Without proper restructuring, we’re heading for disaster, writes Ryk de Klerk |
If the government pursues its current power plans, rolling blackouts will be the ‘new normal’ by 2025
WHAT ESKOM’S stakeholders want is stability and certainty. The power utility and its stakeholders – including holders of Eskom debt, the general public, potential lenders and labour – urgently need to appoint an apolitical global energy expert as an independent chairperson.
The appointee would need to lead Eskom to a proper restructuring, and run a new, independent board of directors comprising highly-experienced professionals.
Restoring confidence in the utility and ensuring it will survive over the long-term through proper restructuring will attract investors to invest in Eskom debt, and even roll over current debt as it becomes due. That, in itself, is likely to enhance Eskom’s cash flows over the next few years.
However, it has became abundantly clear that the South African government and Eskom’s board have decided against restoring Eskom to a fully competent, world class integrated power utility through a full restructuring process. The cash is not there, nor the will or the honesty.
As a result of Eskom’s dire financial position it seems that the utility will continue to be starved of capital, and it is clear that Public Enterprises Minister Pravin Gordhan is getting his way. Essential capital expenditure and crucial maintenance are already cut to the bone.
Eskom has also applied to the environment ministry to delay, by five years, compliance with sulphur dioxide emission limits at its Medupi coal-fired plant, and not to install emission-reduction equipment at its Matimba plant, thereby deferring capital spending of more than R150 billion in 2019 money terms.
To get an indication of what Eskom will look like over the next few years, I used various sources, including government’s Eskom Road Map for planned power station capacity, as well as the utility’s historical and most-recent financial reports.
Where Eskom’s own operational and financial performances are analysed I exclude its dealings with independent power producers (IPPs), as Eskom sells power bought from independent power producers at the same price at which it purchased the power.
Price changes in power purchased, therefore, have no effect on Eskom’s bottom line.
On the operational front, my cash flow analysis indicates that Eskom cannot afford to extend contracts with aluminium smelters.
The first major contract to expire is Hillside Potlines 1 and 2, in July this year, and the non-renewal will free up about 900 megawatts (MW). The mothballing of Saldanha Steel will also probably free up to 400MW.
The closure of the plants would undoubtedly relieve significant pressure on Eskom, and rolling black-outs could be something of the past from July this year for at least the next three years.
Eskom’s operational results would receive a significant boost, as its subsidisation of Hillside Potlines 1 and 2 would come to an end.
In addition, Eskom’s earnings before interest, tax, depreciation and amortisation could improve by more than 15 percent a year, from 2019 to 2025, as Eskom would probably be successful in recouping R27.3bn in the 2020/21 financial year under the RCA mechanism. This is a backward-looking instrument designed to manage variances between returns approved by the regulator in the tariff against actual returns.
What emerged from Eskom’s interim results is that the government’s future funding of Eskom will be in the form of capital injections and debt. For all intents and purposes, I assumed that 50 percent of the funding-needs until 2025 will be met via capital injection.
Eskom will be able to improve the financial position and keep borrowings in check by cutting capital expenditure to the bone and pushing out much needed emission control expenses.
The government’s investment in Eskom will appease the politicians, as the current apparent plan will improve Eskom’s capital and reserves, specifically in the case of further government financing until 2025.
However, by pursuing the apparent current plan, Eskom and the government mask the real truth. By delaying or deferring much-needed maintenance and replacement over specifically the next five years, it is clear that the government is just buying time for election purposes.
In terms of this current plan, by 2025, Eskom’s energy efficiencies (generation, transmission and distribution) will have deteriorated to such a degree that rolling blackouts will be the new normal. Yes, Eskom will be in a worse state of decay than it is now.
The government and Eskom’s apparent current plan is likely to scare investors away, and they won’t roll over their debt. It will probably be impossible for Eskom to approach the markets for finance a few years down the line.
The plan is economic-growth negative, and unemployment will continue its upward trend. It seems that dark forces are at play and only a few will score from an unstable Eskom.
