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Eskom gets cracking on to-do list

Lynley Donnelly

Eskom chief executive Brian Dames has to overcome numerous hurdles. He needs the public to save energy and municipalities to lower profit margins.

Eskom chief executive Brian Dames has his work cut out for him after the National Energy Regulator of South Africa (Nersa) granted the electricity parastatal’s application to reduce tariff increases for 2012-2013 from 25% to 16%.

Dames has begun meetings with ratings agencies to persuade them to maintain Eskom’s ratings to keep its borrowing costs down, despite a massive loss in projected revenues of R11-billion this year.

He has to get more of Eskom’s largest customers to cut back their energy usage by 10% while convincing investors that South Africa is a desirable place to build industry, even if the electricity supply remains precarious.

He also has to convey to users that the reduced price increase does not mean electricity is plentiful.

Dames to convince municipalities to forfeit their profits
With his political principals, Dames must further convince municipalities to forego lucrative levies on electricity, ensuring that the reduction is actually fed through to consumers and not pocketed by local authorities as profit.

As if that were not enough, he has to try and get coal suppliers to make coal available at better prices to the embattled utility.

However, in an interview with the Mail & Guardian, Dames was confident that none of these challenges was insurmountable.

He said ratings agencies, for example, were likely to derive comfort from the government’s continued support for the utility, combined with its commitment to electricity tariffs becoming cost reflective.

Eskom’s financial viability was not at risk, he said, and the revenue reduction had been achieved within the confines of the current regulatory model. Furthermore, Eskom would be able to show that its credit matrixes would improve over a predictable long-term price path, which was critical to reassuring ratings analysts.

Michela Bariletti, lead analyst on Eskom at Standard & Poor’s, said its investment rating of BBB+ with a stable outlook was based on the analysis of three factors.

These were Eskom’s stand-alone credit profile, which represents the rating agency’s view of the credit quality of the company in the absence of extraordinary government support; the agency’s opinion of the likelihood of sufficient and timely extraordinary government support; and the sovereign credit ­rating of the South African government.

Lower tariffs could be negative for Eskom
A decision to lower future tariff increases might have a negative impact on Eskom’s stand-alone credit profile, which was currently assessed at ‘B” and was not investment grade, said Bariletti. Standard & Poor’s assessment of Eskom’s stand-alone credit profile is based on its opinion of the utility’s business and financial risk profiles. Its business risk profile, assessed as ‘fair”, is regarded as riskier than that of most other regulated peers based in Europe. It is driven by Eskom’s massive investment programme and the risks associated with it, as well as by the inflexibility, under the regulatory framework, of electricity tariffs to cover the costs of the programme in the short term.

This, in turn, affects the financial risk profile of the company, which is also deemed riskier than many of its peers as well as ‘highly leveraged”. Furthermore, it is based on the ratings agency’s previous expectations of 25% tariff increases over three years, originally granted under the multi-year price determination process.

Following the revision of the tariff expectations, Standard & Poor’s would need to evaluate how Eskom plans to mitigate the negative effects of the reduction in tariffs before it completes its review of the way this might affect the company’s financial profile.

Eskom keen to become financially independent
It appeared that Eskom still aimed to become financially self-sustainable and reduce its reliance on government support, Bariletti noted. However, given that tariffs under the current regulatory framework were not fully cost-reflective, it might take Eskom longer to achieve this goal.

Furthermore, Bariletti said that it was important for Nersa to consistently apply the principle of moving towards cost-reflective tariffs in the future. But the lowering of revenues would also be associated with the flexibility to review Eskom’s capital expenditure, Dames said, and could work to boost ratings agencies’ view of the reduction.

The R300-billion capital expenditure programme is funded until 2018, but a 29% shortfall remains. Dames gave assurances that this shortfall only extended to ‘uncommitted projects”—specifically, transmission and distribution infrastructure projects that would be reviewed.

Power stations Medupi, Kusile and Ingula were fully funded, he said.

Dames denied that the power utility was effectively shutting South Africa down for business through its call for a mandatory power conservation programme.

‘Going through load shedding will be more harmful to the economy than making sure customers have control in their hands. There are companies that have invested in energy efficiency, brought down demand and maintained their output levels,” he said, adding that a 10% saving was ‘more than possible”.

Demand assumptions were critical to Eskom’s ability to achieve the reduced tariff increases, said Dames.

‘The power system is still constrained. [The lower increases] should not be seen as a reason to not use electricity efficiently.”

With the reductions came ‘a clear pact” to continue conserving power and ensure that the benefits were fed through to consumers. Municipalities would be critical in this respect, he said.

Energy regulator suggests an electricity tariff cap
Nersa recommended last Friday that municipal increases on electricity tariffs should be capped at 13%. Over the last two years the increases in municipal tariffs had contributed significantly to the strain on consumers as electricity levies funded other municipal services.

Eskom has held discussions with the South African Local Government Association on the matter and Minister of Public Enterprises Malusi Gigaba has also spoken to his Cabinet colleagues.

Eskom has secured 80% of its coal supplies until 2018. Thereafter, new mines will be needed to supply Eskom and new contracts must be negotiated. Critically, 30% of its coal is supplied on short- to medium-term contracts.

Eskom was concerned about supplies after 2018 and it was a policy issue that had to be addressed, Dames said. Until then, Eskom would work with the mining industry to manage the interrelation of coal quality, volume and costs.

Ultimately, however, this was just a stay of execution. Electricity prices would go up and the only question was how this would happen and the rate at which they would increase.

Dames said much depended now on the choices South Africa made in terms of electricity supply options, most of which were outlined in the integrated resource plan of 2010.

‘Look at IRP 2010 and look at the price path required in real terms to be able to make those choices—whether Eskom does it or somebody else does it,” Dames said.

‘The only question we are left with as a country is how quickly we move towards that. If we want nuclear and we want renewables, somebody is going to have to pay for that.”

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