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Eskom’s business model is ‘no longer fit for purpose’

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Eskom’s business model is ‘no longer fit for purpose’

Busa VP Martin Kingston
Photo by Duane Daws
Busa VP Martin Kingston

17th November 2017

By: Terence Creamer
Creamer Media Editor

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Organised business made an impassioned plea this week for government to urgently review Eskom’s business model, which it said was “no longer fit for purpose”.

In a presentation to the National Energy Regulator of South Africa, business also warned that, in the absence of a holistic view within government of the problems afflicting Eskom, the “utility death spiral” currently under way would pose a serious existential risk to the power company and could, in turn, threaten the sustainability of government finances.

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Business Unity South Africa (Busa) VP Martin Kingston argued that, until government arrived at an integrated view of both the problem and the solution, the threat posed by Eskom to the fiscus would continue, as “all we will be doing is kicking this particular can down the road”.

Speaking at hearings into Eskom’s application for a 19.9% tariff hike for 2018/19, Kingston lamented the lack of alignment between Eskom, the departments of Energy and Public Enterprises, the National Treasury and the regulator on the crisis confronting the electricity industry and Eskom.

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He described the State-owned utility as arguably the greatest risk to South Africa’s fiscal sustainability and credit rating and argued it was “locked into an inflexible capacity expansion plan that is ill-suited to South Africa’s current and future needs”.

Earlier, the utility acknowledged that its liquidity was “not at desired levels” and revealed that it had again lowered its sales projections for 2018/19 to 211 TWh, from 216 TWh in its application. Closing the 30 TWh sales gap between the new forecast and the previously assumed sales volumes would trigger a 9.4% price increase even before any increase in allowable revenue. However, Eskom is also applying for a R14.3-billion increase in allowable revenue to R219.5-billion.

The 2% lower sales volume for 2018/19 could raise the unit price by another 1.6%, after adjusting for the lower costs associated with the lower volumes. However, Eskom also acknowledged that its request for R11.2-billion to cover the cost of independent power producers could be disallowed, owing to the delay in introducing the renewables generators, which could help lower the unit price.

R20BN SHORT
Acting CFO Calib Cassim revealed that Eskom was currently not generating the cash reserves required to cover debt repayments as these became due and that during the current financial year the utility was R20-billion short after debt repayments were factored in. He also warned that in the 2018/19 financial year, the combination of interest and debt repayment (before any possible debt refinancing) would be R40-billion and that the figure would rise steadily to above R50-billion a year, with a peak of R60-billion in 2021/22.

In the coming two years, Eskom’s interest bill will exceed staff costs as its debt burden rises from R337-billion to R500-billion in the coming four years.

“Obviously, every time we don’t recover our costs and meet our commitments [through the tariffs] there will be a gap in the equation. How is that gap filled? If we can’t raise the debt to fill the gap, ultimately, because we are guaranteed, it has to go back to the sovereign and the National Treasury, which is the taxpayer. That’s the challenge that’s facing us: Eskom’s rating can affect the sovereign and similarly, depending on what the sovereign rating is, it has a direct effect on Eskom,” Cassim cautioned.

However, Kingston argued that, besides tariff hikes and fiscal support, the third way to address the current financial crunch at Eskom was to cut operational and capital costs.

Busa had not yet seen evidence that Eskom was taking steps to reduce wasteful and core expenditure. “Unless and until such time as they do that, we are going to be confronted with this continuing problem, which is now, I think, of crisis proportions”.

STRUCTURAL ADJUSTMENTS
Chamber of Mines chief economist Henk Langenhoven argued that the solution to avoiding the “catastrophic” scenario of unaffordable tariff hikes and/or another government bail-out lay in approving a “holistic” structural adjustment programme for the electricity sector.

Langenhoven argued that drastic changes were needed at Eskom, including: accelerated decommissioning of old, inefficient power stations; bringing Eskom’s operational cost (primarily head count) in line with international standards; completing the regulated asset base re-evaluation as soon as possible, so that the return on asset absolute value diminishes while the weighted average cost of capital stays the same; accelerating the completion and commissioning of the new, more efficient power stations; accelerating the purchase of electricity from private generators; and revisiting the regulatory regime.

“Short-term solutions must be found to prevent Eskom from failing and the economy suffering irreparable damage. [However], any short-term solutions must be conditional on an immediate structural adjustment programme to be undertaken by the utility.

He said that these risks had been raised with government at the appropriate level, where there was still “no comprehensive, holistic view not only of the problem, but also the solution”.

Similar engagements with Eskom itself had been hamstrung by the continual rotation of leadership.

“The people we are dealing with now, we weren’t dealing with six months ago, and those people who we were dealing with six months ago, we weren’t dealing with 12 months ago or 18 months ago. We actually start from scratch on each and every occasion and we are concerned – and I think everybody should be concerned – about the erosion of capability and capacity at Eskom at the level of its board and, indeed, its management and below.”

Kingston acknowledged that Eskom’s capital structure remained a problem, but argued that any recapitalisation could only happen on the basis of an appropriate assessment of the value of Eskom’s assets, which may need to be written down.

“We cannot simply pick up from where we were yesterday and move to tomorrow. We need to take stock of where we are, we need to assess what is the appropriate regulatory asset base under the circumstances and what is a suitable tariff, acknowledging that we cannot possibly contemplate this death spiral continuing – it will render Eskom completely financially inoperable, it will not be a viable enterprise.”

However, the problems would persist until all government stakeholders had a common understanding of the issues and the ramifications of their decisions.

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