Can Eskom be saved?

Can Eskom be saved?

25 Jul 2018 FINANCE

By Khaya Sitole

Over 95 years ago, the Electricity Supply Commission now Eskom was created through the Electricity Act of 1922. As the primary supplier of electricity to the nation of South Africa, Eskom is one of the most critical entities in the country and its sustainability is a fundamental requirement for the country.

This week Eskom published its latest set of financial statements – and easily the most dire yet. Its financial performance for the year indicated that it has lost R2,3 billion in the past 12 months. This is in comparison to the profit of R900 million in 2017.

Such a deterioration in performance is disastrous for Eskom as it comes on the back of the discovery of multiple contracts that delivered no value to the entity. Additionally, its balance sheet – which focuses on the long-term financial position of the company – indicates that Eskom relies heavily on debt and spends around R26 billion paying off interest on debt. Its other key expense – staff costs – accounts for R29 billion in 2018. To keep the company sustainable, Eskom clearly needs to find a way to boost its revenues and cut its costs – at the same time.

The 2018 results indicate that electricity sales are down. Additionally, the National Energy Regulator regularly approves tariff increases that are much lower than Eskom wishes to have. To that end, it is unlikely that Eskom’s recovery path with be driven by revenue growth – especially in an economy that has declining growth prospects. On the other hand, Eskom’s staff costs are already subject to a protracted wage dispute. Eskom’s initial position – a 0% increase for all staff – has been rejected outright by unions. An above-inflation increase is now inevitable which will only worsen the problem.

An alternative cost-reduction strategy would be to reduce headcount through natural attrition, but that is a gamble that cannot be quantified by anyone. Retrenchments therefore need to be considered as the most direct way of reducing the wage bill. But unfortunately, in a general election cycle, few things would attract greater risk for Eskom at this stage.

Since the release of the results, 2 separate developments have come to the fore – one financial and the other more strategic. On the financial side, the Chinese have extended a loan of over R33 billion to Eskom – thanks to the efforts of Cyril Ramaphosa and his investment envoys. The problem with loans advanced to Eskom is that not only do they make the debt position actually worse; they also increase the financing costs for future years. In this case, as Eskom is essentially borrowing to finance operations rather than long-term investments; you get the impression that the very basics of how to run a business are not being applied in the Eskom case.

The Public Investment Corporation, PIC – beset with its own dramas relating to governance issues – has exposure of over R120 billion relating to loans it has provided to Eskom. Paul Mashatile – the Treasurer-General of the ANC, has been quoted saying that a conversion of that loan to equity is on the cards. In this case, the loan of R120 billion would essentially be written off and Eskom would not need to pay it back. This would help its balance sheet by reducing the debt balance and also reducing interest costs. However, such a move would have bigger long-term implications for the country at large.

A unique feature of the PIC is that it runs a defined-benefit scheme which simply means that the pensioners whose money is overseen by the PIC are guaranteed to get their money when they retire. In other words, if there is any shortfall in PIC funds, the taxpayer has to step in and fill the gap. This means that when the PIC is asked to write off amounts of over R120 billion to assist an entity like Eskom, the risk if essentially moved from Eskom to the taxpayer.

A second development, which is more strategic in nature – relates to the possible break-up of Eskom into 3 separate entities – distribution, transmission and generation. Such a break-up would create three discrete, more manageable entities. But – given the governance challenges exhibited by the fact that Eskom has recycled 10 CEOs and 6 Boards in just 10 years – one wonders if 3 different Eskoms will actually make any sense for South Africa.

John Perlman had a conversation about the latest developments at Eskom.