by Chris Yelland, managing director, EE Business Intelligence
Following a comprehensive interview with Minerals & Energy Minister Gwede Mantashe on energy and electricity policy in South Africa two weeks ago, energy analyst Chris Yelland tackles the Minister of Public Enterprises, Pravin Gordhan, on the big elephant in the room – Eskom.
The interview covers Eskom debt, the regulatory framework, rising electricity prices, the need for bailouts and cost-cutting, declining plant performance, Medupi and Kusile, environmental sustainability, unbundling and restructuring, the end-state of the electricity supply industry, the utility death spiral, and issues of transparency and accountability.
Eskom debt – the missing plan?
The unsustainable level of Eskom debt has been highlighted for the last few years, with several credible options for debt restructuring and refinancing now on the table. As minister of public enterprises, what is your preference, and how would you see this being resolved? When will the Department of Public Enterprises (DPE) and the Minister of Finance be taking the necessary hard decisions to give some certainty all round, including to the financial community and rating agencies?
As far as the debt question is concerned, as the Ramaphosa administration, we had two immediate priorities in getting to grips with the challenges that Eskom is facing. The first was to provide whatever fiscal support could be given, and that’s the R23-billion per year, plus the current appropriations indicated in the budget. The second was to ensure immediate operational improvements, including cost savings within the Eskom framework itself.
The next phase was to formulate the various options for managing Eskom’s debt portfolio. That work was done in the latter part of last year.
The third phase will be to focus further on operational improvements, while seeking an integrated way of dealing with Eskom’s debt, including the options of climate finance and other creative mechanisms, as well as the restructuring of Eskom in line with the Eskom roadmap,
When will all of this come to some kind of convergence? I think towards the middle of the year we will have a better appreciation of the options and the kind of direction that we want to take.
Electricity price – too high or too low?
You yourself, the Minister of Minerals & Energy, and customers have indicated that the price of electricity is too high. Eskom on the other hand says the price of electricity is too low, and must rise by 30% to be cost-reflective. The utility is fighting in court for higher annual electricity tariffs, and to claw back over R100-billion from customers to cover a debt hole that is growing by about R50-billion a year. Are electricity prices in South Africa too high or too low, and if so, what is to be done about this?
Electricity prices are part of what we would call administered prices in the economy. The goal of government is set out in the National Development Plan (NDP), which states that we need to reduce the cost of doing business in South Africa. That would include port charges, freight charges, electricity, water and other tariffs that are generally within government control, as well as other more market-related costs.
International comparisons seem to indicate that, objectively speaking, electricity prices in South Africa are not too high. At the same time, South Africa has its own structural challenges in terms of certain industries like mining and manufacturing, and the difficulties in these sectors need to be taken into account by Eskom itself.
Equally, Eskom has its own internal dynamic that it needs to modify. This internal dynamic keeps pushing tariffs up, and we’ve seen the numbers over the last ten years, or so. Whilst there has been no increase in energy delivered, there has been a fourfold increase in revenue, largely resulting from tariff increases. The flip side of this coin is managing costs within Eskom itself, so that its pricing can be kept as low as possible to ensure a competitive economy at the end of the day.
Pricing and energy supply are one side of the equation. The other side is energy efficiency. There has to be a greater focus and push from industry to become more energy-efficient in the way our limited electricity resources are used, and also to contribute to our climate-change goals.
Nersa – is the regulatory framework fit-for-purpose?
Currently we see Nersa’s fourth multi-year price determination (MYPD4), being challenged in court, along with Nersa’s revenue determination for the 2018/19 financial year, and the regulatory clearing account (RCA) determinations for the 2014/15, 2015/16 and 2016/17 years. Eskom blames Nersa for the utility’s dire financial and operational state. Are the current regulatory processes, and Nersa’s pace and cost-plus recovery methodology, really fit for purpose today?
I think the general principle of having a Regulator that objectively determines pricing is a well-held and well-accepted principle. But there is currently the Nersa Amendment Bill that the Minister of Minerals & Energy is taking through parliament, which would introduce an internal appeal mechanism into the regulatory framework, where a tribunal would adjudicate or arbitrate disputes without a court process.
Court processes between government entities, such as the Regulator and an operator like Eskom, should not happen too often in the context of the corporate governance chapter of our constitution.
