/ 23 November 2018

Failing Eskom cripples one and all

Together with other large energy users such as Transnet and Rand Water
Together with other large energy users such as Transnet and Rand Water, Sasol accounts for 40% of Eskom’s sales. This same group ranks an unreliable supply of electricity as the biggest threat to their businesses. (PlanetKB)

Large energy users have flagged the risk of production disruptions and, ultimately, job losses if Sunday’s load shedding, caused by Eskom’s worsening operational problems, intensifies.

At the same time, analysts have warned that Eskom’s faltering operations are likely to worsen its already precarious financial state.

In its latest financial statements for the year ending in March 2018, Eskom revealed that, besides the losses of R2.3-billion, the cash it receives from its operations is not enough to cover its debt servicing costs.

Its struggling operations, outlined at its systems status update last week, are likely to aggravate this. Eskom’s coal stockpiles at several power stations have reached critical lows, requiring an urgent short-term procurement of four million tonnes to bring stockpiles at all stations up to the required levels.

The utility is also planning for the increased use of its open-cycle gas turbines (OCGTs) to reduce the risk of load shedding and forecasts it will spend an additional R1-billion by March 2019 to run them.

Eskom has launched a nine-point plan to improve generation capacity, which includes spending another R1.5-billion to improve the performance of its new plants, Medupi and Kusile.

Nevertheless, large users remain concerned that its financial and technical problems, particularly uncontrollable events such as heavy rain, which dampen its coal stocks, could again trigger load shedding.

“Our members all have plans in place to mitigate the impact of possible power reductions but, because we are reliant on Eskom, these plans unfortunately all result in shut or reduced production and ultimately job losses,” said Tsakani Mthombeni, the chairperson of the Energy Intensive Users Group (EIUG).

“In the medium- to longer-term, industry will pursue power options outside of Eskom to protect its position.”

The utility has applied for additional increases in the electricity price in its fourth multiyear price determination application, seeking a 15% tariff hike each year for the coming three years.

But Mthombeni said the economy simply could not sustain further Eskom “price shocks”. The utility had to take urgent steps to cut

costs and to recover its debt, particularly from defaulting municipalities. Addressing its longer-term financial stability required a change to Eskom’s business model, he said.

EIUG members, which include Transnet, Rand Water, Sasol and a number of major mining companies, collectively make up 40% of

Eskom’s sales and account for about 20% of the country’s gross domestic product.

According to Mthombeni, its members rank the price of electricity and the uncertainty about future price increases as the biggest threats to their businesses, given the high proportion that electricity accounts for in their input costs.

“Business as usual is not an option for Eskom if our members are to survive, preserve jobs and continue to contribute to the productive sector of the economy,” he said.

Precious metals producer Sibanye-Stillwater outlined how severe the effects of electricity price hikes and the increased risk of load shedding are becoming for its operations.

Its investor relations head, James Wellsted, said unexpected electricity supply interruptions to its underground operations posed a huge safety risk because of the number of employees involved and the depth of its underground operations.

To manage the risks somewhat, Sibanye-Stillwater has standing agreements with Eskom that its electricity supply would not suddenly be interrupted or cut because of load shedding.

“Under the agreements, Eskom will alert us of their generating constraints and we will be required to curtail our consumption in a controlled manner, proportionately to other consumers,” he said.

Going beyond stage one load shedding increased the risk of negative effects on operations and could result in significant production losses, as experienced before 2015, Wellsted said.

The company’s expenditure on electricity at its gold mines had increased from 9% of operating costs to 17% in the past 10 years, which had significantly affected the profitability and economic viability of the mines and had accelerated the closure of some marginal mines in recent years.

Generally, the profitability of the mines was achieved with increased productivity and cost management, he added.

“The current electricity price increases requested by Eskom … far exceed the rate at which we are likely to achieve productivity gains and, if the level of increases Eskom has requested is granted, the sustainability of some our operations is likely to be affected, which may lead to operational closure and job losses.”

Olga Constantatos, Futuregrowth Asset Management’s credit and equity process manager, said Eskom’s operational challenges were likely to aggravate its financial position.

Given its existing R2.3-billion in losses, the additional spending it has outlined for items such as the increased use of the OCGTs meant they were likely to increase when its interim results were released in early December, she said.

The company had also incurred an additional R57-billion in debt since January, and at a higher interest rate than before, which would further add to its costs.

The company’s balance sheet was “chronically overgeared”, she said. That was highlighted by the fact that its net cash from operating activities as reported in the 2018 financial results was R38-billion, substantially short of the R44-billion needed to service its debt.

“I would expect a worsening financial position and a worsening cash-flow position as well,” she said.

Eskom appeared to be relying on the tariff increase to get it out of trouble, she said, “but that can’t be their only answer”.

Much would depend on the strategic plan, which Eskom was expected to release at the end of the month, to return it to financial and operational sustainability.

It was critical that the plan involved tough decisions on items such as its cost structure, including its employee costs, as well as its future business model, Constantatos said.

But, given the “ideological re-adjustment” these decisions might require, the government might not be prepared to back Eskom’s board and there was a risk that it might opt to wait until after next year’s elections to take some of the “hard decisions”.

Eskom said in response to questions that it was committed to presenting the plan within the agreed timelines “for the sake of the country and our economy” and to place Eskom on a sustainable path.

The extra costs to address current operational issues would place more pressure on its cash reserves but, Eskom said, it was trying to make savings in other areas of its business to offset these partially.

But the additional coal contracts being signed now would have a greater negative effect in the following financial year, it said. Nevertheless, it had “sufficient liquidity to address additional requirements”.

It had already raised a large portion of the funding it required for the current financial year, it said, and was busy raising the rest. It did not foresee problems in accessing capital markets.

The costs of implementing the full nine-point plan to improve generation performance was difficult to quantify, as many of the costs were already embedded in ongoing operations and plans.

A number of the actions required in the plan were process, policy or structural and so would involve minimal costs. In some cases, specifically the additional coal purchases, the cost was unknown because orders had not yet been placed, it added.

It was “mindful of the implications of load shedding” and did not take the decision lightly. It was a last resort, intended to protect the integrity of the electricity system against more “catastrophic consequences” such as a total blackout, which would take more than two weeks to restore electricity supply to the country and its neighbours.