'Eskom is not broken'

Lynley Donnelly speaks to chief executive Jacob Maroga about the state of our energy.

Is Eskom broken?
Eskom is not broken. We have kept the lights on; we have emerged out of the power crisis.
We understood its impact on our bottom line and we have kept that impact within what was anticipated.

We have seen a R9,5-billion loss on embedded derivatives because of contracts being given to industrial users, which are now becoming financially and politically unsustainable for Eskom. How is this going to be dealt with?

We had huge excess capacity and one way of using excess capacity is to have electricity-intensive processes, of which aluminium is one. One way to attract [these industries] is through commodity-linked prices.What we did [in line with international norms] was to link [electricity] to the price of aluminium and price it in dollars. If the price of aluminium goes up there [is an] upside for us. If it goes down there is a downside for us. But what we also did, [as] risk mitigation, was hedge these contracts. We pay for that hedge, but it’s all included in the total price.
These aluminium contracts have served their purpose for South Africa in terms of utilising excess capacity and the economic activity around it.
One of the things that has fundamentally changed is the accounting treatment of embedded derivatives. There is a recognition that businesses must make this more transparent ... so if the price of something is derived from something that is not connected [an underlying asset], it [should be made] transparent.
In previous years we recorded embedded derivatives as a positive; now we are recording them as a negative [because of the fall] in the price of aluminium, and that is based on the global economic crisis.

Is that R9,5-billion a calculation over the life of that contract?

Yes. With the volatility we’ve seen with embedded derivatives you could move billions of rands, because [the factors involved include] the recovery of the aluminium price and the rand-dollar exchange. Any big moves there, positive or negative, could change this thing. It is an accounting loss; we have not lost money.

Our understanding is that BHP Billiton benefited quite substantially from these contracts. It recorded a positive impact of $170-million on the embedded derivatives contract, which suggests that some of these losses have been realised?

The embedded derivative losses are paper losses, accounting losses, unrealised.
It’’ an accounting treatment of the long term [life] of the contract, not what happened in this particular year.
I’m not trivialising the issue. This accounting treatment is based on prudence. In the absence of valuing contracts such as this in this particular fashion you are hiding potential liabilities and assets [from] investors. If investors don’t see this they may not see the underlying risk. The volatility of commodities impacts on our financials and we need to limit that.
But this is a country discussion, because when we brought [BHP Billiton] here we joined hands with the regulator, with government. So when we talk about how we are going to look at it differently, we all have to talk together so the outcome satisfies everybody.

How will independent power producers (IPPs) fit into the picture?
An IPP makes an investment to make returns, to make money.
The price of electricity should attract [investment] or it should indicate money can be made.
Eskom, as a state-owned entity, can make investment decisions that an IPP, for example, cannot make. An IPP will only make that investment when a clear tariff path is determined [and] once it has sourced the funding.
The regulated price must be able to recover all Eskom’s costs, including the IPPs. If the regulatory price does not recover that, then Eskom is taking the risk.
We want to make sure the price that we ask for should be inclusive of the price that the IPPs ask for. That’s the big issue.
Given the requirements of the country it would be arrogant of us to say we can do it all. Creating a path to bring other people into that space is important—important to bring new capital into South Africa, important to bring in new skills, new technology, new sources of funding. Its also important to say if there are more players in the industry, the issues are no longer [only] about Eskom.

You’ve said Eskom is not broken. What are the key issues that need addressing?
We are making sure [the power system] runs today, [that] it has capacity for the future, [that] it’s funded adequately [and that] the right mix of generating capacity is brought to the fore. We are thinking very seriously about how we diversify, how we bring in new players—it’s a country issue, not an Eskom issue.
Efficiencies around primary energy are important. We are focusing on the coal issue—it’s the biggest cost item on our income statement and we are dealing with that in collaboration with the mining industry. As much as we want to diversify, coal is going to be a big part of our lives. We need secure sources of coal at the right price and [incorporate] the right logistics to get it to power stations.
The second element we will continue to look at is efficiencies right across our operations.
We will also continue [to try to] optimise capital expansion and push certain elements into the future, if necessary.


