Mental floss for the discerning
21 March 2018 08:53 (South Africa)
South Africa

Op-Ed: Eskom – towards a constructive solution

  • Dirk de Vos
    Dirk de Vos

    Dirk runs a corporate finance and advisory firm, QED Solutions ( out of Cape Town.

  • South Africa

Bailing Eskom out, again, is not enough; we need to fix Eskom’s underlying structural problems. And at this critical stage we simply cannot afford another pointless debate about the merits (or not) of privatisation – its goes nowhere. But an interesting way around this is proposed by UCLA psychologist Matthew Lieberman, who is seeking to revive an idea from the 1960s. Could it work? By DIRK DE VOS.

If I were part of the Zuma administration, the slow-moving train wreck that is our electricity system would keep me awake at night. While politicians are often accused of having short-term agendas and so allowing problems to be deferred, this problem is different.

Any notions that any current cabinet ministers might have about an extended political career or a peaceful retirement in comfort will be subject to sorting this problem out. The major achievement of our democratic era has been mass electrification – people have come to depend on it and won’t accept reverting to not having electricity again. You don’t want to be the person in charge if this were ever to happen.

Eskom’s current problems are huge and are not going away. According to Eskom, it has a projected revenue shortfall of an eye-watering R225 billion and an immediate need for a R50 billion cash injection to continue funding its build programme and for working capital to alleviate its current cash flow problems. And so it is that we saw an announcement by National Treasury that the Cabinet had approved a package to close the funding gap at Eskom. We are also advised that this package was the result of recommendations from an Inter-Ministerial Committee which had reviewed an extensive set of options available to ensure energy security.

The funding gaps are huge and this has to be found from budget already allocated elsewhere or borrowed. The details of the funding package were decidedly vague but some funding in the form of equity (i.e. not a loan) would be from the “leveraging non-strategic state assets” (what those assets might be was not disclosed). This, in turn, would allow Eskom to borrow R50 billion more than its original plan of borrowing R200 billion. All Eskom’s debt raising would be supported by an additional guarantee facility from the government. The full details of all this are to be provided by the Finance Minister, Nhlanhla Nene, in his future budget announcements.

Treasury, the one effective part of our government administration, is correct to be wary about funding Eskom requirements, but we all know that there is no real choice. For the same reasons, the National Energy Regulator (Nersa) will also probably have to approve an adjustment to the scheduled above-inflation 8% increase in the electricity tariff.

Eskom is like one of those employees critical to the factory production line who has always done what you asked of him plus, willingly, a whole lot of other odd jobs around the factory that have not been part of his job description. But his salary has not kept pace with inflation and he has been generally neglected. He is also getting near retirement age.

But recently his performance has suffered, there are unexplained incidents of absenteeism and a distractedness at work, and he has made some very expensive mistakes. Then there are those calls from retail credit providers wanting to confirm that he is employed by you but worryingly, a garnishee order against his salary has been delivered by the sheriff. At mid-month, when he asks you for a loan, you don’t have a choice. The production line depends on him. Of course, you also have to adjust his salary as one of the immediate responses, but that means you have to cut costs elsewhere. This factory is not working optimally on many levels: suppliers are expressing concern about long-term viability so won’t extend too much more credit, and customers are threatening to go elsewhere.

Despite knowing that you are partially responsible for the situation your erstwhile trusty employee finds himself in, you have to prepare for a different way of doing things like they have done in most other similar factories. You have to diversify risk, get others to do more of his work and outsource some functions to willing service providers. The whole factory depends on it.

A good part of the current problems are the builds at Medupi and Kusile. It is hard to understate the disaster these have been. It is difficult to get hard numbers, but the budget approval in 2007 for Medupi and Kusile were around R70 billion apiece. According to Chris Yelland, the budget to get Medupi to completion ballooned to over R150 billion including all financing charges. Other estimates are even higher than that.

To help understand this, one could refer to benchmarks produced by the International Energy Agency on the projected costs of producing electricity from various energy sources. Now, while big ticket items are not bought “off the shelf”, the guide for coal-fired power stations using normal financing charges and a four-year construction period is that the total, all in cost of producing electricity from coal power plants, is 50% to the construction costs and financing; 35% to the costs of the fuel (coal); and 15% to maintenance. What this shows is that big swings in the construction price and delays in completion have a bigger impact on the price that must be charged for electricity than any other post-completion factor. Medupi, which was supposed to be delivering 4,800MW to the grid by October 2013, is now 45 months behind schedule. Similarly, the first and last generating units at Kusile, a project of a similar size, are 45 and 56 months late respectively – now scheduled for 30 June 2016 and 30 June 2019.