But there is still a dynamic within Eskom that endeavours to recover as much possible via the tariffs, and that’s a culture shift that we need to make under the new Eskom CEO and board that will come into place. We need a shift towards greater cost-efficiency, and a review of all contracts that contribute to cost inefficiency. We need to track down the different forms of corruption, and recover money that was stolen from Eskom during the state-capture period.
All this will ultimately contribute to a different dynamic between the Regulator and Eskom as a regulated entity.
Cost cutting – where are the opportunities?
Both you and Minister Mantashe have suggested negotiations to reduce coal costs and IPP tariffs for renewable energy delivered to Eskom. The World Bank and Nersa have both indicated excessive staffing at Eskom. Operating and maintenance costs, interest and depreciation continue to increase. Eskom says cost cutting opportunities are limited. So where are the cost-cutting opportunities to be found, and are the kind of public sector staff remuneration cuts announced in the budget the appropriate response?
There are numerous cost-cutting opportunities, and I wouldn’t be able to list all of them here. But in the first instance, the salary scales and benefits of top management are the subject of public debate and calls for review.
If you look at the aviation industry right now in the context of the Corona virus crisis, Singapore airlines has just said it is cutting the salaries of top executives by 15% and middle layers by 7%, while certain staff are on placed on paid and unpaid leave. Various other airlines are following that model as well in the context of a crisis. So, we’ve all got to work out what kind of sacrifices we can make during the Eskom crisis period.
There is also the broad area of procurement. Some of the excessive things that happened in the state-capture period have been curtailed, but there are still huge opportunities here. There is a general demand that we review all contracts, whether for coal, diesel or spares for maintenance and refurbishment processes. Eskom needs to review the arrangements it has with contractors, such as those who do maintenance, including the quality of the maintenance that is actually conducted.
There are many other forms of wastage that you are going to find in any organisation whether in the public or private sector, but in particular in a monopoly like Eskom. So, the opportunities are certainly there, and I am confident that as the new CEO settles in and builds the right team around him, we will see the results of that introspection and careful examination of costs within Eskom.
Equity, bailouts and cash injections – or are these just ongoing subsidies?
A senior executive at Eskom recently told me to stop using the word “bailouts” and “cash injections”, as these were misnomers for what are really ongoing government subsidies for electricity tariffs that are not cost-reflective. Are these “subsidies” here to stay, and what are the conditionalities to the R230-billion of government bailouts to Eskom over the next ten years that were confirmed by the Minister of Finance in his 2020 budget speech?
The conditionalities from the Treasury are set out in the medium-term budget policy statement (MTBPS), and in correspondence between the Minister of Finance and Eskom. Amongst those are requirements for operational efficiency, cost cutting and other measures that Eskom itself needs to make.
But to come back to the main point: state-owned entities (SOEs) need be able to stand on their own, with sustainable financing and effective operations. There should be no need for government to put in any kind of money if the entity is operating efficiently. In the case of Eskom, the dependence on the fiscus will take some time to resolve – but this dependence must be removed completely.
All SOEs must be self-sustaining, save to the extent that a specific developmental mandate may be given to an SOE, which could be reimbursed either through cross-subsidisation, or on the understanding that no dividends are payable to the state, but are instead used for developmental purposes.
It is in this context that we need to reposition the mindsets of boards and management within institutions like Eskom. They must head in the direction of a normal business enterprise that is able to sustain itself and any investments needed, based on what its revenue and the competence of its staff allow. So, words like bailouts, and so on, must begin to disappear from our vocabulary as we go forward.
Declining EAF and load shedding – the diminishing returns of maintenance?
The recently published IRP 2019 and the Eskom roadmap made assumptions of Eskom’s energy availability factor (EAF) increasing to 75%, while the trend is already showing a continued declining EAF as a result of aging old plant, poorly performing new plant, and increased maintenance that takes more units out of service. Surely it is time to be more realistic in planning, to acknowledge the high cost and diminishing returns of increased maintenance on aging plant, and to put greater emphasis on new, non-Eskom generation capacity?
