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HAVE WE REACHED THE INFLECTION POINT?

By 22nd Sep 2014Sep 20th, 2019No Comments

Ladies and gentlemen, in mathematics an inflection point is the moment where the curvature of a line changes from positive to negative or vice versa. Andy Grove, the co-founder of Intel, described a strategic inflection point as “an event that changes the way we think and act”. It is, therefore, a turning point after which a dramatic change can be expected, with either positive or negative results. An inflection point can be the result of action or inaction by actors in the economy, whether they be the Government, public corporations, companies or private individuals.

I know that none of us would like our beautiful country ever to reach a point where perceptions are altered to such a degree that energy’s contribution to the economy is deemed to have become negative. Regrettably, frequent shortages of energy supply, constant uncertainty about the security of supply and constant reports of delays in solving the supply problems are bound to change how South Africa is perceived as an investment destination.
Of course, energy is not the only logistical challenge facing us as a country, but irrefutably reliable energy supply is vital for a thriving economy. On average, energy costs in the metals and engineering sector account for about 8% of intermediary input costs. It stands to reason, therefore, that without reliable energy supply, the sector cannot exist or expand. Indeed, it is unfortunate that even right now the sector cannot operate at full capacity as a result, among other things, of energy constraints.
Actual or realized economic growth in the South African economy has fallen substantially below its potential. While energy provision should support our growth ambitions, there appears to be a real danger of the two gradually drifting apart.
Two definitive studies published in 1984 and 1993 estimated South Africa’s potential economic growth rate to be around 3,5%. In reality, growth only averaged around 1,5% during the nineties, and then accelerated to 3,7% on average during the first decade after 2000. We are now seriously in danger of falling below a 2,5% average in this decade.
Energy provision, measured by the value of electricity production capacity relative to the size of the economy, reached a peak around 1985, and has since halved to around 2007, or fell back to the ratios before 1970! The ebb and flow in electricity generating capacity seemed to have coincided with the super cycles in commodity prices worldwide. Yet, although the economy has grown faster in the past decade (2000/2010) than recorded during the seventies, South Africa missed the last super cycle and completely under-estimated the economy’s accelerated energy demand over this period.
Regrettably, electricity generation has become a significant physical constraint that hampers the economy’s ability to grow at a faster rate. It can be argued that this situation runs counter to the Government’s stated intention to stimulate local manufacturing and value addition.

In fact, manufacturing’s share of the economy has been steadily declining over the last three decades, with investment patterns in the sector far more worrying than the former. Reliable energy supply is absolutely vital to turn the situation around.
Ladies and gentlemen, we should all be concerned about the fact that the size of the manufacturing sector is often confused with its contribution to the economy. According to the South African Reserve Bank, the sector is 29% larger today than 10 years ago, 66% larger than 20 years ago and 71% larger than 30 years ago. However, its share of the economy declined first from 20% in 1983 to 19% in 1993, and then further still to 18% in 2003 and eventually to 16 % in 2013. So, manufacturing has decline by a percentage point each decade in South Africa!
Needless to say, this does not bode well for our economy. Increasingly we have become a country that imports equipments and components that used to be manufactured here at home, in the process leaving many people unemployed.
Many factors determine the health of manufacturing. High capacity utilisation due to strong domestic and/or export demand leads to higher profit margins and higher levels of fixed investment in the sector. Manufacturing exports represent an estimated 35% of production, while imports have captured nearly 45% of the domestic market. On the other hand, the metals and engineering sector exports 60% of its products and competes with imports for 60% of the domestic market.
Reintegration into the global economy has huge benefits due to access to bigger markets, but can develop into a mortal battle for survival between competitors and importers. Higher imports replacing domestic suppliers lead to lower capacity utilisation, lower profit margins and, eventually, lower domestic investment in the sector.
However, the investment patterns within the sector and the size of production capacity show very worrying signs. The value of capital stock in manufacturing relative to output has been declining since the early 1990s. Annual fixed investment, as a percentage of output, has declined by about a third over the last two decades when compared to the 1980s. These patterns are much more profound in the metals and engineering industries where fixed investment relative to output has declined by two thirds of the levels where they were at the beginning of the 1990s.

The key factor is global competitiveness. Without a sufficient and secure supply of energy – and, in this case, electricity – it is not possible for South Africa to be globally competitive. As we all know, electricity supply in the country reached its lowest levels between 2000 and 2008. When investment patterns in manufacturing and metals and engineering are overlaid on electricity supply, the inconsistency of supply and the cost of energy trends, one cannot but conclude that investment is held back by this constraint. Instead, South African manufacturers are importing more and more components for assembly here due to cost advantages and security of supply which their own domestic investments cannot guarantee. The physical value of production capacity in both manufacturing and metals and engineering reached its lowest points after 2000.
Ladies and gentlemen, price escalation of electricity needs special mention. Available data show that similar double-digit price increases for electricity, as we have been experiencing in recent years, also took place in the early 1970s. However, there are some main differences.
Price increases during the seventies were over a short period and were directly attributable to Eskom. They contributed to double-digit inflation after 1973 and were used specifically to expand supply from a shortage to a surplus situation. The current cycle of increases has been going on for several years and has the potential to raise production costs amongst electricity-intensive sectors to the point of rendering them uncompetitive.
Ironically, imported, competitively-priced replacement products may shield domestic customers from feeling the brunt of domestic production costs. The most important additional surcharge on electricity prices exacerbating the price spiral is the cross-subsidization of local authority service delivery ineptitude by the on-selling of electricity. This widespread phenomenon taxes the productive part of the economy to pay for collapsing local authorities.
The argument that higher prices are levied in order to force electricity conservation is not valid since lower demand simply triggers subsequent increases to make up the budget shortfalls in these institutions. Supply interruptions due to lack of maintenance are completely debilitating.
Programme Director, Minister Joemat-Petterson, ladies and gentlemen, energy and logistics are crucial for South Africa to achieve its long-term potential economic growth rate of 3,5% per annum. It is particularly so given the fact that geographically we are so far away from the main export markets and our industrial hub is also a distance away from our ports. These factors should not be allowed to be the weakest links in the chain to unlock the country’s potential.
Several policy documents and institutions are responsible for adequate energy infrastructure. The National Development Plan 2030 vision addresses energy infrastructure in chapter 4. The Medium-Term Strategic Framework takes this further in chapter six, covering the provision of efficient, competitive and responsive economic infrastructure.

Energy provision is a long-term assignment, with 2025 a pivotal year when large portions of current generation capacity will reach the end of their useful life. As a country, we need to tackle this challenge with a single-minded determination as though we were going to war.

It is critically important, therefore, that policy objectives are clear and their implementation decisive. We hear so many comforting things from those in positions of authority in Government and the public sector, and yet often those comforting words are not matched by concrete action on the ground. It is vital that we change course as a country: while talking big is important, doing big is far, far more important.

This conference will be useful if it manages to get both the alleviation of short-term constraints and long-term solutions thrashed out.
Thank you very much.

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