Eskom’s ex­is­ten­tial cri­sis

As it stands, the power util­ity now sur­vives only to pay off its debt

Sunday Times - - Business The Big Read - By ASHA SPECKMAN speck­[email protected]­day­

● 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

Phaka­mani Hadebe

Eskom CEO

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

Pic­ture: Se­ba­batso Mosamo

Philippa Rod­seth, ex­ec­u­tive direc­tor of the Man­u­fac­tur­ing Cir­cle, says that with­out a re­li­able power sup­ply, busi­nesses can­not plan for re-in­vest­ing.

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