Eskom woes to be confronted by task force

South Africa formed an emergency task force in mid-December in a bid to solve the country’s power deficit after a year of rolling blackouts. 

Eskom – the beleaguered state-owned electricity company – has struggled to meet demand and the resultant power shortages have cost the economy as much as $44.4 billion since 2008.

“Eskom needed to implement rolling blackouts to protect electricity supply, given the low reserve margin,” explains Razia Khan, head of macro research for Africa at Standard Chartered. "In the absence of rolling blackouts, they risk greater damage to the grid."

International best practice suggests a peak buffer margin – the difference between peak demand and available capacity – of 15%. Eskom managed 4% in July 2013 and the gap has remained tight since. In response to growing demand, Eskom scheduled rolling blackouts over weekends in March, April and November to preserve electricity and to prevent the grid from collapsing.

Eskom's troubles have contributed to South Africa's slowing economic growth. In 2013, GDP growth in South Africa reached 1.9% and projections for 2014 put growth at 1.4%. “Eskom’s problems are damaging recovery prospects [for South Africa],” says Khan.

Alternatives

While the government tries its hardest to patch up Eskom, Renewable Energy Independent Power Producer Procurement Programme projects are under way and will pick up the slack in energy production in South Africa in the longer term.

Sixty-four projects have been awarded to the private sector through four bidding stages, which started in 2011. So far, private-sector investment has totalled $14 billion and these projects will generate 3,922 megawatts (MW) of renewable power.

“We should credit South Africa with a successful renewables programme,” says Scott Mackin, managing partner at Denham Capital. “And doing these kinds of projects through private stakeholders will be much more efficient and keep costs down.”

However, there have been delays in in getting rounds three and four off the ground.  

“The fact is that Eskom is the one that will have to ensure that these renewable projects are linked to the grid, and they must be able to do this within a reasonable time frame,” says one analyst.

“With Eskom the way it is, with all the funding and infrastructure issues the company is having, they may run into trouble when they need to get these projects online. You can’t just pick the cheapest bid, but you need to pick the most viable one – something that will be able to work with Eskom’s current infrastructure. As a result, there have been delays in awarding the projects.”

Funding pressures

The emergency task force is the latest initiative by the government to address the country’s electricity issues and plug Eskom’s funding gap, calculated by the state-owned enterprise (SOE) at R225 billion over the next five years.

“Eskom calculated the funding gap by looking at the difference in revenue produced by the tariff increase requested by the SOE, which was 16% per year for the next five years [from April 1, 2013, to March 31, 2018], and the tariff increase granted by the regulators, which was only 8%,” says Paul Marty, senior analyst at Moody’s Investors Service.

“But in reality, the funding gap may even be higher than the amount officially stated by Eskom, given lower sales and higher costs than initially expected. In addition, capacity expansion programmes implemented by the company cost in excess of R50 billion per annum, thus putting pressure on the company. 

He adds: "There are many other ways to calculate the funding gap – Eskom has just highlighted one of them.”

When reported results for the six months through to September were announced in November, Eskom saw profits drop by 24% from R12.2 billion to R9.3 billion. For the full financial year, Eskom predicts that profits will fall to R0.5 billion as a result of lower revenue in the summer months (South Africa’s summer runs from October to February).

“The seasonality of Eskom’s business should be considered when reviewing the half-year results, as the expected decrease in net profit over the remainder of the year is a normal trend due to the lower summer tariffs coupled with a contraction in sales volumes,” says Kate Rushton, principal and credit analyst on the Barclays Africa research team in Johannesburg.

Eskom’s maintenance strategy, duly revived in the summer months, will further impact profitability.

In an attempt to revive Eskom, newly appointed minister of finance Nhlanhla Nene announced in October that the South African government plans to inject at least R20 billion into the company through the sale of certain non-strategic assets.

In additional measures, Eskom plans to issue more debt and the government plans to support Eskom’s application to the regulator National Energy Regulator of South Africa for a further hike in tariffs. Qualitatively, the government plans to improve energy policy and support the expansion of the independent power producer programmes to increase electricity production.

“Effective from April 1, 2015, the regulators have already agreed to a tariff increase from 8% to 12.69%, to be reset every year,” says Yeshvir Singh, associate director at Fitch Ratings based in Johannesburg.

“But future tariff increases will depend on Eskom’s audited financial results and funding requirements year on year.”

As Marty at Moody's says: "Eskom's cost of funding might go up unless they issue more debt under the government's guarantee, but we will have to wait and see how investors will react."

However, further details on the complete package outlined by the South African government remain vague. 

“We will have to see what details come up, but so far the indication is that these measures will help in the short term, but won’t do much to fix the longer-term structural issues unless tariffs rise significantly,” says Marty.

Legacy

Eskom has added little in terms of generation capacity during the past decade, and updating Eskom’s old and failing infrastructure has been on the back-burner for years. After the end of apartheid in 1994, the priority of the government was to provide affordable power to the masses.

In 1998, calls by Eskom’s management to increase investment in South Africa’s power infrastructure and build a new power plant fell on deaf ears. The priority continued to be affordable and accessible electricity. In 2003, the department of energy even claimed there was no electricity crisis in the country, despite Eskom’s warnings in 1998.

"For many years, the extent of electricity demand growth in South Africa had been underestimated," says Standard Chartered's Khan. "During the Mbeki years [1999 to 2008], when growth was robust, SOEs were run with a view to extracting greater efficiency. But this meant that the investment that should have taken place did not, resulting in very low reserve margins.

"Despite coming to a head in the 2008 electricity crisis, the situation has remained difficult. Eskom’s latest estimate is that it will take another three to five years for reserve margins to recover."

Steps are now being made to rejuvenate the lagging infrastructure. Medupi, one of South Africa newest power stations, is due to open on December 24. It will comprise six units, each with a gross nominal capacity of 800 megawatts – a total capacity of 4,800 megawatts.

However, this might be too little too late. The average age of Eskom’s power plants is 30 years. The oldest is about 50 years old. Problems with Eskom’s facilities abound. In November, Lethabo power station was covered in ash after conveyor belts in the power station broke down.

“The power plant at Medupi has not only been delayed but is vastly over budget. It hasn’t been made clear exactly how much over budget it is already,” says Mackin at Denham Capital. 

As power plants struggle under the pressure, Eskom has resorted to using expensive diesel resources to offset the losses. However, with limited funds available, Eskom’s capacity to buy diesel will come under pressure in January.

“Old power stations are in dire need of refurbishment and this doesn’t happen overnight," says Fitch's Singh. "South Africa’s power problems could last for longer than expected.”