Consider this: On a capital amount of R100 billion accumulated interest, using an interest rate of 8%, would amount to about R33 billion in 45 months and R43 billion in 56 months. But this is not the full picture. Last year, Eskom’s average selling price of electricity was around 63c/kwh. Given that Medupi will have a 4,800MW capacity when completed and assuming an uptime of 85%, Medupi would generate electricity roughly equal to roughly R26 billion per annum. None of this includes the accumulated penalties reported to be just short of R2 billion already paid to mining company Exxaro for coal that it did not deliver. The net effect is that Medupi and Kusile will only be able to produce power at a cost well above what South Africa can afford for a generation to come – it is now baked into their respective capital structures.

There is no point in criticising the decision to bail Eskom out – there is no choice, but surely things cannot go on like this? Eskom may have avoided a downgrade by the rating agencies, but South Africa’s own government debt spiked upwards on the news. In general terms, South Africa’s debt is not excessive; about 40% of GDP (perhaps closer to 60% if all state-owned enterprise debt is included). But it is no longer comfortable. Recently, South Africa has suffered credit rating downgrades and depending on the rating agency, we are close to the borderline of being sub-investment grade. Our poor growth prospects and increasing our borrowings to fund current consumption means we are heading in the wrong direction. The consequences of losing our investment grading will be dramatic. Not only would raising more debt become difficult and expensive, the costs of servicing our existing debt, an amount approaching R1,5 trillion (without public enterprise debt), would increase too. This would force the government to scale back on the public service and to re-allocate budgets away from a growing welfare and dependency grants budget. The political consequences of this are more than we can manage right now.

Bailing Eskom out is not enough; we need to fix Eskom’s underlying structural problems. The government has set against privatisation of any state assets. What we cannot afford at this critical juncture is another pointless debate about the merits of privatisation – its goes nowhere. South Africans are too ideologically fixated and there are too many lines in the sand on the issue. An interesting way around this is proposed by UCLA psychologist Matthew Lieberman, who has sought to revive an idea from the 1960’s called “latitudes of acceptance”. What this entails is that if you want to make a persuasive argument, you need to pitch it in the range of a bubble surrounding the recipient’s current belief system. The bubble is that area not too far from current positions or arguments that, although outside a fixed position, are still considered to be reasonable. Under different circumstances, Lieberman suggests that these bubbles can flex and move in different ways. He says that the key to getting opposing arguments to work together is getting them to a place where these bubbles overlap. This is not about achieving common ground on the positions that people have, but rather the bubbles that surround those positions. It is therefore not about getting anyone to abandon their prior positions; it is about finding some position that both sides think would not be a crazy position to hold.

Proceeding from this, it is not politically feasible to argue that Eskom should be broken up and privatised even, if this is seen as the best solution. Neither is it workable that government should abandon the idea that Eskom is a strategic asset which can’t be privatised. Perhaps one could say instead that not all of Eskom’s assets are strategic. What could these be? Well, all the older generating plants fit this criterion. Each of them are tightly integrated into the grid and they do just one thing – generate electricity into the grid. However they were owned, they would still have to do the same thing. Nothing else that could be considered strategic, such as free basic electricity allocations or the prices paid for electricity by municipalities or certain “strategic” industries is impacted upon; neither is security of supply undermined. Sure, the grid is strategic – the power plants are not.

The sale of all or a part of the older generators would have to be linked to a long term Power Purchase Agreement in any event, which would fix the terms under which they would supply electricity to the grid. Eskom, having failed to keep to a proper maintenance schedule for so long, now has to do the same thing internally in any event if it is to improve plant availability. There is another point to be made – around the world, there are large pools of capital looking for a half decent and relatively risk-free yield. If this yield requirement is similar to Eskom’s own borrowing costs, then there can be no harm in tapping it. Instead, there would be a number of advantages in doing so. Eskom’s debt would be reduced and with a better mix of debt, capital and free cash flows, the upward pressure on electricity prices would be reduced. The rapidly accumulating inefficiencies and increased downtime at these power plants would also be reduced, as the risks of these would be shifted to their new owners. The risks of not following this proposal seem greater than not doing so. If Eskom needs further bail-outs, its debt would simply be seen part of the country’s debt pushing our debt to GDP ratio over the edge.

What we should all avoid is a situation that arises from excessive indebtedness – this is a kind of privatisation of everything which is done through the back door. It makes the whole country subject to the whims of capital. A review of other over-indebted countries and their loss of sovereignty should provide our government with a cautionary tale.

With Eskom, we have made some terrible mistakes; yet, unlike some of our country’s other problems, we can go some way towards solving them. Importantly, the solutions are very possibly within our “latitudes of acceptance”. Next month, Finance Minister Nhlanhla Nene will need to provide details of the financing in his mid-year budget announcements. We can just hope that he will make the right decisions. To paraphrase a slogan from his political party – we all now need a good story, and it is up to him to tell it. DM

Photo: A picture made available on 04 April 2008 shows a family eating their dinner under candle light during a planned power outage the middle class suburb of Parkhurst, Johannesburg, South Africa, 03 April 2008. EPA/KIM LUDBROOK

  • Dirk de Vos
    Dirk de Vos

    Dirk runs a corporate finance and advisory firm, QED Solutions ( out of Cape Town.

  • South Africa

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