- HSRC economist Dr Miriam Altman elaborates on why the R60-billion capital injection from National Treasury to Eskom should be front-end loaded. Cameraperson: Danie de Beer. Editing: Shane Williams (27/5/27) (2.91 MB)
Moosa, who himself has come in for heavy criticism for assuming far too low a profile during the unprecedented load-shedding that afflicted the country earlier in the year, broke his silence late last month, only days after Cosatu’s Western Cape leader, Tony Ehrenreich, and the Democratic Alliance’s energy spokesperson, Hendrik Schmidt, called on him to resign for lack of leadership.
The calls also came after a number of questions were raised as to why Moosa had not commented on the controversial issue of management bonuses, having left CEO Jacob Maroga in the extremely awkward and inappropriate position of having to field media enquiries on the issue.
But on May 22, the struggle-hero-turned-politician-turned-businessperson fired the first salvo in the fight-back campaign when he rejected, “in the strongest possible terms”, a submission that Eskom management had been preoccupied with profitability at the expense of safeguarding supply security.
The suggestion had been contained in a National Energy Regulator of South Africa (Nersa) report, released following a probe of recent load-shedding events. In fact, the report read as follows: “There appears to be a conflict between Eskom’s business objectives and its reason for existence: the supply of electricity. This observation must be addressed with the shareholder and the necessary changes must be made to Eskom’s shareholder compact to prioritise security of electricity supply.”
In response, Moosa – who showed his political adeptness by successfully navigating the ruling African National Congress’s divisive Polokwane conference, in December, to be re-elected to the National Executive Committee – said: “This is a misguided statement and can never be substantiated in fact.”
He was also quoted in Business Report as saying that he and other nonexecutive directors had been working “extremely hard and many extra hours” at no extra cost to the entity.
“I am constantly taken aback by the commitment that they have,’’ Moosa told the daily newspaper. “They are not paid any extra for the additional work that they do. Since the energy crisis in January, the directors have been working on a weekly basis.”
BEYOND QUIET DIPLOMACY
But it did not stop there, with Moosa, Maroga, and Eskom finance director Bongani Nqwababa again going on the offensive at the recent public hearings into the utility’s application for a 60% upward revision in its tariffs from the 14,2% already sanctioned by the regulator for the 2008/9 financial year.
It was clear from the start that the trio were not merely out to defend a technical application, which had little chance of success anyway, particularly given the political impetus behind the call for ‘smoothing’. But, rather, they were there to wage a public-relations battle, under the theme: ‘extraordinary times call for extraordinary measures and decisions’.
The audacity of the presentation even resulted in a reprimand from some Nersa panellists, who pointed out that it moved well beyond the technical aspects of the application. But it was plainly a strategy designed to use the unprecedented attention created by the hearings to place on the table those issues Eskom saw as key for any future pricing frameworks.
Engineering News has confirmed that it was indeed a coordinated response, informed, in part, by a realisation that the utility’s lack of assertiveness with regard to its earlier engagements with government (whose policy prevented it from building new capacity between 2001 and 2004 in the belief that independent power producers would fill the gap) had often been cited as one of the reasons for the current shortfall.
An insider, who spoke on conditions of anonymity, said that it had been noted that the South African public had queried Eskom’s ‘quiet diplomacy’ even when the demand curves were clearly indicating that 2007 would be a crunch year.
For that reason, it was decided that a more frank exchange was now required on the regulatory challenges, especially on the crucial issue of sustainable power prices. This forthrightness was epitomised by Nqwababa’s assertion that, had Eskom been granted the 18% as well as the pass-through rule change it had requested for primary energy, “we would not be here today”.
FRANK AND ASSERTIVE
But it was really Moosa’s greater stridency in setting the scene for the ‘extraordinary’ pricing request that truly underlined the emerging model of ‘assertive’ communication.
“We must remember that the decision on the part of the South African government that Eskom will be allowed to build new generation capacity was taken in October 2004. That is not a very long time ago,” Moosa asserted.
He added that, since that date, Eskom had made strides in responding to the “real challenge of not having the megawatts”.
“By December 2005, a mere 15 months after that decision, Eskom had taken the investment decision to build and construct a 4 800-MW baseload plant, which is now called Medupi.
“Construction of that power station started in May 2007, which is two-and-a-half years after the Cabinet decision was taken.
“The international norm in this regard is at least a 48-month period before construction starts on a megaproject of that sort,” Moosa averred, noting that site preparations for a second 4 800-MW station, dubbed ‘Project Bravo’, in Mpumalanga, started in March.
This, he stressed, was over and above the 1 050 MW in open-cycle gas-turbine peaking capacity that had been delivered, which was in the process of being doubled; the 3 600 MW of return-to-service capacity, 1 600 MW of which is in the system already; and the 1 300 MW which would arise once the Ingula pumped-storage scheme, under development in the Drakensberg, came on stream.
