In an effort to stabilise State-owned power utility Eskom and other State-owned enterprises (SoEs) in distress, Public Enterprises Minister Pravin Gordhan has moved swiftly to install credible boards and capable executive teams.
However, in the case of Eskom, which remains critical to the performance of the economy, there was even less time to avert a serious crisis. Poor governance and a compromised executive team saw the utility run into serious liquidity challenges at the start of 2018. A serious crisis was temporarily averted only when President Cyril Ramaphosa, who at the time was still Deputy President, stepped in to staunch life-threatening bleeding.
“This critical institution was on the brink of collapse through State capture,” Gordhan acknowledged during his Budget Vote in May. “A compromised board and unscrupulous executives were appointed, who were actively engaged in enabling the looting of the institution.”
However, even after the recent interventions, the business remains in intensive care and, without naming Eskom, Gordhan hinted that more help might be required. “Unfortunately, during my short time in this office, it has become evident that several State-owned companies will not be able to trade and borrow their way out of their financial difficulties and some funding will be required from government.”
Besides diligently implementing interventions to return these companies to financial health, the Minister said, in some cases, a restructuring of their operating models may be required to ensure that they deliver on their developmental mandates.
As part of his plan to “recapture” SoEs such as Eskom, Gordhan said business models might need to be restructured “where issues of sustainability will be integral to any solution we arrive at”.
“We will work swiftly to stabilise these entities and return them to financial sustainability through the appointment of capable executive teams, refocusing the companies on their core mandates and ensuring that the companies have viable business and operating models,” the Minister said.
Note to Self
Likewise, the new leadership of Eskom, under chairperson Jabu Mabuza and interim CEO Phakamani Hadebe, have acknowledged that things need to be done differently to ensure Eskom’s long-term survival. A comprehensive long-term plan is, thus, being developed and should be finalised by September.
Without question, the plan will look to enhance Eskom revenue in the short term through both higher sales and, far more controversially, tariff increases. The problem for Eskom is that further hikes could spur even more consumers to find ways of using less electricity, possibly even through full or partial defection from the grid.
Even the National Energy Regulator of South Africa (Nersa) has warned of a “utility death spiral”, whereby price elasticity of industrial demand, in particular, is emerging as a primary driver of the lack of demand. This served to exacerbate a “vicious cycle” in which increasing electricity prices drive declining sales, thereby resulting in the utility having to recover the same cost base from a shrinking customer base.
Any major or successive tariff increases will trigger further decline in sales, which will result in a utility death spiral if not arrested by way of deliberate and focused intervention.
In a recent reason-for-decision (RfD) to limit Eskom’s latest tariff increase application of 19.9% to a mere 5.23%, Nersa noted that, to break the vicious cycle, Eskom needed to reduce its costs (including its fixed cost base) and, hence, its allowable revenue requirement, while growing its sales volumes and thereby driving its tariffs to their most efficient level.
The RfD document posited that this should result in smaller tariff increases going forward, which would attract additional sales volumes and, subsequently, result in even smaller tariff increases and even higher sales volumes going forward, enabling it to transition to a virtuous cycle, which is the desired future state.
In other words, some form of restructuring of the Eskom business model is envisaged. The question, though, is whether a big-bang approach is required, or whether a more phased restructuring is possible.
The ongoing concerns over Eskom’s liquidity and ability to get all users to pay their bills are problematic for many industry experts, resulting in some radical ideas to save the entity and arrest any further decline in operational models.
Some of the possible options were canvassed at an open debate attended by more than 200 people and hosted in May by EE Publishers. Participants deliberated on three motions for the restructuring of Eskom to ensure its future sustainability.
EE Publishers MD Chris Yelland pointed out that the interim management of Eskom was considering some form of restructuring as part of its recovery plan. The presenters stressed that their presentations were made in their personal capacities and also pointed out that, in some instances, were not even their personal viewpoint on the matter.
Nersa CEO and full-time regulator member Chris Forlee, who served as the debate chairperson, said the motions served as an academic exercise to open the debate and illustrate three radical concepts.
