HOW SHOULD THE NATIONAL ENERGY REGULATOR RESPOND TO ESKOM’S APPLICATION FOR A RETROSPECTIVE REIMBURSEMENT OF R66.7BN FOR THE PERIOD 2014 TO 2017?

THE HSF PARTICIPATED IN THE PUBLIC HEARINGS ON 11 MAY 2018, ORGANISED BY THE NATIONAL ENERGY REGULATOR FOR THE PURPOSE OF COMMENT ON ESKOM’S RETROSPECTIVE REFUND CLAIM OF R66.7BN. THIS BRIEF ANALYSES THE SUBSTANCE OF THIS CLAIM AND HIGHLIGHTS THE REFUSAL BY ESKOM TO CONFRONT THE REALITY OF A CHANGED ENERGY LANDSCAPE.

INTRODUCTION

Eskom’s tariff determinations normally run in five-year cycles, based on revenue and expenditure forecasts, which are used by the National Energy Regulator of South Africa (“NERSA”) to fix the tariff levels for that period.  In the event that these forecasts prove to be inaccurate, Eskom is able to approach NERSA at a later stage, to approve increases (or decreases) in tariffs on a retrospective basis.  This retrospective reconciliation method is described as the Regulatory Clearing Account (“RCA”) mechanism.  This can lead to increased tariffs if NERSA approves an Eskom application which shows that its net cashflows were less than forecast over the relevant period, as calculated in a manner defined within the RCA mechanism.

Eskom is now claiming R66.7bn in terms of the RCA mechanism for a three-year period (2014/15, 2015/16 and 2016/17) -  to put this amount into context, it represents 35% of Eskom’s total annual tariff revenue of R190bn for 2018/19, which was approved by NERSA on 15 December 2017. 

The amount in question in these three RCA applications is of such a magnitude that, if approved, it will have a serious effect on the economy generally, whether the amount is charged to consumers on a one-off basis or spread over a number of years.  It is obvious that it will have this effect and it is hardly necessary to present detailed economic analyses to substantiate this assertion. 

ANALYSIS OF ESKOM’S APPLICATION

From the data submitted by Eskom for the three RCA-claims, it appears that the aggregate claim is made up almost exclusively of a shortfall in revenue, together with an excess in primary energy costs.  Other items in the RCA-process play a negligible role.  It needs to be highlighted that operational and capital expenditure overruns are not included in the RCA-mechanism.

The main components of the RCA-claims are summarised in the following table:

Whilst there is a R44.4bn shortfall in revenue over this three-year period, expenditure has steadily increased over the same period.  This is reflected in part by the excess in the cost of primary energy (which forms part of the current claims and is included in the table above), but also by the operational and capital expenditure overruns (which are excluded from the RCA-claim process).  Even if they are not included for purposes of RCA-claims, it is nevertheless relevant to mention the operational and capital cost overruns, in order to provide an overall impression of Eskom’s general spending behaviour, during a period of stagnant demand.  Over the three-year RCA claim period, operational cost overruns amounted to R33.8bn and capital expenditure overruns amounted to R36.5bn (these figures are taken from the Eskom applications). 

Given the magnitude of the annual revenue shortfall over the whole three-year period, Eskom could hardly have failed to notice that in order to avoid serious financial problems, it had to adjust its expenditure.  One would like to assume that Eskom, as a public utility with a monopoly on a crucial economic and social service (and therefore an economic and social responsibility to the country as a whole), would have come to this conclusion.   

However, judging by its own expenditure statistics (as included in the RCA-applications), it is clear that Eskom has made no effort to curb its spending.  The documentation presented to NERSA makes no mention of cost-cutting efforts of any substance.  (This general attitude of indifference is also evident from Eskom’s revenue application for 2018/19.) 

As a result, Eskom’s attitude can effectively be summarised as follows: 

- we are selling less than forecast, but our expenses continue to rise and it is the consumer’s duty to fill the gap.

ESKOM’S OUT-OF-DATE BUSINESS MODEL

In considering Eskom’s current application, it is evident that Eskom’s problem is not confined to cashflow management issues.  There is a much more important issue at stake here:  Eskom has an out-of-date business model which shows no signs of changing to a fit-for-purpose model. 

Briefly put, Eskom is faced by a combination of the following:

- an overly aggressive capital expenditure programme, coupled with an inability to avoid  major cost overruns and multi-year delays;

- surplus generating capacity, increasing further by the year, in line with the completion of the Medupi and Kusile power stations (idle capacity of this kind has obvious cost implications);

- the insertion of an IPP (renewable) 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 capacity;

- renewable energy which has by now become much cheaper than the alternatives  -  and instead of taking a longer term view and studying how renewables can be integrated in an efficient way, Eskom prefers a dismissive attitude;

- a fixation on “base load” energy, used as a justification for a nuclear energy programme which even if it were suitable for “base load” generation, is clearly unaffordable;

- a massive increase in borrowing (to finance capital expenditure), 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 limited economic growth; 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, expected out-of-the-ordinary tariff increases and easily installed alternative energy sources, such as solar panels.

The factors mentioned above do not even include the many well-documented instances of corruption at management level.  However, it would seem reasonable to assume that the level of corruption has contributed to the lack of focus on the profound challenges that are affecting Eskom’s financial health.

In its Budget Review of 21 February 2018, the National Treasury stated:

“It is apparent, however, that Eskom can no longer rely on tariff increases to compensate for flat electricity sales growth.  To remain financially sustainable, the utility needs to reduce operating costs.  Eskom’s business model will also have to change as part of broader transformation in the electricity sector.”

Not a peep has been heard from Eskom about the overdue changes to its business model, until its new chairman, Jabu Mabuza, stated on 7 March 2018 that the problems at Eskom had run for too long and were too big and deep for any hope of a quick fix[1].  The issue is at least now acknowledged in public, which represents a major departure from Eskom’s previous stance.

The fact remains that until Eskom confronts reality and makes the necessary changes to its business model, it will continue to be faced by increasingly problematic funding issues over the years to come.  As a consequence, NERSA, in turn, runs the inevitable danger of continually being confronted by Eskom’s financial problems. 

HOW SHOULD NERSA RESPOND?

The RCA-applications which NERSA has to consider, reflect an attempt to rectify negative historic cashflows, caused by massive overspending in a situation where demand is stagnant and shows no signs of increasing.  No meaningful cost saving has been attempted.  Eskom has made no mention in its application that it is even aware that the situation requires urgent changes to its strategic policies. 

Eskom’s approach can therefore only be described as callous and irresponsible.  It carries on with an out-of-date business model and refuses to engage with reality (no further action has followed its chairman’s comments of more than 2 months ago, which are referred to above).  There are also no signs of its spending being curbed where demand continues to stagnate.  In these circumstances, the HSF’s position is that Eskom’s applications should not be approved.  If this leads to cashflow problems at the utility, it is for the State (as Eskom’s 100% shareholder) to come to the rescue.    

In addition, we also indicated that NERSA has no choice but to become more forceful in ensuring that Eskom takes the necessary strategic decisions that a changed energy landscape requires.   Eskom needs to be guided into the real world and NERSA has an important role to play in this context.

This article first appeared as a HSF Brief.

Footnote:

[1] Business Day, No hope for a quick fix at Eskom, Jabu Mabuza tells conference, 8 March 2018