We’ve already had a recognition in government, both by the Minister of Minerals & Energy and the President, in various addresses in recent times, that generation must become less and less of an Eskom monopoly as we go forward. So, I think the loosening of the knot, so to speak, has begun – through the concepts self-generation and embedded generation, plus the kind of investments that are happening in renewables, and in other areas as well.
I believe there are still possibilities for improving the EAF, even in old plant, provided that there is a more careful diagnostic of the problem. This is what the ministerial technical task team has been doing in recent times. If Eskom doesn’t have the right kind of people or management skills, the new CEO will have to start recruiting certain types of engineers and artisans to get that right.
Eskom must revolutionise the maintenance approach and strategy in terms of the quality of maintenance done and the type of contractors that are utilised. There must be penalties for contractors if they do a shabby job – which seems to be the case as some of the more recent data is showing. These micro diagnostics that the ministerial technical task team has been performing is now of increasing benefit to the Eskom leadership and management.
So, if you put all of these efforts together, I believe an EAF of between 73% and 75% is still a realistic possibility. As I understand it, not everything can be attributed to old and aging plant – it is also about people and the consequences of poor management. Already some of the managers at power station level are feeling the heat because there has been too relaxed an atmosphere.
At the same time, those who perform well – at certain power stations like Matimba and Koeberg where the plant actually runs properly – those people must be rewarded and recognised.
Medupi and Kusile – bringing Eskom to its knees?
After a recent visit to Medupi, President Ramaphosa said the mega-project is “a fitting symbol of the importance of our state-owned enterprises”. In reality, however, the Medupi and Kusile projects are experiencing massive cost and time overruns that have brought Eskom to its knees, and resulted in the current loadshedding that is damaging the economy. What has to be done to fix these projects, and are they likely to become white elephants and stranded assets in future years?
Clearly, stranded assets and white elephants are what we need to avoid.
Eskom management has now produced a maintenance plan which involves taking each of the six generation units at Medupi out of service, one at a time, for up to 75 days between now and the end of the year, so that they can undergo a proper design optimisation and maintenance programme. This would cover the various areas that have proved problematic, from conveyor belts to mills, boilers, fabric filters and whatever.
There is no doubt that these two mega-projects have had a massive impact on Eskom’s debt issue. But our immediate goal is to achieve some level of operational stability. This might not be as optimal as originally designed, but at least stability at a new level of optimality.
In this way, Medupi, and in due course Kusile, will still contribute whatever they can to meet the electricity needs of South Africa, and not become white elephants or stranded assets. This means the investments have opportunity to recoup their costs, and we can also learn important lessons about these sorts of projects going forward.
Environment – the sacrificial lamb?
Since 2010, Eskom has been obtaining exemptions from compliance with South Africa’s environmental legislation and regulations, and in the meantime the utility has done little to address its ongoing non-compliance with limits for atmospheric emissions. As Eskom holds the country to ransom, is environmental sustainability, and the lives and health of Mpumalanga, Gauteng and Limpopo communities, set to become the sacrificial lamb of the utility’s environmental mismanagement?
There seems to be no doubt that there has been, what you call, environmental mismanagement. Both from a government and an Eskom point of view, we are completely revamping the approach to compliance with environmental requirements and minimum emission standards.
Some of the coal-fired power plant closures that are indicated in the integrated resource plan for electricity, IRP 2019, will contribute to a reduction of air pollution in the form of toxic NOx, SO2 and particulate emissions in the areas that you have mentioned, as well as a reduction in carbon emissions that contribute to climate-change.
We need to recognise that, in the South African context, we don’t have easily available alternatives to coal at this point of time. The best we can do is to start the process towards compliance with minimum emission requirements, and to making the right contribution to South Africa’s commitments to the climate-change process, both within the country and outside.
In the next few weeks, Eskom management, the DPE and the Department of Environmental Affairs (DEA) will be interacting in order to find the right balance going forward.
Restructuring – the roadmap to the end-state of the ESI?
Eskom’s CEO has said the utility has started a process of divisionalisation, which is little different from the status quo. How will this enable structural reform, where an independent transmission system and market operator (ITSMO) can procure electricity from a diversified, competitive generation sector on economic grounds and at least cost? Is it reasonable to expect a dominant incumbent to restructure itself? Should government not be providing more urgent leadership?
