Eskom’s existential crisis
As it stands, the power utility now survives only to pay off its debt
● In its almost 100-year existence, Eskom has perhaps never faced such an existential crisis as now. In the short term, the operational woes that have emerged recently, resulting in the return of load-shedding, will be eased when maintenance is completed.
But load-shedding is likely to persist unless the issue of the company’s balance sheet is addressed by its shareholder, the government. Eskom, which provides more than 90% of SA’s energy, survives only to pay off its debt, which has rocketed from R40bn to more than R400bn in just over a decade.
If costs continue to rise and its bottom line doesn’t improve through higher demand and tariffs, Eskom’s debt could climb to R600bn over the next three years.
While state capture has been a central narrative around Eskom during former president Jacob Zuma’s tenure, fuelling a crisis in confidence in the institution and by extension SA, the root cause of the company’s woes can be traced to the administration of former President Thabo Mbeki.
A former executive said Eskom’s troubles stemmed from a policy decision by Mbeki’s government that prevented Eskom from building new capacity. The decision was subsequently reversed but because Eskom had not made provision, the cost of new power stations was absorbed into the business. “Later we saw that operationally the money for the new build became a problem … That’s one of the strategic errors of the past that caused many issues. The capture and Gupta issue are also part of it,” the executive said.
The Guptas played a central role in choosing executives at Eskom and so got preferential treatment for their companies, in particular their coal business.
Tegeta, at the time owned by the Guptas, reneged on its coal commitments to Eskom, and the then Eskom CEO Brian Molefe stopped investment in cost-plus mines. These mines were historically built with Eskom support on condition that the coal would be supplied at cost with a modest margin on top.
Eskom CEO Phakamani Hadebe told Business Times: “If we continued to invest in cost-plus mines, we wouldn’t be here. The relationship with the coal industry is broken, and was further affected by the preferential treatment of Tegeta. This was all avoidable.”
Given the focus on the build programme, maintenance of infrastructure slipped. As a
If we continued to invest in cost-plus mines, we wouldn’t be here
result, Eskom is battling to keep ailing power stations, some more than 50 years old, operating. Maintenance over the past five or six years has been insufficient and has been about “bandaging the problems”, Hadebe said.
Now Eskom finds itself in a debt trap, with chair Jabu Mabuza saying this week that the utility planned to ask for a R100bn bailout from the government.
The government’s guarantee portfolio totals R670bn, of which Eskom holds R350bn — it has R14bn left.
Pravin Gordhan, public enterprises minister, said: “There’s nothing definite about any amount of money. The money question will be entertained in the context of [a] roadmap for the next five years.”
But if the government did agree to a bailout it would send SA’s debt-to-GDP ratio to levels that would trigger further downgrades by rating agencies, raising borrowing costs and weakening the rand.
Finance minister Tito Mboweni told Bloomberg that Eskom should raise money as the state’s resources were limited.
The Government Employees Pension Fund (GEPF), whose funds are administered by the Public Investment Corp, this week said it had an appetite for Eskom’s bonds.
Principal executive officer Abel Sithole said: “I don’t think that the GEPF can just stand by ... To simply say ‘let Eskom fail’, I think, doesn’t understand the impact that will have on the economy. If the government came to me or the GEPF or any investor and says, ‘We will issue a bond because we need to refinance Eskom, we’ll give you a guarantee, and we’ll give you a good coupon, the duration of this bond is suitable for your liabilities,’ yes, thank you very much, we will take them.”
The National Treasury did not respond to requests for comment.
S&P Global Ratings this week warned of the possibility of an Eskom default on debt repayments in the next six months if debtraising initiatives failed.
Gordhan said Eskom’s debt restructuring was “an issue that is being discussed in government” and would be finalised “sometime in the new year”. He added the government and Eskom were in “serious conversations” with the international and domestic financial sector so that “working capital doesn’t become an issue in the immediate term”.
But even if Eskom were to raise the required debt, the question is how it would sustainably service its debt costs, with revenues unlikely to climb significantly in the foreseeable future through a rise in tariffs or demand. The Treasury sees SA growing at 0.7% this year, rising to 1.7% in 2019 and 2.1% in 2020.
The decision that needs to be made is what equity-type investment in Eskom the government will be comfortable with.
The separation of Eskom’s businesses has been mooted. The former executive said there would be interest in the utility’s business from foreign companies, such as those running power utilities internationally that might want to expand.
Gordhan said there was no plan to partially privatise Eskom.
Mabuza said a review of Eskom’s structure had begun. “We are approaching this organisation on the basis that we must functionally separate these various areas: generation, transmission and distribution — see them for what they are, so that we can in each one tell where inefficiencies are [and] how to bring efficiency.”
He said this would help to answer questions from the National Energy Regulator of SA about “how much it costs to produce a megawatt of energy”.
On unbundling some of Eskom’s assets, Mabuza said: “We don’t own the asset. Only the owner of the asset can decide how it wants to deal with it. Ours is to manage and operate it.”
Heading towards elections next year and leading a party beset with divisional politics, it’s unlikely that President Cyril Ramaphosa will make a call about the utility’s future and the private sector’s role. The solution for Eskom lies with the shareholder. The board’s competence, or lack thereof, according to some of its fiercest critics, is but a sideshow.