Moosa noted that the utility was in the process of contracting suppliers for a 100-MW wind project and that a decision had been made to increase the profile of wind to 200 MW over the short term. Further, bids, which were being coordinated by Eskom, were out for cogeneration and independent power production facilities.
THE ONLY GAME IN TOWN?
But Moosa’s defence of Eskom went well beyond the bounds of the tariff application itself. “If this country did not have an institution like Eskom, you would not get private-sector investors to invest in the transmission system that Eskom is investing in now and the power lines that are under construction and the power stations that are under construction within the current environment.
“You would already know from the work that you are doing that private-sector investors would require prices which are, more or less, three times what they are currently, in order to even begin investing.
“Whether or not the private sector would have the appetite to invest R100-billion in a 4 800-MW baseload power station, with a lifespan of somewhere between 50 and 70 years, is an open question. I have not seen anyone present a business case for that.
“So, what is clear is that the strategic nature of Eskom’s role in the economy will be here for a very long time to come and what the private sector can do is help us in playing a role in cogeneration and in other forms of generation . . . but in support of what is happening at Eskom.
“So we are not making a case for running the business on a purely utilitarian basis and we are not making the case for pure cost recovery and profitability, because if that were the case, in the context of growing demand and short supply, Eskom would be one of the most profitable companies in the world today,” Moosa argued.
He then went on to argue that the challenge facing Eskom “was not simply, as some people have said, a management turnaround challenge”.
Moosa noted that Eskom had consistently spent above what Nersa had allowed for primary-energy costs in its multiyear price determination.
“In this current phase of the three-year price determination (commencing April 1, 2006, and ending March, 31, 2009), Eskom will spend R13-billion over and above what the regulator has allowed in its determination,” Moosa asserted.
He also noted that, in Eskom’s formal written response to Nersa, the utility had given the assurance that its interests coincided with the national interest of ensuring adequacy of supply and a predictable price path.
“It was further noted that Eskom could not operate in an unsustainable manner as this would be prejudicial to Eskom and the country as a whole. Our prudent business decisions take into account security of supply, but must also balance financial consequences in line with the Public Finance Management Act and the Companies’ Act, technical, social, economic and environmental considerations,” Moosa concluded.
Even more boldly, but without saying it in so many words, Moosa delicately highlighted the regulatory failings that had left Eskom in the position of having to request a 100% increase in tariffs over a two-year period.
His appeal was for a long-term sustainable solution, where the “right price” was set, or the country could face the risk of Eskom coming back “next year and the following year” to seek a sustainable solution.
With the fight back, it is apparent that Eskom is tired of being the nation’s whipping boy and is likely to be far more vocal in pointing out the policy and regulatory failings that either got Eskom into the current crisis, or is preventing it from overcoming it.
But it should never be forgotten that communication strategies that diverge too far from reality or experience will always fail. The road to restoring credibility is going to be a long and arduous one, and will hinge primarily on delivery – delivery of the current fleet in keeping the lights burning, despite the tight reserve margins, and delivery on time and within budget, of some of the biggest projects in South Africa’s history.
NERSA HEARINGS: Eskom Downgrade could impact on South Africa's own credit rating
Allowing Eskom’s credit rating to slide or, alternatively, shifting the debt burden associated with the R343-billion build programme across to the Republic of South Africa could have negative consequences for the country’s own credit rating and its cost of borrowing.
This was the view of Human Sciences Research Council economist Dr Miriam Altman who, speaking at the public hearings into Eskom’s application for a 60% price hike for the 2008/9 financial year, said that while she could not estimate with any certainty what the impact of a downgrade could be, the link between Eskom and South Africa’s credit position was already strong, and any downgrade of the utility could have a knock-on effect on South Africa’s sovereign rating.
“Eskom’s credit rating is intricately linked with the government’s credit rating and the kind of investment that you are talking about is so huge that . . . it could ‘lead’ the credit rating of the country,” Altman argued.
She also urged caution in accepting the assertion of Business Unity South Africa’s Roger Baxter, who argued that an interest cover of one times earnings before interest and taxation (Ebit) would be sufficient for the utility.
In fact, Baxter had argued that, while a three to five times Ebit was necessary for a JSE-listed entity, the fact that Eskom was 100% State owned meant that the ratings agencies should be given comfort, as government would likely step in to cover any interest-payment shortfalls should such a necessity arise.
She said that, in the context of global risk aversion, a domestic slowdown and the fact that Eskom needed to raise a material amount of money on the capital market, it would probably be inadvisable to allow its ratings to dip and for Eskom’s financial ratio to fall outside of the interest-cover and debt:equity bands sought by the ratings agencies. The impact of such a slide on the country’s rating should also not be taken for granted.
