Eskom’s latest tariff application - Our Submission to the National Energy Regulator

Introduction

The Helen Suzman Foundation has submitted its comments to the National Energy Regulator of South Africa (“NERSA”) in response to its invitation for public comment on Eskom’s latest tariff application (the fourth Multi-Year Price Determination application for the years 2019/20, 2020/21 and 2021/22 (“MYPD4”)). To view the full submission, click here.

Financial implications for consumers of the Eskom applications

Adding together the financial effect of the current tariff application and applications for reimbursement of historic shortfalls, Eskom’s proposal implies an aggregate increase of no less than 60% over a three-year period from 2019 to 2022, with an average annual increase of 17%. 

Eskom’s analysis of the economic impact of increased tariffs

Eskom’s analysis is that high tariff increases have a negative impact on growth and employment in the economy as a whole: a tariff increase of 19% is forecast to lead to GDP growth of 2% per annum (0.3% lower than with a tariff increase of 8%) and employment is forecast to grow at an average rate of 0.9% per annum, (compared to 1.2% with a 8% tariff increase). 

The GDP assumptions in the economic report on which Eskom bases its comments[1] are 2.0% (2018), 2.2% (2019) and 3.0% (2020-30). However, the National Treasury’s latest economic growth forecast is 0.7% for 2018, 1.7% for 2019 and 2.1% for 2020[2]. Eskom’s GDP growth assumptions are therefore substantially higher than current forecasts. The report used by Eskom is dated 6 June 2017 and almost 18 months later, it can now be considered to be out of date. South Africa is clearly in a worse economic situation than assumed in Eskom’s analysis. 

Major reasons for the tariff increases

The major reasons why the requested increases in tariffs are so substantial, are:

• the ever-increasing cost of debt service (comprising interest payments and debt repayments);
• the increasing cost of primary energy; and
• electricity demand which has been stagnant for 10 years. 

The cost of Eskom’s debt service

The increasing cost of debt service is the result of debt-financing the massive capital expenditure programme which Eskom has undertaken, mainly centred on the new coal-fired power stations at Medupi and Kusile. Eskom itself decided to manage the implementation of these projects, which have been plagued by huge cost overruns and serious delays. 

These cost overruns of more than R100bn have a direct impact on the size of Eskom’s debt and its debt service requirements. The point that must be made in this context is that Eskom is effectively attempting to recoup the increased funding requirements (arising through cost overruns and delays) through increased consumer tariffs. Whether these increased capital costs are reasonable or not does not seem to be addressed anywhere, and the question arises as to whether NERSA has ever been provided with evidence that these increased costs were reasonable. Why should consumers be expected to pay whatever the final number may be? Why is Government, as Eskom’s 100% shareholder, not attempting to alleviate this burden on consumers and indirectly on the economy? 

Eskom’s 2017/18 annual report reflects debt service of R44.5bn[3] and its forecast for 2018/19 amounts to R68bn[4] - this compares to the current tariff application’s debt service forecasts of R73bn, R95bn and R95.5bn for 2019/20, 2020/21 and 2021/22 respectively. To put these debt service numbers into some kind of perspective: they represent 33% of the total revenue which Eskom has applied for over these three years. (Eskom has, however, announced in its tariff application that it has decided to forgo R50bn of the debt service over these years, “in the interest of the potential impact on consumers”.)

The 2017/18 Annual Financial Statements[5] also admitted that

“… while Eskom generates adequate cash to meet its operational requirements, it has to borrow to service debt and for investment activities.”

A company whose debt service equates to a third of its revenue and which has to keep on borrowing to service that debt, is in serious financial difficulties.

Eskom’s debt situation becomes even more critical after the MYPD4 period: its forecasts for debt service in the year 2023/24 amount to R141.5bn, which is R46bn more than the debt service for 2021/22 (the last year of the MYPD4 period)[6].

Primary Energy Costs

The increase in Primary Energy Costs (excluding IPPs and international purchases) is 54% from the 2018/19 NERSA decision to the first year of the MYPD4 application (and by 25% over Eskom’s application for the 2018/19 year). The increase is mainly related to coal usage, with a variety of individual issues behind this increase, including the increase in the volume of coal purchased through short and medium term contracts.

Eskom’s previous practice of engaging in “cost plus” contracts has been discontinued to a large extent (these long-term contracts applied to coal mines close to power stations which are dedicated to supplying coal to Eskom power stations, often with conveyor-belts). Eskom did not want to spend the capital needed to extend the life of these mines and this has given rise to increased short-term contracts, where the costs are much more unpredictable and where logistical issues create other problems (such as trucking by road). This problem is acknowledged in Eskom’s 2018 Annual Report.[7] Whilst “cost plus” contracts may seem expensive from an up-front capital expenditure perspective on day one, short-term contracts can be vastly more expensive over the longer term. 

The increased costs which result from this short-sighted policy, are now being placed on the shoulders of the consumer. It is submitted that NERSA should investigate the financial effects of Eskom’s policy not to conclude “cost plus” contracts, but instead to replace them with short term coal purchase agreements. 

The size of Eskom’s workforce

In its analysis of its staffing levels, Eskom’s 2018 Annual Report states that “we may be up to one-third overstaffed”.[8] The number of employees is 48 628[9]. The tariff application states that the number of employees is assumed to decrease over the application period and that “this will occur through planned attrition or alternates that support savings initiatives and efficiencies”. However, no details are provided in the application as to the expected rate of decrease.

