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Axe hovers over Eskom: here are the problems and ways to fix them

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Axe hovers over Eskom: here are the problems and ways to fix them

As Ramaphosa vows unbundling will go ahead, we analyse the sorry state of the utility, and a few solutions

By Qaanitah Hunter and Reuters


Come hell or high water, Eskom’s unbundling will go ahead, and the state will also look closely at the power utility’s cost structure and staff “benefits and perks”, President Cyril Ramaphosa said on Thursday.
He told the National Assembly that despite criticism from his political rivals, unbundling Eskom was the best option on the table for now.
“Ultimately, the restructuring of Eskom is intended to ensure security of electricity supply for the country, which is critical to building up the positive investor sentiment and confidence essential for the investment required to the sorely needed jobs,” Ramaphosa said in his reply to the debate on his State of the Nation address.
He also said there were anomalies in Eskom’s cost structure that required urgent attention.
“Financially, the reference to cost-cutting should be understood not to mean retrenchments. The preferred strategy in reducing human resources costs will be to offer voluntary packages to staff ...
“We further need to look at the benefits and perks received by Eskom staff, including those offered through Eskom Finance Company (EFC), and we need to jointly ask ourselves whether it makes sense for Eskom to have this business unit and be offering to its staff below-market rates finance packages, whose losses are ultimately underwritten by the state.”
Ramaphosa said finance minister Tito Mboweni would announce measures the government would take to help Eskom to stabilise its finances.
Reuters reported on Thursday that experts believed bolder steps, and not just the unbundling of Eskom, were required to rescue the state utility, which supplies 90% of the nation’s power.
Below is an analysis by Reuters on Eskom’s problems and possible solutions.
Why are the lights going out now? Eskom's power station performance has deteriorated steeply in part because of delays to critical maintenance work.
This week, about a third of Eskom’s 45,000-megawatt installed capacity was out of service because of plant-related problems, diesel shortages and planned maintenance.
Eskom has a plan to improve performance, such as overhauling units that have been shut down for long periods, and fixing design flaws at two major power projects, Medupi and Kusile.
The aim is to lift the energy availability factor – the level at which capacity can be used – to 77% by late 2020 from below 70% now.
But long-term neglect means there are no quick fixes. “It will take years to sort out the problems that have built up,” said Chris Yelland, a Johannesburg-based energy analyst.
How can Eskom fix its coal problems? More than 80% of Eskom’s power is produced from coal dug from SA mines. But spending on primary energy, mostly coal, has more than quadrupled in the past decade, reaching R85.2bn in the year to March 2018. It has also faced supply shortages.
“Eskom’s coal procurement needs to be sorted out, with people brought in who understand mines and the quality of coal. Bribe-taking is still a big problem,” said Xavier Prevost, a senior analyst at XMP Consulting.
Eskom’s new management acknowledges its finances have been hurt by fraud and corruption, and says it has investigated hundreds of instances of alleged wrongdoing.
Eskom’s supply problems were compounded by its decision to reduce investment in “cost-plus” mines, where it contributes to costs and receives a guaranteed volume and quality of coal.
Eskom’s new management has reversed that policy, pledging to invest up to R12bn in cost-plus mines in the next five years. It has also signed more than 40 contracts to supply coal.
Is it time to cut the workforce?
Eskom employs 48,000 people, after hiring about 12,000 additional employees in the past decade. A World Bank research report published in 2016 said two thirds of employees weren’t needed.
Cutting jobs will be politically difficult for Ramaphosa before this year’s election, when he will have to rely on unions allied to the ANC if he wants a decisive mandate.
But analysts say it is a case of when, not if, jobs will go.
Eskom has trimmed its executive management from 21 people to nine by combining roles. Eskom executives have also told investors they hope to gradually reduce staff numbers by a third, one investor has told Reuters.
What about Eskom’s debt mountain? Eskom’s debt pile, which stood at R419bn at the end of September, is perhaps its greatest challenge. The utility has been assigned a credit rating from S&P Global of CCC+, deep into “junk” territory.
The debt was largely racked up to build Medupi and Kusile, two of the largest coal-fired power stations in the world, which have suffered enormous cost overruns.
Analysts say Eskom needs a bailout – a tough call for the government when its sovereign credit ratings are under pressure.
In 2018, Eskom chairperson Jabu Mabuza urged the government to take on R100bn of the utility’s debt.
Ramaphosa was initially cool on the idea but has since said, in a budget speech on February 20, that the government would unveil measures to support Eskom’s balance sheet.
Nedbank CIB analysts estimate a bailout of R150bn would be required to cover Eskom’s liquidity shortfall, while R190bn would put it on a more sustainable path.
Why not just raise electricity prices? Eskom has eroded its capital base by selling power for many years below production costs. That remains the case even though average power prices have risen about fourfold since 2007.
The World Bank’s 2016 report found that SA had some of the lowest electricity tariffs on the continent.
Eskom has applied to energy regulator Nersa for tariff increases of 17.1% in 2019/20, 15.4% in 2020/21, and 15.5% in 2021/22. But Nersa tends to grant much smaller increases than Eskom demands.
Nersa will respond to the latest requests by mid-March.
Will splitting up Eskom help?
Ramaphosa wants to split Eskom into entities responsible for generation, transmission and distribution, although they would still operate under the same Eskom holding company.
Analysts say that doesn’t go far enough.
“Separating within Eskom means the incentive issues and monopoly mindset will remain, and any upside from internal capital allocation being more transparent within entities may be limited,” said Peter Attard Montalto, head of capital markets research at Intellidex.
One option would be to remove the holding structure and make the public enterprises ministry the shareholder of all three, making each unit function more independently.
Another would be to break up the generation business into several smaller companies owning a mix of old and new power stations, which would compete with independent power producers to supply the cheapest electricity to the grid.
How tangled is the distribution network? Eskom is responsible for distribution in some areas of SA, while municipal distributors are responsible in others. And all of them face problems collecting payments.
Eskom is owed more than R30bn by municipalities and customers in Soweto township, a debt that continues to grow.
“Municipalities are dragging Eskom down,” analyst Yelland said. “The distribution sector needs to be rationalised into a much smaller set of efficient, viable businesses.”

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