All three of the rating agencies that track Eskom – Standard & Poor’s, Moody’s and Fitch – had placed Eskom on notice over recent months, asserting that they needed greater certainty on the nature and make-up of the funding plan to be employed in Eskom’s build programme. In fact, only last week, Moody’s indicated that it could even consider downgrading Eskom by multiple notches, until the ambiguity of the mix of funding sources was resolved.
Eskom estimated that a single-notch downgrade by the international rating agencies of Eskom’s credit worthiness could add between R3-million and R4-million to the cost of each R1-billion borrowed on the capital markets.
Finance director Bongani Nqwababa warned in his presentation that the impact could be even more severely felt with regard to access to both the debt markets and the project-stretched equipment suppliers, which were seeking to reduce their credit exposure. He also pointed to international experience, showing that it took far longer for a company that had been downgraded to regain its rating, even once its ratios had been restored.
Asked by the National Energy Regulator of South Africa (Nersa) panel to quantify the costs, Nqwababa said it was impossible to offer precise figures, but that it could add as much as “R4-billion over time” to the cost of its current build programme.
Eskom was planning to spend R343-billion over the next five years on new power stations and on expanding its transmission and distribution systems and felt that it could raise a maximum of R150-billion of that on the domestic and international capital markets.
However, it argued that it would be difficult to reach that level of debt financing if its ratings were downgraded, which, in turn, would place pressure on it to raise additional funding from either its shareholder (ultimately the taxpayer), or Eskom’s customers. Alternatively, projects could be reviewed, until viable funding plans could be found.
The agencies were said to be demanding that Eskom sustain an interest cover of three and a debt:equity ratio of 200%. But the Nersa panellists were keen to understand what the effect would be on the business and its ratings if those ratios were not sustained.
Nqwababa said he could only “play with the cards that had been dealt” and stay within the rules, as outlined by the agencies.
“Those are the rules, which are based on [the rating agencies’] experience of utility companies across the world,” he said, adding that their credibility was also geared towards the way they applied their matrices.
Earlier in his presentation, Nqwababa had also argued that it was not only access to capital markets that concerned him, but also access to reputable equipment suppliers.
“If people are not confident of your rating, they will seek to front-end-load payments to limit their credit exposure,” he warned, suggesting that this threat was amplified by the fact that equipment suppliers were stretched to their limits, with many build programmes under way throughout the world.
“The global dynamics of a credit crunch and the fact that there is less appetite for issuing lower-investment-grade debt mean that it is absolutely important that we maintain our strong credit rating,” he averred.
Altman offered four pricing scenarios, ranging from Eskom’s application for a 53% real hike in 2008/9, followed by a 43% real hike in 2009/10, through to a 15% real adjustment spread over five years. All four took as given a R60-billion injection from the fiscus.
She argued for a four-year smoothing, implying yearly tariff hikes of about 20%, as well as a far more front-end-loaded injection from the National Treasury.
The Treasury’s favoured transfer was back-end-loaded, with R6-billion for 2008/9, R12-billion for 2009/10, R20-billion for 2010/11 and R22-billion for 2011/12. Instead, Altman called for the bulk of the injection to be made in the first two years, when the utility’s ratios were going to fall well below those demanded by the rating agencies.
Nersa will make a final determination on June 18.
Coal and diesel inflation at the heart of the matt
Coal and its surging price is at the very heart of the utility’s application to Nersa. Eskom CEO Jacob Maroga said that the State-owned company was likely to experience an R13,7-billion under recovery on its primary-energy budget (which includes diesel) for the three-year tariff-determination period, which would end in March 2009, mainly because it was having to by more and well as more expensive coal.
He said this was a direct consequence of the fact that Eskom’s reserve margin had fallen well below 10%, which itself was far short of the 15% margin considered to be best-practice in the industry.
Finance director Bongani Nqwababa added that, in 2007/8, of the 120-million tons of coal procured, 21% had been purchase under expensive short-term contracts, of which 6% had been supplied by the mines already tied to Eskom through long-term contracts, and the 15% balance from new black-empowered junior miners.
The percentages purchase on a short-term basis would rise further this year and peak at close to 30% in 2009 and 2010. This, in turn would have a serious knock-on effect for primary-energy costs at Eskom, with the contribution of short-term contracts likely to rise to between 40% and 50% by value.
Eskom noted in its submission to Nersa that, since January 2004, the StatsSA coal-cost index has increased by 93% compared to the Producer Price Index’s rise of 29%, Similarly, the StatsSA diesel index, which had now become important given that Eskom had invested in open cycle gas turbines, which run on diesel, had increased by 190% over the same period.