Business Maverick

Business Maverick, Politics

Questions, and some answers, with Eskom’s Paul O’Flaherty

Eskom recently announced its interim results for the financial year ending 31 March 2010. Chris Yelland asked Eskom finance director Paul O’Flaherty the big questions about the parastatal’s operations. How much does Mozal pay for electricity, really? What’s up with the Kusile funding plan? And will the first phase of Medupi actually come online in 2012? O’Flaherty answered some of them but was a little reticent on Eskom’s future plans. We hope this isn’t because there aren’t any.

Chris Yelland: Is there any specific reason why this year Eskom’s annual financial report was not published and available at the announcement of the annual financial results last week? When will it be available?

Paul O’Flaherty: What we’ve done this year is actually a record for Eskom. We’ve come out and announced our results two months after our year-end. We’ve published our preliminary results as listed companies do, and they have been reviewed by our auditors. Our full final financial statements – the whole 360-page integrated report – will be available after the annual general meeting, which is held at the end of this month. So it is actually a big positive for us to come out with these preliminary financial results.

CY: With the Eskom financial year-end being 31 March 2010, should the income statement not reflect the financial year ending 31 March 2010, with the balance sheet as on 31 March 2010? In which case, why is the revised Mozal special pricing arrangement, which was only announced two weeks ago and is still subject to regulatory approval, being reported and factored in for the year ending 31 March 2010?

PO’F: From an accounting perspective, we had signed a “heads of agreement” before the end of the financial year, and so we have what is called a “post-balance sheet event” that is adjustable. In other words, we signed the revised Mozal contract after year-end for an event and negotiation that was firm before the year-end. So, from an accounting valuation point of view, this is the correct accounting treatment.

CY: What is the revised pricing arrangement with Mozal? Are they on a published tariff like other “normal” energy intensive customers? What average price per kilowatt hour is Mozal now paying, and how does this compare with other energy-intensive South African customers, and with the other special pricing deal customers (Hillside, Bayside and Scorpion Zinc)? What justification is there for keeping all this a secret?

PO’F: I believe this is a question for BHP Billiton to answer – not us. However, the aluminium smelter business is a competitive one worldwide. The electricity price is a very significant component of their cost structure; it provides a competitive advantage, and is a key factor in determining where they establish their plants. Eskom cannot disclose the new tariff as it is confidential competitive information for BHP Billiton. What I can say is that we now cover the full costs of power from Cahora Bassa, plus associated wheeling. We charge a fully rand-denominated tariff, which includes mark-up, and incorporates price increases per annum that are greater than the increases we pay on Cahora Bassa power. We therefore have no embedded derivatives; we have a natural tariff hedge on the Cahora Bassa power costs, and we now sell electricity to Mozal at above full total cost.

CY: About two years ago, Eskom was about to place orders for Nuclear 1 and 2. But the decision was deferred. Then about a year ago, Eskom was saying it needed an imminent decision on Coal 3. But then in late 2009, Eskom indicated that it will not be building Coal 3, Nuclear 1 and Nuclear 2, and these would have to be done by others. When do you think “others” will pick up this ball, and is another capacity crisis looming if this is not done now?

PO’F: Yes, I think that it is true – there is another capacity crisis looming. But we have to make sure at Eskom that we can at least finish Kusile. We currently have a funding problem in actually finishing off Kusile, and we cannot possibly commit ourselves beyond that without actually having enough money to finish Kusile. So when we talk about others, Eskom is hoping that the Integrated Resource Plan for Electricity (IRP 2) that is due to come out in September will provide further clarification. Eskom will then ascertain whether it can participate in these new nuclear and/or coal power stations or not – it will all depend on our financial ability.

CY: Has the placement of new contracts for the construction of Kusile restarted since this was stopped in December 2008, or is this still awaiting a funding plan, for example, finding a private equity partner for Kusile?

PO’F: Brain Dames and I are working very closely on this. We are following what we call a “limited notice to proceed”. So we are signing the contracts that are aligned to the critical path of Kusile, but we are doing it in a much slower fashion than we would if we had a proper funding plan in place. At this point we don’t have an approved funding plan, so we are taking it month-by-month, as we go. There are potential delays if we don’t get the funding plan approved within the next two to three weeks.

CY: How long is it likely to take to find an equity partner for Kusile and close the deal, or to make another funding plan for Kusile? Six months? A year?

