On the brink of a death spiral

July 31st, 2019, Published in Articles: EE Publishers, Articles: Energize, Articles: Vector

With debt approaching R450-billion and an operating deficit of R20,7-billion for the 2018/2019 financial year, and the utility being unable to cover its operational and debt-servicing costs with revenue from sales of electricity, Eskom is on the brink of a death spiral.

This is the implication from the figures presented at Eskom’s recent Integrated Results (IR) 2019 meeting in Johannesburg. Without government bailouts, the deficit would have been even bigger, the meeting heard. Furthermore, the utility warned, next year’s results are likely to be similar.

Eskom cannot cover its operational and debt financing costs from the money it receives from the sale of electricity. In order to address this, the organisation is seeking legal support in the form of a court order, to force the national energy regulator (Nersa) to allow the utility to increase its tariffs significantly. International experience shows that where this approach has been followed by other utilities, those utilities sold even less electricity than before and continued to be unable to cover their costs, resulting in their ultimate collapse. This phenomenon is known as the “utility death spiral”.

The state-owned power utility has posted large losses before, but never anything like what was announced at the recent IR2019 meeting. According to published results, the loss for the 2017/2018 period was R2,3-billion; in the 2016/2017 period the company lost R870-million; while in the 2015/2016 period it made a profit of R3,1-billion.

The utility says that its earnings before interest, tax, depreciation and amortisation (EBITDA), expressed as a percentage of revenue, fell from 25,6% to 17,5% resulting mainly from increased primary energy and employee benefit expenses. This was exacerbated by a combination of declining sales of electricity and increasing municipal and end-user (mostly residential) arrear debt. Apparently, the cost of primary energy (i.e. coal and diesel) increased by 17% year-on-year. Poor plant performance resulted in the utility using diesel-powered open-cycle gas turbines to meet demand.

Jabu Mabuza, Eskom’s chair, said that the utility faced some difficulties when trying to source funding in both the domestic and foreign markets, primarily due to decreased investor confidence. Eskom’s reputation has been damaged following the audit modifications to the 2016/17 and 2017/18 financial statements related to the completeness of irregular expenditure, previously reported governance issues, ongoing operational challenges, and uncertainty regarding its proposed restructuring.

Phakamani Hadebe, the organisation’s outgoing CEO, said that Eskom has developed a turnaround plan which would put the organisation on a path towards achieving structural, financial and operational sustainability. The turnaround plan is supported by the CEO’s nine-point generation recovery plan and is supported by four pillars: cost containment and sales growth, cost-reflective tariffs, balance sheet optimisation, and business separation.

It was announced that Freeman Nomvalo, the CEO of the South African Institute of Chartered Accountants, would be appointed to set up and head a restructuring office which would make use of a team of experts who would assist in the drawing up of a comprehensive restructuring plan for the utility.

Calib Cassim, the utility’s chief financial officer, said that costs must be reduced “by at least R33-billion in 2022/23, with cumulative cash savings of approximately R77-billion required over the next four years.” The success of this pillar will depend on the utility selling more electricity at higher tariffs to increase revenue. According to Cassim, the tariff Nersa has allowed is not cost related and will make the utility unsustainable.

Eskom employs 46 000 people, which is apparently about 13 000 more than other power utilities of similar size to Eskom. Therefore, reducing headcount would be a significant cost containment measure, but as the national unemployment figure has already increased to 29%, it would, in the words of Minister Gordhan, “be socially irresponsible” if Eskom were to “throw workers out onto the street”, without reskilling them and giving them “a life after Eskom.”

The government has committed itself to provide about R290-billion over the next ten years, yet the minister of public enterprises, Pravin Gordhan, has not said what conditions accompany this bailout. We are yet to hear what it will take for Eskom to fulfill its mandate of supplying reliable, affordable electricity without relying on bailouts.

 

 

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