Debt – The millstone around Eskom's neck
10 June 2019
ESKOM CANNOT SERVICE ITS DEBT FROM OPERATING REVENUES
Eskom’s total debt amounted to R419 billion at the end of September 2018[1]. Most of this debt was taken up to fund Eskom’s expansion programme, including the two mega-power stations (Medupi and Kusile). Both have suffered massive cost overruns and delays to construction. Eskom itself decided to play the role of overall project manager and is unable to lay blame on to others for the situation.
Eskom’s most recent six-monthly cash flow statements reveal that after subtracting capital expenditure from its operating cash flows, it was left with a grand total of R9.6 billion to cover its six-monthly debt service obligations of R45 billion. This resulted in additional debt of R34 billion being raised. One can only assume that a similar scenario has played out since then, with additional debt being incurred to permit it to comply with its debt service obligations, leading to aggregate debt of what must be well over R450 billion by now[2]. Continuously incurring further debt in order to service already existing debt obligations, is generally a tell-tale sign of a financial situation which is out of control.
ADDITIONAL DEBT IS BEING USED TO FUND ITS DEBT SERVICE OBLIGATIONS
It is estimated that debt service will amount to approximately R88 billion per year for the next five years.[3] As a result, Eskom will have to keep on raising new debt in order to fund its debt service obligations. This is the result not only of insufficient operating cash flows, but in addition, continuing annual capital expenditure of R45 billion for at least the next three years.[4]
CAN AN INCREASE IN ELECTRICITY TARIFFS DEAL WITH THIS SHORTFALL?
The National Energy Regulator of South Africa (NERSA) approved Eskom’s revenue of R190 billion for the 2018/19 financial year. In line with this, Eskom’s interim financial statements up to end-September reflect gross revenue of R98 billion for a six-month period.
In any event, there is no provision for recompensing Eskom for its debt service costs in the methodology used by NERSA in evaluating Eskom’s revenue applications. In respect of large projects under construction, the allowable cost is limited to labour and direct costs, excluding borrowing. When such projects are completed, the methodology used in NERSA’s formula is to provide Eskom with a reasonable return on the replacement value of its assets. The cost of debt is included in the calculation of the permitted return on assets, but this is expressed as an interest rate applicable to debt (as part of the cost of capital calculation) and does not reflect the actual cost of debt service.
Eskom cannot service its debt from its operating income. In order to cover the annual R88 billion debt service, its tariffs would need to increase by about 46%. This is obviously out of the question, essentially because there is no way in which the economy could carry an increase of this magnitude.
It also needs to be kept in mind in this context, that electricity consumption has been stagnant for a decade. Eskom is therefore confronted with a situation where its operating costs keep on rising and it has to fund huge capital projects, but sales show no sign of increasing. To put it mildly, this is obviously not a commercially viable scenario.
WHAT IS ESKOM AND ITS 100% SHAREHOLDER (THE STATE) DOING ABOUT THE DEBT SITUATION?
Given the lack of communication on the subject, who knows what is being done? In the 2019 Budget, Government announced a R23 billion assistance package per year to Eskom - but given the numbers set out above, this will only plug a small portion of the debt hole. Much more needs to be done by Government, but nothing has been announced since the Budget in February 2019.
Government is unwilling to face the fact that the contribution of R23 billion per year is seriously inadequate. At the very least, it would want further financial support to be conditional on restructuring, but the timing is difficult, since the support is needed now, whereas a restructuring plan will take time for a chief restructuring officer to formulate.
Moreover, Eskom’s workforce needs reduction at a faster rate than natural attrition, implying conflict with the unions, and coal supply needs urgent attention. What is needed is the termination of problematic high cost supply arrangements, accompanied by an increased reliance on low cost coal production.[5] Rationalisation of labour and coal costs would increase the resources available to service debt. But they cannot be undertaken by the Eskom board and management in the absence of government backing.
The snag is not only that the debt is increasing (since there is as yet no other way to fund the debt service costs), but the situation has been reached where outside funders have become very hesitant or are simply not prepared to provide any further funding.
Government has already guaranteed R295 billion of Eskom’s debt[6] and the time has come for it to decide how Eskom can be reconstituted as a solvent entity. Splitting it into three different components, as already announced by Government, may make general business sense, but it will not affect the total debt that remains owing.
IMPLICATIONS OF AN ESKOM BAIL-OUT FOR GOVERNMENT’S OWN DEBT
There do not seem to be realistic alternatives to a bail-out of Eskom by Government. This will obviously have an effect on Government’s own debt aggregate, as it will have to fund any bail-out out of an increase in its own debt. Given the fact that the economy is hardly expected to grow at all in 2019 (after the decrease of 3.2% in the Q1/2019 GDP), it can be assumed that Government’s own fiscal revenues will be lower than forecast, thus forcing Government to cut expenditure in certain areas or to further increase its already substantial debt. Pressure to deal with less revenue is therefore already on Government, quite apart from any further financial support to be granted to Eskom.
In order to put all of these numbers into some sort of perspective: gross loan debt currently amounts to R3 trillion, with debt service costs for the year 2019/20 already at R202 billion, almost equal to Government’s annual expenditure on health (R222 billion).
Aggregate current debt service costs amount to an average of 6.64% of gross debt per year - so an additional R300 billion debt would incur additional annual government expenditure of about R20 billion - and to get an impression what this constitutes in the greater scheme of things, it represents two-thirds of the annual expenditure on agriculture and rural development by Government (amounting to R30 billion).
POLICY CERTAINTY IS A PRE-REQUISITE FOR BUSINESS CONFIDENCE AND ECONOMIC GROWTH
Resolving the Eskom debt issue (quite apart from its very serious and well-publicised operational issues) is one of the most important economic policy items that needs to be addressed by Government as soon as possible. Eskom’s overall strategy also needs to be formulated. Its March 2018 Integrated Report stated that a strategy review would be completed by September 2018. Eight months later, we are still waiting for the results of this review. The absence of a CEO will probably just add further delays to the process.
In order to deal with the general feeling of uncertainty which is hanging over the economy, Eskom’s situation is a crucial issue that needs to be clarified. Business confidence will not improve from a very low base until there is a broad perception that important policy issues have been dealt with in a decisive way, in order to instil some sort of certainty. It is all very well for Government to talk about job creation policies, but they will come to nought in the absence of policy certainty, an improvement in business confidence and economic growth - in that order.
Anton van Dalsen, Legal Counsellor, HSF.
Footnotes:
[1] Eskom Interim Financial Statements for six month ended 30 September 2019.
[2] On 15 May 2019, Bloomberg estimated Eskom debt at R241 billion in bonds, and R253 billion in loans, making a total of R 491 billion in debt
[3] Eskom Integrated Report for the year ended 31 March 2019 (page 65), estimates debt service on existing debt to amount to R443 billion over the next 5 years.
[4] Eskom Integrated Report, page 64.
[5] Long-term supply contracts from large producers had been discontinued, partially because Eskom would have needed to provide large upfront funding for capital expenditure for the relevant coal mines. However, this upfront funding is not expensive if amortised over the life of mine, and in retrospect, would have been by far the cheapest option. In addition, suspicions have been raised that long-term supply contracts with large established companies do not offer the same opportunities for potential corrupt behaviour, if compared with short-term small scale contracts with junior coal producers.
[6] Budget Review 2019, National Treasury, 20 February 2019.