PO’F: We’ve spent a lot of time on this with Credit Suisse. We gave them a mandate, and that mandate is now over. We have gone all around the world talking to various people – talking to how we would do this. The best-case scenario is that we can get this deal done in 18 months, and it could take longer than that. And it all comes down to framework – what is the regulatory framework and government support that is required by a potential strategic equity partner, and how soon can this be put in place. For example, a power-purchase agreement (PPA)…

CY: You mentioned 18 months (minimum) to close the deal on funding for Kusile. Does this mean we could be faced with a further 18 month delay in the construction of Kusile?

PO’F: What we are saying is that it will take 18 months to find an equity partner. So we’ve put another solution on the table with government that can be done much quicker – a more holistic solution for Eskom. We are awaiting government approval for this in the next two to three weeks, because this will fast-track Kusile.

CY: Can you give any details on this alternative or interim funding solution, or is this not open for discussion yet?

PO’F: What I can say is what we’ve said before in the public domain – that we have about R59 billion of the R176 billion government guarantee left. To date we’ve been using this guarantee one-for-one for debt. We believe there is another mechanism by which we can use it to strengthen our credit profile. So a combination of the guarantee and potential international bonds is a solution we can put on the table now for implementation within six months.

CY: How have the current and possible further delays in placing contracts at Kusile impacted on the overall cost and delivery time of Kusile? Have the additional costs due to the delays in Kusile, for example, cost of finance during construction, cost price escalation and exchange rate risks, been factored in to the current price tag yet?

PO’F: The total construction costs, excluding escalation and interest, are estimated at R100 billion, and we’ve placed 70% of these contracts by value. So we believe that the remaining contracts that need to be placed are limited in terms of how far they can go off the money. However you are right – we’ve calculated that for every 12-month delay on Kusile, just in terms of interest during construction, the impact is R14 billion of additional interest per annum. We haven’t done a detailed exercise yet to estimate the cost-price adjustments or escalations in the contracts, and we are still working to the R145 billion that we’ve spoken about. We do have contingencies built into that, and certainly in the next two to three weeks, as soon as we can finalise the funding plan, we can go and do the real detailed calculations.

CY: What is the latest revised cost for Kusile and what would be the cancellation costs? I have heard a revised price tag of R175 billion mentioned, with a figure R21 billion for cancellation. Is this correct? Is the cancellation of Kusile a possible least-cost outcome of IRP 2, or is Kusile to be taken as a given? Could Kusile be replaced with say three or four smaller base-load coal-fired stations from IPPs with lower costs, shorter lead times and lower risks for Eskom, the government and the country? Is the cancellation of Kusile still an option?

PO’F: Personally, I don’t think it’s an option, and we have not seen somebody come up with anything better. So if anybody suggests a modular approach with a number of smaller power stations to replace Kusile, we haven’t seen the technical details yet. They would still have to go through all the licensing; they would still have to secure all the coal; and they would still have to sort out all their water issues. So we believe that this is a bridge too far.

In terms of cancellation costs, what I can tell you is that I have done this before in the Middle East. When you cancel, it’s in terms of the International Federation of Consulting Engineers conditions of contract. So you would have to pay the contractors all the money that they have spent to date in manufacturing whatever equipment, and that’s well advanced; you would also have to pay them for loss of profits; and you would obviously lose any advance payments that you have made. So the figure is higher than R21 billion – a lot higher considering that we have placed 70% of the contracts by value. Regarding a revised cost of R175 billion – I’ve quoted a figure of R145- billion. But this R145 billion depends on receiving the go-ahead with everything we need to do on Kusile within the next two to three weeks. Should we be delayed beyond this, then the price will just rise. So I can’t give you an exact number at this stage.

CY: Which contractor(s) are overall responsible for the commissioning of Medupi, or is Eskom taking on this risk and liability? Is the Medupi price tag still R124 billion excluding flue-gas desulphurisation? And is the first unit at Medupi still scheduled for April 2012?

PO’F: The contract is being run as an engineering, procurement and construction management project. So Eskom, together with an external professional contract management team, provides the overall project management and is therefore responsible for the ultimate commissioning. However, as it relates to the equipment itself, within the contacts with the various equipment suppliers, they obviously have to commission their equipment on time and to the right quality. But the overall responsibility lies with Eskom. The Medupi price tag is still R124 billon, and this excludes flue-gas desulphurisation plant because this will only be completed post-commissioning [in about 2020]. The first unit at Medupi is definitely still scheduled for April 2012.

By Chris Yelland

(Yelland is the MD of EE Publishers)


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