Future is tied to Eskom’s fate

Could Eskom cause a banking crisis? That is the unspoken question that lies behind the new “co-operation” between the government and the financial sector on a rescue plan for state-owned companies. The problem is twofold. Companies such as Denel, South African Airways, South African Express and the Trans Caledon Tunnel Authority face immediate liquidity problems and cannot pay salaries and suppliers. They need cash, and banks have not yet agreed to give it to them.

The second problem is bigger, in fact it is huge. It is Eskom and its R367bn (and still growing) mountain of debt. This debt, mostly in bonds, is not held in any significant way by banks. Asset managers are more exposed, with the Public Investment Corporation holding R80bn in Eskom debt alone.

But these amounts are not so big that they could cause a banking crisis in themselves. The problem would arise if Eskom defaulted on its obligations. This might not necessarily mean the failure to repay a lender, but could also include a default on some other technical element in a loan agreement such as the failure to get a clean audit or to submit financial statements on time.

Because of the cross-default provisions in loan agreements and bond indentures, a default by Eskom would trigger a default on all government bonds. Government would need to impair all debt on its balance sheet. It would also immediately have to take over Eskom’s bonds and pay the interest.

Government’s fiscal framework would be put under huge pressure and the expenditure ceiling — which is SA’s commitment to getting its finances back on track — would be breached. It would almost certainly lead to a further downgrade of SA’s debt and a sudden spike in bond yields, which if sharp enough could put the banks under enormous pressure, even into crisis.

This scenario does not have a high likelihood of materialising as there is a strong consensus that Eskom is too big to fail. But if it did, it would have a serious impact on the economy. The purpose in sketching it out is to underline the huge significance of Eskom to the economy, apart from its most immediate and obvious economic function of providing a reliable supply of electricity. It is imperative for the government, financial institutions and SA at large that Eskom does not fail. How can SA minimise this risk?

Eskom must slash costs and grow revenue. This is what Sipho Maseko did at Telkom. It will be more difficult at Eskom. The two largest costs — for employees and coal — cannot be easily slashed. Trade unions have made clear their opposition to any attempt to curtail their rights and benefits. Their response has been violent and reckless. To significantly cut employee costs at Eskom, the government needs the appetite to take on the unions no matter the consequences. This it does not have.

Coal costs can’t be easily cut. Eskom has locked itself into expensive contracts. Its contracts with cost-plus mines are maturing and there has been no recent investment to open new mining areas. These contracts are getting very expensive.

Could Eskom grow revenue? Electricity sales have been flat for several years. Eskom will soon have both Medupi and Kusile fully on line, each producing 4,800MW. The problem is: who will buy it?

As technology for renewable energy advances and prices decline, companies and wealthy individuals are finding it cost effective to generate their own energy. This is a large global trend and it is foolish to expect it to be reversed.

Eskom will not easily get itself out of trouble even if it is now run by smart and honest people.

That is why credit ratings agencies have now begun to suggest that for SA to improve its rating Eskom would have to receive “more government support”. That means the government itself taking on more debt, exactly the opposite of what has been envisaged in the medium-term expenditure framework.

It is an awful predicament.

TRADE UNIONS HAVE MADE CLEAR THEIR OPPOSITION TO ANY ATTEMPT TO CURTAIL THEIR RIGHTS