Motion 1 was presented by Development Bank of Southern Africa deputy chairperson and former National Union of Mineworkers secretary-general Frans Baleni. This motion set out the case for no restructuring of Eskom, but for improving the governance and efficiency of the utility.
Baleni argued that, although renewed financial, operational and maintenance discipline, as well as the rooting out of maladministration and corruption, were required, the current Eskom structure as a vertically integrated State-owned entity was suitable and appropriate for the socio-economic and developmental needs of South Africa.
Stating his case for no restructuring, he added that the sheer cost to restructure would be too much and any efforts to do so would take more time than would otherwise be required to address the current challenges: “It is quicker to stabilise the business than to restructure.”
Any effort to restructure Eskom would also require attention to other factors of the greater electricity industry, thereby costing more money and taking even longer.
Further, any effort made by Eskom to deal with its issues would benefit growing investor confidence, and this would go a long way towards creating desperately needed certainty among customers, investors and staff.
Motion 2 was presented by Eskom nonexecutive director and former Department of Energy director-general Nelisiwe Magubane, which entailed a “light restructuring” of Eskom, including some retention of the current status quo, but with increased public participation.
However, such public participation in the business of Eskom required additional public and/or strategic equity partners to recapitalise the business and introduce enhanced accountability and transparency.
Describing how Eskom could benefit from light restructuring, Magubane said the process of limited restructuring needed to be approached with the end goal in mind. In this regard, three key questions needed to be answered: What is the most appropriate model for South Africa to meet the stated objectives? What are the priorities for socioeconomic success? What role will electricity play in ensuring socioeconomic success as outlined in South Africa’s long-term plans?
Therefore, Eskom needed to establish its current position on these questions and subsequently develop solid plans to reach its desired end state, she added.
Such a restructuring would require that several key factors be addressed, including collaboration between Eskom and municipalities, and efficiencies in the distribution sector. The capital structure of the utility would also require attention, with specific focus on loan covenants.
Motion 3 was presented by infra- structure and regulatory economist Dr Grové Steyn. This motion laid out a complete and thorough restructuring of Eskom, as well as the broader electricity supply industry.
Steyn argued that the entire electricity supply industry in South Africa needed to be fundamentally restructured to make it fit for purpose to face the challenges of future electricity supply and disruptive technologies, generally along the lines proposed in the Government White Paper on Energy Policy of 1998.
He said an undoing of an institutional framework – with roots going back 95 years, when Eskom was established (in 1923) – was required, as the entity had long since outlived its usefulness. “It has now become critical for South Africa to embrace the technological disruption and address the environmental imperatives in the power sector. However, to achieve this, institutional reforms are required.” This would also require the opening of the market.
“By the late 1970s, the Eskom model became increasingly dysfunctional,” said Steyn, adding that, at that time, the operating model typically resulted in inexorable “boom and bust” cycles. These cycles involved the initiation of inflexible megaproject build programmes, which were based on unrealistic demand forecasts, bespoke designs and sometimes partly proven technologies.
Significant time and cost overruns, load-shedding and tariff spikes followed, as well as surplus capacity and stranded assets. He also pointed out that this situation would go on to repeat itself 15 years later with greater negative effects.
The complete absence of competition and being a monopoly would ultimately lead to the abuse of dominance and the promotion of large inefficiencies, he added.
All this leads to new institutional models being required. “It is now globally recognised that electricity generation is best organised as a competitive sector,” said Steyn.
As a first step in the reform process, South Africa urgently needed an independent transmission, system and market operator, as this would resolve the inherent conflict of interest arising from Eskom as a generator that also controlled the platform on which it competed with other players, averred Steyn.
This motion also involved the deregulation of smaller projects and greater customer choice.
While most of the participants supported Steyn’s call for a radical overhaul, the route that government will take with regard to the restructuring of Eskom is far from certain.
What is certain is that the authorities are, at last, alive to the fact that it can no longer be business as usual at the State-owned power company. Changes will have to be made to reduce the risk Eskom poses not only to government’s fiscal balances but also to the economy as a whole.