Department of Public Enterprises, Vote 30 address by Minister Barbara Hogan to the National Assembly, June 23 2009

Mr Speaker

Historical role of state-owned enterprises

State-owned enterprises, in their past and present form, have played an indispensable role in the development of our country and our economy by providing essential infrastructure, such as postage, rail, water, telephony, communications, fuel, energy and development financing, without which no economy or country could have functioned or survived.

As is the case elsewhere, they are creatures of their time, reflecting in their practices or founding mandates the socio-political objectives of their governments. In the case of South Africa in particular, this was most evident in the era of apartheid, where they were aggressively used to disempower blacks and drastically reduce white poverty by privileging the white working class, to insulate the apartheid economy from economic sanctions and to develop, euphemistically speaking, the homelands. Finally, they became the aggressive entry point for white Afrikaners into the economy, from beyond the traditional confines of agriculture a form of white Afrikaner affirmative action.

With the advent of democracy in South Africa in 1994, government inherited a large and complex array of State Owned Enterprises (SOEs), with varying degrees of efficiency, efficacy and purpose. Its job, as a developmental state, both then and now, is to re-orient the SOEs towards the twin goals of attaining our socio-economic developmental goals and maximising operational efficiency and financial sustainability.

From the point of view of efficiency and sustainability, government has adopted a multi faceted approach to restructuring, which, whilst incorporating privatisation as an option, is not limited to that alone. Restructuring is officially defined as the matrix of options that includes the redesign of business management principles within enterprises, the attraction of strategic equity partnerships, the divestment of equity either in whole or in part where appropriate, and the employment of various immediate turnaround initiatives.

Privatisation on its own is never a guarantee of either success or failure in attaining efficiencies and sustainability. Decisions have to be taken on a case-by-case basis with careful consideration of the context and the environment, and of the value of the transaction to the state. For instance, the privatisation of Telkom had some negative consequences for it entrenched monopolistic practices and undermined accountability for service provision. The problems are compounded in a poor regulatory environment. On the other hand, the disposal of non-core assets in Transnet stable has enabled the corporation to focus on its core business, and we look forward to seeing dramatic improvements in that regard.

The entities that fall under the Department of Public Enterprise (DPE) stable are in the main all corporative, with independent boards. Most of the SOEs in our portfolio operate in key network infrastructure areas in the electricity, broadband, aviation and port, rail and pipelines sectors, as well as areas of advanced manufacturing, which have the potential to catalyse economic growth and to ensure that this growth is accompanied by the creation of much-needed jobs.

To be able to fulfil this role these SOEs must be strong enterprises and must be institutionally responsive to the strategic intent signals of government as shareholder. Being a strong enterprise means that there is an enabling external environment for the SOEs to operate in. A strong enterprise also means that these SOEs have:
* adequately capitalised balance sheets
* adequate and predictable cash flows going forward, sufficient for the execution of their respective business plans
* strong boards and management teams
* solid strategic and business plans
* alignment with labour
* responsiveness to government's strategic objectives.

All of these characteristics are of course to varying degrees not in place.

Our responsibility as the shareholder manager is to balance the commercial sustainability of the SOEs with the state's strategic intent in owning these enterprises. This creates a delicate balance in that if the strategic purpose subverts commercial viability, the enterprise will collapse, but if commercial considerations override the strategic purpose, government objectives will be compromised. It is our challenge to provide shareholder oversight in a manner that builds financially robust, developmental enterprises, rather than to see these two aspects of the SOEs as mutually exclusive.

This is in line with the ruling party's Polokwane resolution that calls for "strengthening the role of state-owned enterprises and ensuring that whilst remaining financially viable, SOEs, agencies and utilities as well as companies in which the state has significant shareholding respond to a clearly defined public mandate and act in terms of our overarching industrial policy and economic transformation objectives."

There is a further strategic, historical imperative. In the present worldwide economic recession and in the light of the huge backlog in infrastructural investment, the SOEs must massively expand the rollout of their infrastructure programmes. This will help to counteract the economic downturn by accelerating jobs and investment. Comprising an investment of R787 billion rand, it is the world's third largest infrastructural investment programme. Both Eskom and Transnet are critical to this programme.

