South Africa’s electricity producers pre-audited financial results show that they are living on borrowed time. What should the government do to avoid being dragged down by it?
Eskom the South African state-owned electricity producer and distributor, which effectively has a monopoly, briefed the parliament on their financial situation recently. The picture that emerged was not pretty.
Their debt increased to R488bn. The interest costs were R39.5bn but the operating cash surplus was only R36.2bl. This means that Eskom must borrow more to pay the interest portion on their existing debt. One does not need more than grade 4 maths skills to realise that this is not sustainable. Because the debt burden is equivalent to 12.5% of South African governments total outstanding debt, it poses are very real risk to the South African Government. The Credit Rating Agencies have identified Eskom’s debt burden as the single most important risk.
As the Investors view the South African governments fiscal situation as more unstable (because of the potential Eskom liability), the servicing of the South African government debt will become more costly. A 1% rise in the interest demanded would result in a R38bn increase is debt servicing costs for the South African government. It is more than what the government currently spend on Agriculture & Rural development or what they currently spend on Infrastructure.
To most South Africans it feels like the sinking of the Titanic – previously thought impossible or at least unlikely. As we are about to hit the iceberg, the music is still playing for the intoxicated tenderpreneurs, celebrating themselves and admiring their Captain. Under deck in the cramped quarters, most of the poor are passing their time by dreaming about a better future on the other side, only to be awaken by the thundering roar cause by the crash. As everyone scrabbles to abandon ship, it is once again the poor that find themselves last in line.
What to do?
Eskom is a product of the apartheid system. Since self-reliance was the driving force of capital allocation. Most power stations were built in the late 1970’s and early 80’s. Although many are due to retire over the next 20 years, the date can surely be pushed out by appropriate maintenance, something currently in very short supply.
Most power stations should be sold to private investors, who generally have better incentives to get the best long-term performance out of the Assets.
At the same time, Eskom should offer new owners 10 year and 20 year off-take agreement, thereby giving the power producers certainty over future cash flows. It would also make it easier to fund the purchase of the power stations, because the off-take agreements should be bankable. This would also go a long way to attain the Governments stated goal of creating 400 black industrialists.
Eskom might retain a few power generators, primarily the diesel turbines and the pumped storage systems which only come in service when there is a peak demand, as well as Koeberg, the nuclear power station.
The two main reasons government often sites as why they should not privatise the power stations are senseless. The first one is that they will not be able to control stable power generation. It could hardly be worse than in the current situation. The private sector will be incentivized to supply as much and as consistent electricity as possible, because that’s where they generate their profit. If they don’t do it, somebody else will.
The second reason often cited for not privatizing is that the sales price is probably below what it had cost them, especially their two newly build monsters. That is probably true. Any project that has been overcapitalized will not be worth as much as all the inputs combined. That is the result of bad capital allocation and poor project management.
But getting anything to reduce the debt burden is surely much better than the never ending increasing of the debt burden.
Just look at what private sector companies have done when faced with unsustainable high debt burdens, like EOH, Aspen and Tongaat Hulett. The management sold anything that did not fit into their recovery strategy and used the proceeds to slash their debt.
Eskom would then make a margin on selling on the electricity through their grid. Since they retain the distribution network, the government can make sure that they fulfill their promise of connecting every household to the grid and providing electricity to every South African. Finally the poor would actually benefit from Government policies.