The tariff application also confirms that Eskom employees are to benefit for the 2019/20 and 2020/21 years with an above inflation annual wage increase of 7%. (Note: annual CPI inflation in October 2018 was 5.1%[10]).

Stagnant demand

Electricity demand has been stagnant for 10 years, as a result of low economic growth and consumer reaction to constantly rising electricity prices. The signs are that demand is actually decreasing at the moment: Eskom’s presentation of 28 November 2018 on its 2018 interim financial results, states that there has been a decline of 0.8% in year-to-date sales volumes. 

Eskom has a business model that is no longer appropriate

It is disappointing to see that the tariff application shows no signs of Eskom realising that drastic action is needed to address its basic problems: it is unable to contain its costs in the face of stagnant demand, which shows no real signs of changing.

In its 2018 Annual Report, Eskom announced that it would undertake a strategy review, expected to be complete by September 2018. The most recent reference by Eskom to such a strategy review is contained in its presentation on its 2018 interim financial results of 28 November 2018. In that presentation, it mentions that Phase I of the strategic review is currently being discussed with the shareholder ministry, but no further details are provided. Given the circumstances in which Eskom finds itself, one would also have expected some reference to Eskom’s medium to longer term strategy in a three-year tariff application, but the document is silent on this aspect. The three-year tariff application reads as if it is business as usual.

The simple truth is that Eskom’s business model is no longer fit for purpose and there is no publicly available indication as to what it is doing about it. 

Government now accepts that renewable energy is cheaper than the alternatives

The Department of Energy published a draft Integrated Resource Plan (IRP) for comment on 27 August 2018. This document represents Government’s long-term electricity infrastructure development plan. The draft IRP states that the Independent Power Producer programme (“IPP” - the Government approved renewable energy programme), together with Eskom’s own capacity increase, ending with the completion of the Kusile coal-fired power plant in 2022, will provide more than sufficient capacity to cover projected demand up to 2025. It also finds that the scenario which does not place any limits on the building of renewable energy sources, provides the least-cost option by 2030 (and beyond that, to 2050). The IRP’s recommended plan provides for wind and solar power to make up 21% of total installed capacity by 2030.

Thankfully, this draft IRP does not suffer from the obvious manipulation which allowed the previous draft IRP of November 2016 to include a nuclear option. Pending finalisation of the new draft IRP, Eskom cannot now avoid having to work out how it can integrate this cheaper electricity into its network. 

It is interesting to note the major global users of variable renewables (i.e. solar and wind) are: Denmark (55%), Uruguay (30%), Germany (27%), Ireland (26%), Portugal (24%) and Spain (22%).[11] In contrast, purchases from the IPPs by Eskom in 2017/18, constituted only 4% of the total available electricity for distribution[12]. 

NERSA’s wider responsibility

It will be noted that we have not even addressed the well-publicised instances of corrupt behaviour at Eskom or the reasons for the continued danger of load shedding. These relate to board/management oversight or operational issues which Eskom should be able to deal with internally within its existing structures and procedures. 

However, the issues of stagnant demand, very high debt service costs and a changed energy environment, require a major strategic review which would need to consider realistic demand forecasts, Eskom’s financial position and its future generating and distribution policy.

In this wider context, NERSA has a definite role to play. The legislation which sets out NERSA’s mandate provides that in addition to regulating prices and tariffs, it may perform any other act incidental to its functions and it must act in the public interest.

It is clear that NERSA’s role goes well beyond that of the limited field of administrative or technical issues and NERSA should therefore not only draw important strategic issues to the attention of Eskom but should also emphasise the importance of urgent attention being paid to them.

Conclusion

Given Eskom’s current predicament, it is not clear how it can expect NERSA to give proper consideration to a three-year tariff application without details of at least a medium-term strategy. NERSA should request Eskom to carry out a strategic review of its current business model and to present it to NERSA. In any event, NERSA should, in keeping with its recent decisions on Eskom’s tariff applications, weigh the inevitable effects of high tariff increases on a struggling economy. 

Specific issues which appear highly problematic in Eskom’s tariff increase application include the following:

• demand has remained stagnant over the past decade (and has actually decreased during the year to September 2018), whereas costs keep on increasing at a rate above inflation;
• there does not seem to be a realisation that Eskom’s business model is out of date and as a result, it is submitted that NERSA requests details of Eskom’s medium-term strategy before considering this application;
• the financial effects of cost-overruns/delays in Eskom’s capital programme and the damage done to Eskom’s financial situation by its conscious decision not to continue with “cost plus” contracts, raise the question of whether the consumer should pay for the consequences of Eskom’s poor decisions, or whether the Government (as 100% shareholder, and therefore ultimately responsible) should contribute; and
• above inflation wage increases for a workforce that is one-third overstaffed.

It is surely time for Government to realise that Eskom’s financial situation is so serious that it cannot be dealt with by tariff increases alone (especially given a struggling economy). A recapitalisation of Eskom appears to be unavoidable and Government cannot expect NERSA to shield it from its responsibility to ensure that Eskom is appropriately managed and adequately funded.

Anton van Dalsen
Legal Counsellor
anton@hsf.org.za

[1] The macroeconomic impacts of alternative scenarios to meet Eskom’s five-year revenue requirement, report prepared by Deloitte for Eskom Holdings SOC Ltd, 6 June 2017, p. 33.