I think the President has been very clear, from the time that he has taken office in 2018, that Eskom is not going to be able to trade itself out of its troubles. On the advice of the President’s sustainability task team, it is clear too that Eskom needs to be restructured and repositioned as a utility. We needed a roadmap towards the end-state of the electricity supply industry, which we now have at a structural level. In the context of this roadmap, there are various transitions that are occurring both within and outside of Eskom.
Firstly, there is an energy transition away from toxic emissions into the environment that result from the burning of coal. Secondly, you have the utility transition, with divisionalisation being just one step to towards the ultimate separation of generation, transmission and distribution. Thirdly, the transmission is beginning to undergo its own transformation, as we begin to recognise that a vertically integrated national electricity utility is not the only way of transmitting electricity.
There are different solutions to which we will have to adapt, whilst recognising that transmission is an important strategic asset in any nation’s electricity reticulation process. We do see the buying office as an important component in the future scenario – one the plays the role of purchasing electricity into the grid, with the financial capability to actually do so.
Ultimately, we will have an independent transmission entity, and we foresee a future where there isn’t this 95% dependence on Eskom as a generator.
On the distribution side it is more complex, with about 60% of electricity sales taking place through municipalities. There is a constitutional issue that we have to resolve here, and this reality will take more time to resolve, both from a fiscal policy point of view in terms of how much money is allocated to national, provincial and local government, and from an operational point of view as well.
So, I think that South Africa is well on its way on a journey that will incorporate various forms of transitions that are already occurring. It is the dynamism and the interaction between these different transition trajectories needing to be managed over the next five to ten years that will be crucial to the success of this project.
Death spiral – where is all this self-generation heading?
The parting shot from the outgoing former Eskom CEO, Phakamani Hadebe, was that Eskom is in a death spiral of rising costs and electricity prices, and declining sales volumes. Eskom’s ambitions to increase the electricity price by 30%, and the immediate solutions to capacity constraints of self-generation, municipal generation and IPPs, are set to accelerate this death spiral. Where does all this leave Eskom as an electricity utility of the future?
Essentially, if we leave the decline of Eskom to its own dynamic, then we will inevitably have harmed the utility itself.
So, managing the different trajectories of transition on the one hand, and having the financial models that underpin the transition on the other, will ultimately ensure financial stability and sustainability of the outcome. And institutional stability and sustainability is crucial to success.
So again, this is not an area where one looks at just one dimension of the challenge. You have got to look at all of the dimensions, how they interact with each other – the institution, the plant, the financial aspect, what’s happening currently in different markets, in the wider energy and electricity environments, and the global dynamics such as climate change.
The challenge is how to integrate all of the above into a transition path that ensures an outcome which meets all the requirements, including financial and institutional sustainability.
Transparency – a driver for accountability and performance?
Since completion of work on Eskom by the President’s sustainability task team, the ministerial technical task team and the chief restructuring officer (CRO), their reports have never been made known. At the same time, in contrast to Eskom’s peers globally, there is an almost total lack of transparency on Eskom’s operational performance in sufficient granular detail and time resolution. Do Eskom and the DPE not recognise how such transparency can drive accountability and improved performance throughout the organisation?
We certainly recognise that transparency is crucial to accountability. It is crucial in a public entity like Eskom, and there is no doubt that accountability is crucial to getting the right kind of performance, and to ensure there are consequences if the right performance is not delivered. So, on the principle of transparency, there is absolutely no argument with that.
Of course, we must decide on how the necessary information, and what level of information, is made available to the public. The engineering fraternity and those in the energy sector would need the micro-details, but I think the general public would require a different set of information.
Getting the general public to understand the performance of each of the power plants, the different parts of the system, and the system as a whole, is certainly a challenge that Eskom must meet in the coming year. Whether it is nuclear power at Koeberg, the coal-fired power stations, pumped-storage stations, open-cycle gas turbines (OCGTs), wind or solar, we need to understand what contributes what, and over what period. This understanding will then also give rise to the right kinds of debate and questioning.
So, it’s a constructive process that I think we should initiate. Once we have bedded down the new Eskom management team, I think this is the next stage we need to get into. But there is always a resistance in monopolies, whether private or public, in terms of making information – and indeed reliable information – available. But the goal of accountability and transparency is one that is non-negotiable.
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