These infrastructural investment programmes can be used to systematically develop the manufacturers that supply the SOEs with the components necessary for the infrastructure roll-out. This leverage is optimised when there is long-term infrastructural planning, combined with a high level of standardisation of requirements and the building of strategic relationships with national suppliers.

This gives industry a firm basis to invest, and allows them to achieve economies of scale and high levels of efficiency as a result of the learning curve. The department established the Competitive Supplier Development Programme (CSDP) in 2007 to embed the supplier development process into the heart of the investment programmes. However, in order to achieve these objectives, sophisticated procurement capabilities are required a further reason to emphasise the building of procurement capacity. In addition, it is critical that we build our capacity to coordinate a range of government incentives with the procurement process to ensure investment in advanced manufacturing capabilities. We believe effective procurement leverage can result in sustained job creation and ultimately, in exports.

The current regulatory system was established during a period of minimal investment, and has not been adequately revised. The consequence is that tariffs, particularly in electricity, are not designed to provide enterprises with the cash flows to fund an aggressive build programme. Given the scale of the investment programmes, it is unlikely that the fiscus will be able to fund the costs of the capital build. This is a major threat to the investment programmes and needs to be given considerable focus.

Given the accumulated backlog of investment in infrastructure, it is critical that we create an environment where the private sector can participate in the system alongside SOEs, rather than as an alternative to them. A further problem with the low tariff regime is that it hinders the ability to introduce private operators and funding into the system, as the returns offered to these players will not be sufficient to justify the investment. These investors do not only bring much needed financial capital, but can also introduce a competitive dynamic to the system that will increase efficiencies, and in certain instances will give consumers greater choice.

Finally, it is absolutely critical that funding models for our enterprises be finalised as soon as possible. Many of our SOEs are unable to adequately generate their funding requirements from their own operations and are reliant on borrowings that are often guaranteed by the state. It is absolutely clear that additional sources of funding must be sought.

The state as 100 percent shareholder is a potential source of equity funding, but as is well known, the fiscus is not in a position to provide the scale of funding required. We are living in harsh economic times when even yesterday's newspapers were reporting on the imminent collapse of a number of welfare organisations, when only a few months ago a province ran out of anti-retroviral medication and when pressures on the Unemployment Insurance Fund (UIF)will accelerate. These sobering reminders of the desperate need out there must galvanise the department to urgently address the finalisation of appropriate funding models for our SOEs this must become an absolute priority.

While we will deal more intensively with each of the SOEs in our regular interactions with the portfolio and select committees, it is prudent that I speak here directly to the issue of Eskom.

Eskom

Despite significant funding challenges, the implementation of Eskom's capacity expansion programme must continue, with particular emphasis on bringing the two new 4 000 megawatt plus baseload coal-fired power stations, Medupi and Kusile, into service as soon as is humanly possible.

Eskom's planned capacity expansion programme will spend R385 billion in nominal terms over the five years which began in the 2008/9 financial year. The programme in its entirety plans to double Eskom's generating capacity to 80 000 Megawatts by 2026, with a projected spend in excess of R1 trillion.

The funding of Eskom's capital expenditure programme remains a challenge, especially in these times of reduced debt access in the global markets, in the context of an electricity price that does not accurately reflect the cost of production.

The price of electricity, for instance, has not been reflective of the true cost of production, especially in light of the new build programme. Since 1990, Eskom has foregone over R148 billion in revenue in nominal terms (R257.8 billion in 2009 money). This has led to falling financial reserves, to the point where Eskom is no longer able to meet its expansion requirements without significant borrowings, or financial injection from the state.

The Electricity Pricing Policy (EPP) approved by Cabinet in December 2008, states that "revenue from tariffs should reflect the full cost (including a reasonable risk adjusted margin or return) to supply electricity and ensure that the industry is economically viable, stable and fundable in the short, medium and long term."

