Eskom’s 2018 Financial Results

This brief provides a commentary on the main features of Eskom’s 2018 annual financial statements, released on 23 July 2018.

Too early to expect major changes in financial situation

Eskom released its financial results on 23 July 2018, six months after the appointment of the new Eskom board, under the chairmanship of Jabu Mabuza. The financial year ended on 31 March 2018, so one could not expect major changes to have been made to the financial situation by the new board, and the contents of the 2018 financial statements were not unexpected. Major features are stagnant electricity consumption, large capital expenditure (on new power stations), and an increase in debt and in associated financing costs. The annual report recognises that operational cash flow is insufficient to service debt. New debt is therefore partially used for this purpose, which is not a good sign of financial health.

In respect of irregular expenditure of over R20 billion, the auditors to the financial statements state that Eskom did not have adequate internal control systems to identify, investigate and control such irregular expenditure in the current and prior years. The scope of “irregular expenditure” is very broad. It includes contraventions of any laws and regulations as well as internal policies and procedures, regardless of whether the breaches were deliberate or accidental, if they happened unknowingly or in good faith, or if value was received or not. Further, it is irrelevant whether or not the expenditure was justified from a business perspective. Irregular expenditure is not necessarily fraudulent, though it may be. The fact remains that R20 billion is a big number in this respect.

The fact that Eskom is in obvious financial difficulties is mitigated by the fact that as it has an effective monopoly on the country’s electricity supply. The reality is therefore that it is implicitly guaranteed by government, as it cannot be allowed to fail. The implications of further financial support by government will, however, have an impact on government’s own finances, where there is very little fiscal room for manoeuvre.

New features which are encouraging

In spite of the general content of the financial statements, there are a couple of aspects of the annual report which show that there is an attitude which differs greatly from that of the previous board and management. This is encouraging. These aspects are: firstly, the attitude to corruption and secondly, a recognition that a new business model is needed.

The chairman’s statement in the annual report emphasises the action taken to bring to account those engaged in corrupt and irregular activities - seven members of senior management have already departed, and 250 cases which have been reported through Eskom’s whistle-blowing channels are being investigated.

Secondly, the annual report states that Eskom will be reviewing its business model, a process which is expected to be complete by September 2018. The annual report recognises the challenges confronting traditional power utilities, which have suffered significant declines in market share and profitability. The report refers to the “utility death spiral”, which it describes as being “due to a number of transformational changes and energy disrupters”. It describes this spiral as the decline of a utility’s sales volumes, resulting from alternative energy options for consumers, whereas the utility, having invested in long-term assets, requires an ever-increasing tariff to generate the required revenue from declining sales. These price increases encourage consumers to move off the grid, further decreasing the consumer base, which in turn leads to lower revenues. This issue has at least now been acknowledged in public. The previous top management at Eskom simply ignored the issue and saw no need to do anything to Eskom’s longer term strategy.

Main issues to be dealt with in the out-of-date business model

We see this development as very important. For too long, Eskom has been sleepwalking into a new world, apparently oblivious to the fact that things had changed permanently. It has been stuck with an out-of-date business model for far too long.

The most serious issues to be considered in a business model review, are:

  • stagnant sales (the annual report mentions that power consumption has declined by about 0.5% a year on average since 2006);

  • increasing costs, is spite of stagnant sales (an increase in operational costs from 2013/14 of 18%);

  • overstaffing by up to one-third (this is acknowledged in the annual report);

  • an overly aggressive capital expenditure programme, with the construction of two very large coal power stations - funded by a very substantial debt package with significant costs; and

  • increasing surplus capacity (which not only has an obvious cost implication but also leads to resentment at having to pay for renewable energy).

It seems as if Eskom continues its serious dislike of the independent power producer (IPP) industry. The annual report states that the IPP programme

“translates into greater non-dispatchable capacity being made available to the electricity grid thereby affecting grid stability and exacerbating operational challenges. The decision to sign the PPAs (purchase price agreements) with IPPs also has significant implications for our financial sustainability, with IPP power - which is more expensive than the current average cost of Eskom power - being purchased ahead of Eskom’s offering, thereby creating additional surplus capacity on the Eskom side.”

In terms of the PPAs, Eskom has the obligation to pay for electricity provided to it, whether it wants it or not (on a take-or-pay basis). This is the basis, agreed by government, on which investors were prepared to fund the IPP construction.

What the annual report prefers not to mention, is the fact that in comparing the cost of IPP power with Eskom’s “offering”, it compares the aggregate cost of the IPPs (which includes capital expenditure), to coal and nuclear power, where capital expenditure has long been written off. Apples are not only not being compared with apples, but the report also omits that new IPP costs are now far lower than the initial ones, and that IPP electricity has become far cheaper than new coal or nuclear plants (if we include the capital cost). Eskom should be encouraged to see how it can integrate an increasing level of renewable power into the grid - instead of complaining in a rather bland way of “operational challenges”. If this is not feasible, then Eskom should set out the reasons in detail. Otherwise, its position is not credible.

As a last comment, there is no enthusiasm expressed in the annual report for a nuclear programme. This is also encouraging, as such a programme is clearly unaffordable and, in the light of surplus capacity, not needed.

Anton van Dalsen

Legal Counsellor