The Mail & Guardian posed two questions to stakeholders:
1: Is Eskom broken?; and
2: How best can it be fixed?
These are the responses:

South African Independent Power Producers’ Association
1: A more relevant question would be: “Is Eskom headed for such a situation?” Cracks have recently appeared in Eskom, which are of huge concern. The system reliability and functionality has been compromised. Load-shedding and rolling blackouts will probably resume early next year. The implementation of Eskom’s power conservation programme (PCP) is a journey into uncharted territory—there are industries that just cannot save 10% and be productive.
Eskom is removing 3600MW from the economy just to keep in reserve and protect the grid. This response to the crisis is a damaging and negative signal to investors and will not attract foreign investment to South Africa. We may miss the boat on the global economic recovery and will not ride the potential growth wave.

2: There are two issues here: fixing Eskom and fixing the current crisis. Clearly, a rapid increase in the supply of affordable power is what is required to address the supply crisis. Or, and this is more difficult, increase the plant availability to reduce reserve margin requirements and therefore alleviate the necessity for the PCP. We believe that if the government can press the right buttons new capacity can be rapidly added by independent power producers before Eskom commissions the first Medupi unit.
Fixing Eskom’s challenges is a long-term plan. Finance, maintenance and skills are the primary challenges.
Their new plant will also face huge challenges as it still needs to place all its outstanding contracts. By the time the plant is commissioned, pent-up demand will absorb this capacity and little effect will be noticed until substantial capacity is added.
We are seeing a potential change to the structure of the electricity supply industry. If South Africa had the depth and breadth of skills other developed countries had at the time of structural change we would be more confident of the power future. South Africa needs to tread cautiously in experimenting with so complex an industry.

We do not believe that Eskom is broken, but rather that the government’s vision for leading Eskom is broken. There is still no plan from government’s side to finance the expansion of Eskom’s infrastructure.
The problems at Eskom will not be resolved before government announces a clear plan to rebuild it.
The consumer must not finance such a plan.

2. No further electricity tariff hikes above inflation should be allowed. The government must announce financing for new developments and there should be more emphasis on nuclear energy and renewable energy sources.
The crisis of long-term contracts for the supply of coal must be sorted out. Coal companies may not be in the driver’s seat.

The Democratic Alliance
1: The failure of Eskom to run as a sustainable power utility derives from a larger problem—misguided economic policy. Government actively excluded independent power producers (IPPs) from entering the market and continues to do so—while existing power stations were being mothballed.
Eskom itself is certainly not without flaws—mismanaging coal supplies is unthinkable in a country that exports the commodity. The distressing thing is that the taxpayer is ultimately responsible for bailing Eskom out every time this happens.

2: The problem is twofold—policy and management—and should be addressed in the appropriate manner.
The broader policy direction of propping up state-owned entities, in accordance with the so-called “developmental state” concept, is one problem.
IPPs represent efficient competition to the lumbering Eskom—something that is contrary to the ANC policy of creating a dominating set of state-owned entities.
The utility must review its term contracts with its industrial clients and coal providers. We now know that Eskom’s procurement of coal on short-term contracts last year contributed massively to the company’s record loss. An even bigger contributor to the loss was the embedded derivatives from the contracts that Eskom has with its big industrial consumers.

Association for the Study of Peak Oil SA
It is of great concern that Eskom has been unable to balance its budget even while focusing mainly on maintaining existing supply. This is especially so considering that coal prices could rise considerably in the future, either as a result of competitive pressures and the need for new mines to be developed, or perhaps because of climate-mitigation policies. The recent cancellation of several renewable energy projects is, from a sustainability point of view, a step in the wrong direction.
As Eskom has indicated, further substantial annual rises in electricity tariffs will be necessary to keep it afloat. In particular, large industrial users should no longer receive preferential low tariffs. But the government and Eskom should promote energy conservation and efficiency extensively, as these are relatively easy ways of saving money and resources—as well as cutting carbon emissions.

National Union of Mineworkers
Eskom can be fixed through the shareholder [government] investing in infrastructure development.
We need a development [bond] to be established by the Development Bank of South Africa so that pension fund monies can be invested in development bonds and Eskom can borrow from the bank.

The department of public enterprises had not responded by the time of going to press, nor had the Energy Intensive Users’ Group or Business Unity South Africa.

Treasury and the department of trade and industry referred all comments to the department of public enterprises as the department responsible for Eskom. — Compiled by Lynley Donnelly

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