Eskom’s financial problems - how is it going to dig itself out of the hole?

Introduction

We have had a good look at Eskom’s financial statements for the year ended 31 March 2017, which were released on 19 July 2017.  The purpose of this brief is to highlight the major cash flow issues which it will have to confront over the next few years.  We have tried to set this out in a manner which is easily understandable, since the use of specialist accounting terms in analysing companies’ results can be very misleading to outsiders.  We have also chosen not to address the issue of corporate governance at Eskom in this brief. That is a subject in itself, and it may still take some time for clarity to be obtained on the goings-on within Eskom’s management.  It has become difficult to feign surprise at any new disclosures, given the lurid nature of revelations over the past few months.

Eskom’s current cash situation

Simply put, the cash flow statement shows the company’s cash position at the end of the year. Eskom’s 2016/17 results show a negative cash flow, set out in summarised form below:

Eskom ended the year with a positive cash balance of R19.9bn, after taking into account the decrease in its cash of R8.59bn.  In analysing the above calculation, particular note should be taken that the financing activities include new borrowing of R51bn  -   a cash inflow  -  and a substantial interest bill of R29bn  - a cash outflow.  Without this level of new borrowing, the net result of the cash flow statement would therefore have been much worse.

Cash flow forecast

Whilst it is difficult to produce a precise cash flow forecast without having access to detailed internal financial information, a projection is possible, on the basis of using five-year forecasts which are contained in the annual report, in particular for capital expenditure, debt funding and debt service.  On the further assumption that operational cashflow remains constant, an approximate annual cashflow forecast for each of the next 5 years (based on averaging the five-year forecasts for capital expenditure, new debt and debt service), would read as follows:

Once again, the high level of average annual new borrowing of R68bn  -  a cash inflow  -  is to be noted, together with substantial annual outflows relating to debt repayments of R40bn and interest payments of R43bn.  Taken together, these items reflect a net outflow in financing activities of R15bn in the above summary.

On the assumption that its operational income is the same as in the year ended March 2017 (i.e. any increased tariffs would cancel out the inflationary operational costs, but no more), there will be an average annual outflow of cash of R32bn over each of the next five years. This does not take into account the amount of just under R20bn that Eskom still has in cash at the moment, which should be seen as a prudent cash buffer and which should in principle not be touched.  

In order to deal with this annual projected shortfall of R32bn, Eskom’s revenue of R177bn for the 2016/2017 financial year will have to increase by that amount for the company to break even on a cash basis   -   this represents an increase in revenue of 18%.  Eskom submitted a tariff increase request of 19.9% on 9 June 2017 to the National Energy Regulator (NERSA). This requested increase follows tariff increases of no less than 43% since 2012/13.  

In our calculations, we have assumed a zero increase in demand over the next five years. This may seem extreme at first sight, but given current economic growth and the growth expectations over the next few years, taken together with the general phenomenon that consumers are trying to cut reliance on Eskom energy where they can, it is not unreasonable.  This is also in line with the statistics in Eskom’s 2016/17 annual report, which confirms that overall sales volume decreased by 0.2% over the 2016/17 year, in spite of a 12% increase in international sales.  

The essence of Eskom’s financial problems

As we have indicated in a previous brief [1], Eskom is faced with a steadily increasing surplus supply of electricity, which will grow even more over the next five years, with the incremental commissioning of the new Medupi and Kusile power stations.  The essential financial problem which confronts Eskom is therefore one of stagnant consumer demand and a steadily growing surplus of electricity.  This growing supply will be produced by very expensive new power plants, which are being financed through debt, which needs to be serviced.  The total costs for Medupi and Kusile are R145bn and R161bn, respectively. Medupi will reach completion in 2020 and Kusile in 2022.

Eskom has made much of having to purchase the initially expensive wind/solar energy from Government’s Independent Power Producer (IPP) programme, at a time that it has more than enough surplus energy from its own sources to cover both the required reserve margin and IPP power.  However, as has been pointed out [2], the high initial tariffs that Eskom is paying to the IPPs, already form part of Eskom’s tariff structure as approved by NERSA and it should therefore not complain too loudly.  Eskom does not mention this latter aspect in its public statements.

In trying to make sense of this financial mess, we see it as stemming from a combination of various factors:  

• an overly aggressive capital expenditure programme following the load-shedding nightmare, followed by major cost overruns and serious delays incurred in that programme;

• the insertion of an IPP programme by Government which Eskom has to pay for and has grown to dislike, since it would rather find customers for its own surplus electricity;

• a massive increase in borrowing, together with an interest bill which is certainly higher than originally foreseen, due to Eskom’s repeated credit downgrades;

• the slackening of demand as a result of economic growth of less than 1% per annum and the likelihood of continued pedestrian economic growth in the present political atmosphere; and

• consumer behaviour, which is not only trying to limit electricity usage, but is moving away from Eskom altogether, as a result of unpredictable supply over the past few years and expected further tariff increases.

In these circumstances, what should we expect?

Eskom’s chief financial officer says in the annual report that

“… low economic growth, customer concerns about affordability, as well as uncertainties in the electricity industry will see NERSA encountering resistance to significant price increases in 2018/19 and beyond.   ….   As a result, the price of electricity will still not reflect its cost; this will have an even greater negative impact on our financial health.  Although no further credit enhancement mechanisms are expected from Government, further shareholder support may have to be considered should our revenue not improve significantly, as the only other option is additional borrowings, which would further weaken our key financial ratios.”  

The approval by NERSA of tariff increases of the requested 19.9% is hard to imagine.  For its part, Eskom would be hard-pressed to increase its own debt beyond presently envisaged levels, unless it manages to obtain a guarantee from Government for such additional debt.  Government has a guarantee in place for an aggregate amount of R350bn of Eskom debt, of which R254bn had already been used by the 2016/17 year-end.  There is therefore just under R100bn still available under this guarantee umbrella, which will not be enough for the envisaged debt of R338bn over the next five years.  

The possibility of another capital injection by Government, is therefore clearly on the cards. But keep in mind that with the current minimal economic growth, Government tax revenue is not set to grow much over the short term.  An annual amount equivalent to the expected shortfall of R32bn may seem small in Government’s aggregate 2017 annual budget of R1 563bn, but it is, for example, more than the amount spent on the item under the heading “Agriculture, Rural Development and Land Reform” in the current tax year (R26.5bn).  

Government can instead always increase its own debt in order to keep Eskom afloat. Current Government debt of R2 trillion equates to 51% of GDP, which is not in itself a worrying level, but going beyond this in a substantial manner will set the red lights flashing.  Government’s debt service costs for its aggregate debt amount to R162bn in the current tax year, representing 10% of Government expenditure.  Increasing debt service will obviously force Government to cut into other items on its budget.  This makes the problem clear   -   what budget item is Government prepared to cut in order to fund additional demands like that of Eskom (and potentially, other parastatals), through a bail-out funded by cash or debt?  The potential sale of state assets to fund shortfalls in parastatals (as recently aired by the Minister of Finance) is a time-consuming exercise and not ideally suited to providing quick solutions.

The only other alternative is for it to effect a drastic change to its own activities and priorities, which would have to include major changes to its medium-term capital expenditure programme.  Whether it is actually a practical option to halt a mega-power project in midstream is certainly questionable.  

Conclusion

The financial consequences of poor planning and management in Eskom are now plain to see.  A large surplus in electricity supply and much lower forecast demand over many years to come, together with the financial issues which we have highlighted, have pushed out the planned building of new nuclear power stations for a very long time, if one assumes a rational decision-making process.

Anton van Dalsen

Legal Counsellor

anton@hsf.org.za