The principles behind the EPP are based on a sustainable electricity supply industry where a prudent operator can recover the full prudent costs of production and earn a reasonable return on their assets, and energy efficiency is promoted through a cost reflective tariff.

To ensure efficiency in consumption, revenue generated from tariffs should at the very least cover operational expenditure. This cost is borne by the consumer through a progressive tariff which provides protection for poor households. The current 34 percent price increase is based purely on the increases in operational expenditure and excludes the cash flow requirements for the capital expansion programme.

It is absolutely paramount that the Eskom capital expenditure programmes continue unabated as it will also serve to support South Africa's economic growth and provide jobs in these difficult times.

There is some concern over Eskom's ability to access the debt markets to the extent necessary to fully fund its capital expenditure programme in the current economic climate. Any shortfall in funding that is not provided for either by additional government support or through its electricity tariffs will result in the curtailment and/or re-phasing of build programme projects.

In addition to the capital expenditure, Eskom's cost of operations is on the increase. One of the fastest rising costs is that of primary energy which is comprised of coal, diesel and water.

It is an imperative that Eskom's operational costs are fully funded through its tariff which is regulated by the NERSA. The lack of clarity regarding the funding of Eskom's capital expenditure programme and the appropriate mix of government support, access to debt and tariff support has necessitated that Eskom apply to NERSA for an interim increase for this year to enable it to cover its operational costs only. Failure to obtain the 34 percent increase will result in a severe cashflow shortfall for Eskom and it will have to take the necessary steps to curtail its business operations to remain financially stable.

Improving shareholder oversight

Until 2004, official government policy focused on privatising SOEs, rather than leveraging the enterprises to achieve strategic national goals. This resulted in a high level of uncertainty and a limited view of the shareholder management process. Consequently, the relationship between the shareholder manager and the SOEs remains relatively immature. A number of improvements have been achieved in the form of the following interventions introduced in the past four years:
* Shareholder compact with clear Key Performance Indicators (KPIs) between the DPE and the individual SOE
* SOE CEO and Chair forums
* Information sharing and compilation of the DPE-SOE dashboard
* Regular KPI-based reporting on the various SOEs based on an in-depth analysis of the financial and operation performance of the SOE
* The development of a rigorous shareholder management model by the DPE which is still to be fully implemented.

In order to exercise ownership towards capital efficiency and achieve strategic objectives, the DPE must be clear, transparent and accountable in its communication to SOEs of expectations on shareholder value maximisation. The primary objective is to ensure that the State's shareholdings deliver sustained, positive returns and return their cost of capital over time within the policy, regulatory and customer parameters set by government, by acting as an effective and intelligent shareholder. In order to achieve this, the DPE has to co-ordinate policy and commercial positions within government before directing an SOE to align its corporate strategy with the State's strategic intent in respect of financial, operational and socio-economic performance.

The DPE is strengthening the measurement of SOE output, and key principles underlying this approach include:
* Clarity and transparency of objectives, ensuring that such objectives are measurable and can directly demonstrate their impact on the economy
* A shared vision for each SOE, based on agreed objectives, which are explicitly agreed by the shareholder, the Board and the management team
* Active involvement of the shareholder around the exercise of its key levers of interest, namely best practice corporate governance, board appointments, strategy formulation and performance monitoring.

Conclusion

Our ability as the shareholder to give clear, long term strategic direction to the SOE is vital to ensuring that these enterprises deliver on government's strategic intent. The department remains committed to ensuring that the SOEs are turned around to become viable enterprises which add value to the economy.

I would like to thank the Director-General, Ms Portia Molefe and her team for their hard work in ensuring that we become a more active shareholder.
I also look forward to engaging with portfolio and select committee members and their Chairs Ms Mentor and Ms Themba; we look forward to your continued support and vigilance when it comes to the work of the department and the SOE.
To the Chairs and CEOs of the SOEs, a lot of hard work lies ahead, but I have no doubt that all of you are up to the task.

Honourable members, I commend this budget to the house.

Source: Department of Public Enterprises

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