Eskom identifies CEO candidate, expects to make announcement in June

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Article by: Terence Creamer

Published: 02 Jun 2010

Eskom identifies CEO candidate, expects to make announcement in June

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.

O'Flaherty said it would have been "a disaster" for the Eskom during the 2009/10 reporting period had it not been able to come to terms on the Mozal smelter contract.

All commodity and currency risk had been transferred to BHP Billiton and that the Mozal contract was no longer onerous, with chief officer customer network business Erica Johnson explaining that the principle of cost reflectivity had now been embedded in the new contract.

In other words, Eskom would no longer supply the resources group's smelter at below its cost of production. It emerged recently that the smelters paid only 12,3c/kWh in 2008/9.

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, while its cost of production increased 8,8% to 28,2c/kWh. In the prior financial year, Eskom sold power at 24,7c/kWh, which was below its cost of production of 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. The company ended the year spending 57-billion on capital projects, which was up on the R47,1-billion spent in 2008/9.

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 had also related to the deferment of "new contracts" at other project sites.

Dames told Engineering News Online that, as the group's funding challenges were resolved in the coming months, Eskom was likely to begin accelerating its expenditure across the sites and he was, thus, confident of meeting the target of R87,7-billion for 2010/11.

Overall, the group was committed to spending some R553-billion over the next seven years, and had other uncommitted projects worth a further R140-billion, which could not currently be funded off its distressed balance sheet.

In other words, the total potential project pipeline stood at R693-billion up until 2016/17, but would result in a cumulative funding shortfall of R190-billion should it be pursued.

The utility was, thus, interrogating alternative funding and contracting models for the expenditure that could not currently be financed, but which was regarded as key to developing the necessary capacity to "keep the lights on". It was likely that independent power producers would be key to plugging the anticipated supply and capex gaps, but Eskom was also contemplating participating through partnerships with others, including a partnership on the nuclear programme, should one be restarted.

Dames told Engineering News Online that Eskom remained convinced that the immediate nuclear solution lay with pressure water reactors (PWRs). But he also indicated that it might be in South Africa's interest to have a more open discussion on the technology choices, instead on merely retriggering the Nuclear-1 programme, which was based on the latest generation of PWRs on offer from Areva and Westinghouse respectively.

During 2009/10, Eskom group added some 452 MW of new capacity, 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 now stood at 4 900 MW, of the 18 000 MW to be added by 2017.

Further, the utility had reached agreements with IPPs to introduce 400 MW of mostly cogenerated electricity into the system by the middle of next year. However, Eskom was of the view that a total of 50 000 MW of capacity was required by 2028 in addition to the current installed base of more than 42 000 MW.

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.