● Philippa Rodseth, executive director of the Manufacturing Circle that represents SA’s manufacturers, says Eskom needs to release its turnaround strategy “as a matter of urgency” because the future of manufacturing in the country depends on it.
It was supposed to have been released in September.
Earlier this year Eskom CEO Phakamani Hadebe hinted that significant retrenchments would be part of it, but the government is strongly opposed to this.
Meanwhile, a combination of load-shedding and uncertainty is “striking at the heart” of the manufacturing sector, says Rodseth.
“Government needs to resist putting politics first because we can’t risk losing industry, and the situation is becoming pretty dire,” she says.
“Showing us the turnaround plan is fundamental to providing some predictability and comfort to our manufacturers and our investors.
“It’s a fundamental component of providing confidence that … there is a plan that has been thought through and that is implementable.”
Manufacturing provides employment for 1.8-million people and contributes 12% to GDP, less than half its contribution in the early 1990s. There are 300,000 fewer manufacturing jobs than 10 years ago when loadshedding started.
According to the World Bank, for every job directly created in manufacturing, another four are indirectly created. Some economists have calculated the indirect job multiplier to be between five and eight, making manufacturing by far the most important source of jobs.
“Manufacturing is the engine of growth for our economy. But in order to function properly, electricity is one of the primary inputs. Manufacturers need consistency with regard to certainty of supply and price escalation.”
At the moment they don’t know how much electricity is going to be available to them, when, for how long and at what price.
This is making it “very difficult to function adequately”, she says.
“If businesses can’t plan ahead it makes it very difficult to meet demand and orders.” Businesses that can’t meet demand or fulfil orders don’t survive.
Having a back-up supply is unaffordable for all but bigger manufacturers, and almost prohibitively expensive for them.
“Some of them use diesel generators, but smaller businesses can’t afford this.”
When larger manufacturers switch to diesel it increases their costs “massively”, she says.
One of the larger manufacturers represented by the Manufacturing Circle has calculated that bringing its diesel generators online during load-shedding increases costs by 30%. And electricity is already one of its largest cost components.
“That precipitates the vicious cycle in which manufacturing currently finds itself,” she says.
“If you’ve got a problem with one of your primary inputs you make less profits, which means you manufacture less and have to reduce shifts or labour. This reduces consumer and investor confidence, and so that negative cycle is perpetuated.”
Lack of consistency of supply is making it “very difficult” to meet existing orders. Making alternative plans is taking operational and managerial energy away from where the focus should be, on growing markets and increasing efficiencies.
The damage inflicted by electricity cuts is exacerbated by the ongoing absence of any turnaround strategy from Eskom.
“It makes investment decisions difficult,” she says.
“Manufacturing is capital intensive. So if you’re going to buy new equipment or expand your factory, you have to have a predictable basis on which to make that decision, because you’ve got payback periods and you’ve got to assess your returns over the medium- to long-term period.
“If you’re uncertain what will happen in terms of one of your fundamental inputs, it makes planning very, very difficult.”
The same goes for pricing. A year ago, when Eskom proposed a 19%-plus tariff hike, the Manufacturing Circle put out an investment tracker assessing at company level how much manufacturers were investing in property, plant and equipment, inventory, research & development and human capital.
They said they would not be able fully to recover the increase in costs from customers, and therefore would have to explore “rationalising strategies”, including cutting jobs and freezing investment in expanding productive capacity.
Now Eskom has applied for a 15% per annum tariff increase over the next three years. Based on previous research, this will lead to another significant drop in demand, she says.
“Eskom must do what other manufacturing businesses do. It must address its own efficiencies before it seeks to recover losses from its customers, because they’re going to look to alternative strategies.”
If Eskom needs a short-term capital injection to deal with its debt crisis, it must come from the shareholders, she says.
“You can’t kill your customers.” Load-shedding has already driven them to look for other options, a process that is now accelerating.
Sappi, which is a member of the Manufacturing Circle, has five manufacturing operations in SA. They’ve been “requested” to reduce electricity use at their mills by 10%.
On top of this, load-shedding is becoming “a daily occurrence”, she says.
With stage two load-shedding, they can at least confine the usage reductions to noncore operations. Once stage three load-shedding starts, this will be unsustainable.
“Production output will be curtailed, which will hurt their business significantly. They’ve had to do some quite hectic planning.”
If Eskom’s problem is a lack of coal then load-shedding is not a solution, she says.
“All that will happen is that industrial customers will try to catch up lost production once load-shedding has been lifted.”
If it’s a capacity problem then Eskom needs to call on more private generation.
Whether Eskom can be turned around is not a matter for debate, she says.
“We have no choice. So very urgent interventions are required. There needs to be a prioritisation of what is important to drive this country forward.
“So it’s really a case of prioritising the importance of industrialisation and manufacturing, which are needed to create jobs and get us out of this vicious cycle we’re in.”
Showing us the turnaround plan is fundamental to providing some comfort to our manufacturers and our investors
Philippa Rodseth, executive director of the Manufacturing Circle, says that without a reliable power supply, businesses cannot plan for re-investing.