Recent reports suggest that Treasury is seriously considering a sale of 49 percent of Eskom although Eskom’s management – the bulk of the ANC and Cosatu – are strongly opposed to the idea. But here’s a thought: The tipping point for Eskom’s restructuring and privatization has already happened. The politics playing out are merely akin to the 5 stages of grief: denial, anger, bargaining, depression and, finally, acceptance.

Just when the tipping point occurred is hard to establish. Was it Eskom’s 1991 price pact that kept electricity cheaper than what it cost to supply for so many years? Was it that Eskom funded the vast electrification program almost on its own? Was it the delays in building new capacity? Was it the huge cost and delays in building new capacity at Medupi, Kusile and Ingula? Was it the ruinous maintenance regime on existing capacity? The management of coal supplies? Perhaps the loss of competent staff together with a ballooning staff and salary overhead?

One could also point to the fact that Eskom is but one of the electricity utilities around the globe facing enormous pressure. New technologies, energy efficiency and a move away from centralized and dirty coal based generation is captured by concepts referred to as “the energy transition” causing what some (but certainly not all) predict will be a “Utility Death Spiral”.

When Eskom reliably supplied huge amounts of electricity at prices that were the lowest anywhere, nobody really cared what happened within Eskom and so the tipping point passed us all by without anyone really noticing. Eskom’s main assets, its generation plant lasts almost as long as our own lifespan. Like us, the consequences of poor choices made when we are younger, such as our health, only impact us much later when we are older.

On a purely theoretical level, the case for a simple privatisation of an electricity utility such as Eskom is not that strong. Electricity production, transmission and distribution is relatively simple but done on a gigantic scale. The product, electrons, never changes and, for a monopoly, there is relatively low market risk. Demand for electricity, against a pre-determined price of supply, ought to be broadly predictable.

The key determinant in a capital intensive operation is the cost of capital and since Eskom’s debt was downgraded to junk status, the costs of its roughly R300 billion existing debt (excluding its own estimated additional R225 billion funding shortfall to 2018) is now the problem it really shouldn’t be.

One of the metrics against which Eskom sets its tariffs is a permitted return on assets. This is, in turn, calculated using a permitted “regulatory asset base” multiplied by Eskom’s weighted cost of capital (WACC). Just how this is works is the subject of an excellent paper by Rashaad Amra an economist at Parliament’s budget office.

In general terms, you want to have a utility like Eskom carrying as much debt as possible because it should be a very cheap source of funding. And it is this point, more than any other, which justifies full public ownership. Public ownership should mean a lower cost of capital and it is precisely this, in a capital intensive and relatively simple business, ought to outweigh the advantages of private ownership. But this is not where we are. Eskom’s junk credit status means that the only advantage of public ownership confers no longer exists and we don’t have the advantages of private capital which is more efficient and generally free of political meddling.

The fact that Eskom, with its junk credit status, has higher borrowing costs than its shareholder, the South African government doesn’t make any sense. One can fully understand why Treasury, working furiously, to preserve South Africa’s own investment credit rating would want to keep Eskom at an arm’s length. It can do so because Eskom is an incorporated company with all the features of a separate identity including its own board of directors, management and operational structures. For the present, the rating agencies also accept that Eskom is a stand-alone entity even while the government guarantees its debt. It can’t do on for much longer. At some point soon, South Africa’s creditors will take the view that failing State Owned Enterprise debt is one and the same as government debt.

Eskom’s recent RCA application to the regulator, NERSA, for an additional tariff increase to recover expenses and lost revenues in previous years has been met with strong opposition from just about everyone.

In relation to unbudgeted costs like vast amounts of diesel to run Eskom’s Open Cycle Gas turbines, the argument is that a “prudent operator” the standard against which NERSA measures Eskom, would never have had to incur those costs. In relation to Eskom’s claim lost revenues, the argument against, is that it is precisely the tariff escalations that have depressed demand for electricity and increasing them will depress demand even further. It should be obvious that this creates a vicious cycle of decreasing demand and increased tariffs. In the meantime, the broader economy, suffers.

Let us remind ourselves where we are. The increases in electricity over the last decade are amongst the highest anywhere which means that our competitive advantage as a country, cheap and abundant electricity, no longer exists. What’s more is that every indication points to further sharp increases. It can’t go on, so it won’t.