The government and Eskom’s apparent current plan also ignores the fact that Eskom is exposed to humungous currency risk. So much so that it dwarfs Eskom’s technological misfires and previous wrongdoings.
According to my estimates, Eskom owes $12.5bn (R179.5bn) in hard currency, of which payments of more than $5.5bn are due within the next six years to 2025. In addition, more than $2bn of interest is payable over the period to 2025.
The current outstanding amount equates to R179bn (at an exchange rate of R14.50 to the US dollar) and is more than 39 percent of Eskom’s official debt. The vulnerability of Eskom is such that if the rand depreciates steadily by eight percent a year against the US dollar over the long-term, Eskom’s total repayment of the current offshore loans will more than double to R364bn.
Interest due on the offshore borrowings until 2025 will increase by nearly R10bn, to R45bn. And that excludes any new future funding!
Eskom’s income is such that the bulk is rand-denominated. Therefore it does not make sense to rely on offshore borrowings, as the utility has no protection against a weakening local currency.
The government as sole shareholder should be the party obtaining offshore funding, and not Eskom, with the former on-lending the offshore capital raised, converted into ZAR, to Eskom. The right thing for South Africa is that the government should take over Eskom’s offshore debt and Eskom should issue rand-denominated bonds to the government.
While such action will remove a massive uncertainty about Eskom’s future finances and the sustainability of the utility, it will not mean much for the South African economy. Credit rating agencies are unlikely to improve the country’s positioning, because with the government being the ultimate guarantor of the utility’s debt, South Africa’s consolidated offshore debt will remain unchanged. That is if the government and Eskom pursue their apparent current plan.
In contrast, in the case of a proper restructuring, Eskom’s major capital projects and expenditures to be incurred over the next five years are likely to be hugely economic-growth positive.
Capital expenditure will decrease dramatically after 2030, as all the necessary expenses to put the utility on a long-term growth path would be in place.
Higher efficiencies and improved technologies may in fact lead to capital expenditure peaking earlier than 2030, resulting in a significant improvement in Eskom’s finances.
Proper restructuring will be credit-rating positive, the rand’s devaluation limited, and Eskom’s offshore debt less vulnerable to currency fluctuations. Most importantly, it will attract investors to invest in Eskom debt and even roll over their current debt as it becomes due.
There are numerous aspects that the new independent chairperson and the independent board of directors, consisting of highly experienced professionals, should urgently investigate.
Off-balance sheet finance: From Chris Yelland’s report at the end of August last year, the true total cost for the completion of Medupi and Kusile, based on information sourced from Eskom, differed from what was mentioned in Parliament and in the 2019 AFS. The capitalised interest of R50bn in the case of Medupi, and R65bn in the case of Kusile, were ignored. The understatement of the combined numbers totals R115bn.
This number closely matches the sum of the difference between the anticipated capital flows of the existing debt portfolio at March 31, 2019. This is according to the 2019 Integrated Report compared to my calculated yearly repayments of loans and borrowings when they become due.
Diesel costs: From my analysis using Eskom’s financial reports, it appears that Eskom paid R1 per litre more than the base price of diesel at the coast. Apparently more than 40 companies and individuals (BEE’s and producers) supply Eskom with diesel, and some are not primary producers. The new board of Eskom and the independent chairperson should investigate this urgently.
With the governments’ Industrial Development Corporation holding 24 percent of the Mozal aluminium smelter, and the contract with Eskom terminating in March 2026, the question is whether the government and/ or the new Eskom board will support the renewal of the contract. I estimate that Eskom subsidised the smelter by more than R1bn rand last year. Termination of the contract could free up to 900MW.
Yes, some bold and difficult political decisions will need to be taken. But never before was an independent gatekeeper and inclusion of experts on the board of Eskom more important than now.
A major paradigm shift is unavoidable to get this economy off its feet. Honourable Minister Gordhan, we cannot afford uncertainty and instability that benefit only few.
Ryk de Klerk is an analyst-at-large. Contact rdek@iafrica.com. His views expressed above are his own. You should consult your broker and/or investment adviser for advice.