Revenue shortfalls just part of Eskom’s troubles

Commentary about Eskom’s financial woes usually focuses on the refusal by the National Energy Regulator of South Africa (Nersa) to grant the utility its requested large annual tariff increases over the next five years. Whereas Eskom sought annual hikes of 16% on top of the already high increases awarded since 2008, Nersa allowed only 8%. As a result, Eskom’s revenue is lower than it hoped, creating funding problems for its operations and its ambitious expansion plans.

Revenue shortfalls tell only part of the story. Eskom’s financial difficulties are also caused by huge expenditure overruns on its new power stations, Medupi and Kusile, as well as the extraordinarily long delays in bringing Medupi into production. At the start of construction, Eskom estimated Medupi would cost R34bn. The latest estimates suggest it will cost more than R100bn. So Eskom must now pay interest on additional loans of R70bn. This has added about R5bn a year to Eskom’s annual costs and will continue to do so for decades until the loans are repaid.

The delays in bringing Medupi online have increased pressure on Eskom’s already vulnerable cash flow. Had Medupi come on stream as planned, the electricity it would be generating would bring new revenue to relieve Eskom’s cash squeeze. Instead, Eskom has had to resort to very costly diesel generators to meet the consumer demand Medupi was meant to supply. As a result, Eskom had to spend R11.3bn on diesel in its last financial year, far more than an operational Medupi would have cost to generate the same electricity. In addition, Eskom funds a large advertising campaign urging its customers not to use its product! Even so, it cannot always meet electricity demand.

Eskom wants to increase its consumer tariffs to cover these cost overruns. Rightly, Nersa has blocked this, arguing that only unavoidable cost overruns should be built into tariffs, not those arising from administrative and management failings.

Eskom can contemplate passing on its spending blunders to consumers only because it is a monopoly. If it operated in a competitive market, it would have to accept the market price for its product. Private firms operating in markets with competitors are not able to set prices that suit them. To remain profitable, private companies that have overspent on new capacity must restore profitability by cutting costs or writing off the capital wasted. If the firm is large and profitable, it can manage the write-off on its balance sheet. Alternatively, it must turn to its shareholders for funds to replace the wasted capital or sell parts of the business and use the proceeds to pay for its project.

For private companies unable to do any of these things, the final sanction is that they remain unprofitable and are forced to close. The plant and machinery are sold off cheaply to new buyers at prices at which they can be run profitably. Unprofitable operations that cannot find buyers are sold for scrap.

By rights, Eskom should restore its profitability in similar fashion. It has already approached its sole shareholder, the government, for an injection of equity. But the government faces its own funding challenges and so is reluctant to do so. Alternatively, Eskom could sell some power stations to private producers and so pay for its new projects. It should also rethink its expansion strategy. Rather than build more power stations itself, it could share the cost and project management with private partners, or it could purchase additional power supply from private providers and so reduce its funding needs.

Opponents of such steps claim they would undermine Eskom’s key role in the "developmental state". This is clearly nonsense. The developmental state model is based on cheap electricity for the needy. The developmental state also requires cheap and plentiful power for the new private and public businesses the model is supposed to promote in order to create the new jobs needed to improve our quality of life.

Neither of these goals requires that Eskom be the sole generator of electricity. This is already acknowledged by the licensing of private wind farms and solar electricity generation, whose production Eskom is buying then selling through its national grid. Why would the sale of a power station to private investors be any different from what is already in place? Moreover, the dream of the developmental state is seriously threatened when Eskom resorts to swingeing tariff hikes that households cannot afford and which undermine the sustainability of businesses. With prohibitively expensive electricity, where are the new businesses and jobs to come from?

Lack of electricity is hampering economic growth. But it is as important to find a sustainable model for funding expansion as it is to increase generation capacity. The wrong formula will lead to unaffordable electricity provided by a debt-crippled utility. This will undermine South Africa’s future economic growth.

Article Source: Business Day Live

Article by Gavin Keeton

• Keeton is with the economics department at Rhodes University.