robust policy environment needs to be in place in many African countries, which would encourage energy developers into the market; secondly, there must be a clear legal environment in place so that people can pursue their rights should there be a need to go to arbitration; and finally, Africa needs to ensure strong primary off-takers, be they existing operators or commercial and industrial players.

Echoing this view, Simon Hodson, CEO, of Gridworks reiterated that the solution largely lies with host governments, which need to have direct support in a targeted pathway for sector reform that will create a pathway to sustainability. If one combines that pathway with targeted utility reform and mixes that with donor-funded support in the form of programmes focused on fixing new connections, then private-sector capital and private-sector management will flow.

The report adds that James Manda, Technical Director, contributed on behalf of AFUR: AFUR has a huge responsibility to convince governments to change the vertically integrated utility model as this structure hinders the process of securing investment into the energy sector. Governments are often reluctant to ‘let go of the utilities as they are often seen as cash cows.

Simon Hodson commented that businesses cannot wait 20–30 years to fix their power needs, and require affordable and reliable power today. This is resulting in a rapid increase in embedded generation and off-grid solutions, which will further exacerbate the affordability gap left for utilities and host countries. Regulators need to push for sustainable long-term, least-cost solutions with utilities that have critical mass and drive efficiencies across the network.

Could Africa resolve the energy funding gap through an alternate investment model? A significant increase in donor and multilateral credit enhancement for utilities combined with technical support and accelerated market reform certainly seem to be top of mind.

‘Business Unsusual’ is not an option

It is becoming clear that ESG (of which Net Zero is a significant role player) is not a tick-box exercise. There needs to be a ESG strategy which incorporates the company’s mission, vision and values to provide an updated value statement that investors would be interested in.

This begs the question, we have pointed out in previous Turnaround Talk articles that companies need to fastidiously work hard to become more attractive to investors. No investor is going to commit funding to a company that will ultimately not be able to implement its business rescue/turnaround plan. If South Africa was a country in need of business rescue, would we secure the necessary funding to roll out a business rescue/turnaround plan?

The first PwC report points out that it is clear that a business as usual approach to Net Zero is not an option and will undoubtedly lead to shareholder value erosion and a losing organisation.

The Net Zero journey begins with a robust understanding of Energy Transition risk, opportunity and investment appetite. This sets an organisations Net Zero Ambition as a critical platform to progressing the design, governance, optimisation, measurement and implementation over the coming decades. If done correctly, a Net Zero journey will deliver enhanced shareholder value through a winning culture and sustainable organisation.

The report adds that South Africa is well positioned to take advantage of global innovation and lessons learnt, leverage growing pools of global green finance and make the bold move of displacing the few dissenting fossil incumbents in favour of the benefits to, and participation of, the majority of South Africans.

However, the time to act is now.