State-owned power utility Eskom reported a solid turnaround in its financial performance for the year to March 31, 2010, recovering from a whopping R9,7-billion loss in 2008/9 to record a R3,6-billion profit for the 2009/10 period.

However, speaking at the release of preliminary results on Wednesday, finance director Paul O'Flaherty cautioned that the company's earnings were still insufficient to fully cover its interest costs.

Therefore, he argued that it would be necessary for the National Energy Regulator of South Africa (Nersa) to grant the utility two more tariff increases of around 25% in 2013/14 and 2014/15 in order to "rightsize" the tariffs and place Eskom back on a sustainable financial footing.

R115BN FUNDING SHORTFALL

He noted that the group's three-year funding gap currently stood at a cumulative R115-billion, falling to R50-billion over the seven-year period, once the tariff increases were factored in.

That gap would have to be closed by a combination of: further tariff increases; international bond issuances; the injection of private capital into the Kusile project; and the possible conversion of the R60-billion currently unallocated from a R176-billion National Treasury guarantee into a quasi-equity-type structure to boost the utility's overall credit profile and sustain its BBB+ credit rating.

Further, the utility was targeting cost savings of R20-billion over the next three years, with most of these likely to arise from efficiencies surrounding its yearly procurement budget of R90-billion.

Earlier this year, Nersa granted Eskom average tariff increases of 25% for the three-year period from April 1, 2010, until March 31, 2013.

MOZAL BOOST

O'Flaherty said that the turnaround could be partly attributable to an amendment to the "onerous" supply contract with the Mozal aluminium smelter, in Mozambique, which boosted the results by R2,2-billion.

He was also confident that the remaining three commodity-linked contracts, which were recorded as embedded derivatives in the group's statements, would be amended by the end of the current financial year.

These contracts were with BHP Billiton's Hillside and Bayside smelters in Richards Bay, KwaZulu-Natal, and with Anglo American's Skorpion zinc mine, in Namibia. The three remaining contracts were recorded as a liability of R4,6-billion on its balance sheet, down from the R6,9-billion liability in 2008/9. In fact, the loss associated with the embedded derivatives last year was R9,5-billion and was the main feature of the utility's overall loss of R9,7-billion.

SALES AND PRICES

The 2009/10 results were also buoyed by higher sales of 218 000 GWh, a rise of 1,7% on the previous year, but still below the 2007/8 peak of 224 000 GWh. Eskom expect that sales would rise to the 2007/8 peak again during 2010/11, and continue to grow at between 2% and 3% a year.

Further, the interim price increase of 31%, which was granted by Nersa ahead of the current second multiyear price determination, was key to boosting overall group revenue to R71-billion from R54-billion in the previous year.

In fact, the utility's average tariff for the period rose to 31,9c/kWh, as compared with 31,9c/kWh as a result of the increase. In the prior financial year, Eskom had sold power below its cost of production, which was reported at 25,9c/kWh.

"But it is still a concern to us that we are having to use borrowings to fund borrowings and to fund interest. So, we really need to make sure that we follow this rightsized tariff increase over the next three years with additional tariff increases of a similar level," O' Flaherty asserted.

CAPEX CUTBACK

Owing to its financial constraints, the utility trimmed its capital expenditure (capex) by a massive R15-billion against a target of R70-billion for the period.

These cuts related mostly to delays at the R142-billion Kusile project, in Mpumalanga province. But chief officer generation Brian Dames acknowledged that some of the cuts also related to the deferment of "new contracts" at other project sites.

Nevertheless, the group added some 452 MW of new capacity during the year, primarily from its return-to-service projects at Grootvlei, Komati and Arnot. The net additions since the restart of the group's build programme in 2004/5 stood at 4 900 MW, of the 18 000 MW to be added by 2017.

Committed and uncommitted capex for the next seven years stood at R693-billion, but Eskom would experience a R190-billion cumulative funding shortfall should it attempt to meet that expenditure profile. Therefore, other solutions would be sought for some R140-billion worth of uncommitted capex that would be required to meet South Africa's growing power demand profile. It was likely that independent power producers would be key to plugging that supply and capex gap.

LEADERSHIP UPDATE

Acting chairperson Mpho Makwana argued that the corporation - which had been rocked over the past year by funding and leadership challenges, including the resignation, in November, of its former CEO Jacob Maroga and its former chairperson Bobby Godsell - was on the "path to recovery".

He argued that there was also better alignment between Eskom and its shareholder, arguing that this would become apparent in the coming months when Public Enterprises Minister Barbara Hogan unveiled the progress made by the interMinisterial Committee on Energy, which she chairs, and when Energy Minister Dipuo Peters released the draft of the second integrated resource plan, or IRP2010.

He said that key vacancies were also being filled and that he was hopeful that the new CEO would be unveiled during June, with the board selection committee having made its recommendation, which had been redirected to the shareholder Minister, Hogan, who would take the recommendation through the requisite government approval processes.