Although Eskom has three separate licenses for each of generation, transmission and distribution, South Africans do not get to see how Eskom operates at these three levels. Eskom’s reporting is also on a consolidated basis with all underlying operations reported as one entity.

This makes it very difficult for anyone on the outside to work out what is actually going on inside or to make sense of information that does emerge. Most recently, there have been reports about Gupta controlled companies taking over coal mining assets that supply Eskom. Leaving aside questions of any impropriety, one could reasonably ask how a newcomer to the coal sector step into the shoes of and make a go of a mine that forced its previous owners to put it into business rescue? Moreover, a business rescue motivated for reasons stated under oath? We just don’t know. If the recent NERSA hearings are anything to go by, even outside experts are in the dark – not about the overall picture but about the individual parts that make up the whole.

South Africa (and NERSA) suffers from what is known as information asymmetry and we don’t have the information we need to understand what is really going on. In relation to Eskom’s management, we can’t avoid pointing to the “principal–agent problem”, a problem that describes how management in any company, acting as an agent, is supposed to make the decisions that would best serve the principal (shareholders) but is naturally also motivated by self-interest. The agent’s own best interests may differ from the principal’s best interests.

Privatizing Eskom is not without difficulty. The worst decision would be to sell off 49 percent of it “as is”. The result would be a situation where private capital invested in Eskom demands an investor’s return but without the power to effect the necessary management and operational changes.

This was the route followed with the Telkom partial privatisation in the 1990’s which set our telecoms sector back by several years. By insisting that Telkom’s monopoly be extended, it also did Telkom no favours even as the dividend cheques to its investors kept flowing. As was the case with Telkom, private investors in Eskom might insist that the long overdue changes needed to liberalise the electricity sector be perpetually deferred. Without providing such assurances, Eskom is probably not worth much especially in the current global economic climate. Besides, knackered, carbon-intense, dinosaur-like electricity utilities are not attractive investment propositions anywhere.

At the same time, Eskom’s existing debtholder obligations and internal operations means that it is just not possible to sell bits of it off. A much better solution might be a process where the government as the only shareholder restructures the operations of Eskom by separating out each generator, have each of them issued with their own generating license, then have them manage their own operations including coal supply contracts on a stand-alone basis.

Depending on the age, condition and existing coal supply arrangements, one could fashion the terms of a suitable power purchase agreement between each generator. The transmission grid division, for its part, could develop its own investment programme and be free to procure new generating capacity from IPP’s of all types. Eskom’s distribution division could be broken up into regional distributors in much the way government intended before this valuable initiative was abandoned. If municipalities running their own electricity distributors don’t pay their bills, these simply get absorbed into Eskom’s, to-be-formed regional distributors. The big metros must come to understand that extracting massive surpluses from the redistribution of Eskom’s electricity can’t go on and they must ring-fence their electricity business and keep it separate from other municipal activities.

Of course the restructuring described above doesn’t solve Eskom’s problems but it allows all stakeholders, the government, NERSA, the business sector, the trade unions and consumers to understand what and where they are and what may be required to fix them. It also helps with planning and allowing for greater certainty a critical factor if we want to secure greater investment in the broader economy. In time, privatising Eskom’s generators will be inevitable. As an aside, South Africa’s privately owned renewable projects’ cost of debt is no higher than Eskom’s.

There is another immediate benefit to the above. It is clear that South Africa cannot continue in its low economic growth trajectory. Government is going to have to cut its own costs and raise taxes to keep our budget deficit under some control. It will force down another layer of misery in an already unhappy country. But merely keeping the budget deficit down is not enough.

We have to grow our way out of our economic predicament. It is hard to imagine a better way of signalling that South Africa is serious about economic growth than addressing directly the major and widely known constraint on growth – Eskom the electricity supply sector. Inevitably, Eskom will be back at Treasury for yet another bail out. If this bail-out is simply to shore it up until the next bail-out, that would be distinctly credit-negative for the country. If, however additional funding is provided on the back of actually fixing structural problems, the additional borrowing would be perceived quite differently.

The tipping point for having to do these things has long passed. It is time now to push quickly through the process to acceptance and do the things that, after the tipping point was breached, became inevitable. DM

Photo: Eskom’s electric pylons are pictured in Soweto, southwest of Johannesburg, March 31, 2015. REUTERS/Siphiwe Sibeko.