Barely a week goes by that Eskom isn’t mentioned in the press for all the wrong reasons. The state owned enterprise (SOE) suffers from a litany of problems, including:
- The inability to produce sufficient and reliable power for SA;
- Old power stations that are suffering from neglect of maintenance;
- A business model designed in the 1980s that has not adequately evolved to take into account the new challenges facing a modern power utility, such as adjusting to power supplied by renewable producers;
- An unsustainable capital structure and debt load;
- The inability to profitably produce power; and
- Being incapable of claiming payment from municipalities for the power that is actually delivered.
There are no easy fixes to this situation and, without a doubt, all potential solutions will involve significant costs in terms of financial and job losses.
The question really is about who will bear these costs. For example, one suggestion is that the National Energy Regulator of SA (NERSA) grants the parastatal significant electricity tariff increases. This has the benefit of saving jobs at Eskom, however, it comes at the expense of jobs in the mining companies where some shafts are certain to become unviable. The tragic moment has unfortunately arrived where we can shift job losses around, but we cannot avoid them.
Similarly, the moment has arrived where financial losses have become a reality. We can charge citizens excessively for electricity, making everyone pay their share of the loss, we can ask pension funds to write down their assets, or National Treasury can assume some of the liability, effectively plunging the country into true junk status and removing SA from the all-important global bond indices.
Whichever path is chosen there can be no doubt that someone is going to pay in order to fix Eskom’s broken balance sheet. We have unfortunately seen this movie all too often in SA. An SOE manages its operations poorly, often with nefarious intent, the inevitable financial disaster materialises and the SOE wraps itself up in our national flag, cries that SA cannot survive without it and secures a bailout from National Treasury.
One needs to think no further than the South African Broadcasting Corporation (SABC) or South African Airways (SAA) for examples of a perpetuating cycle of poor decisions leading to bailouts and further bad decisions.
It has become clear, even recently, that an independent board at the SABC makes the government too uncomfortable, yet somehow we are to believe that a board at a future Eskom will be free from government interference when the stakes there are so much higher.
We are of the view that a bailout of Eskom without fixing the underlying root causes just perpetuates the bailout machine. The only difference being that this time the machine is big enough to wipe out the entire SA economy.
The immediate priorities in fixing Eskom are clear – we must keep the lights on while also addressing the dual challenges of a broken business model and a destroyed capital structure, while not bankrupting SA.
Many are arguing that National Treasury should assume Eskom’s excessive debt load. The argument essentially being that Eskom is no longer sustainable and we should therefore add additional debt to an already overburdened state to save the parastatal. Perhaps it is just us, but borrowing money from a different source to address an excessive debt problem at both an SOE and at the national level seems to be just another way of kicking the can down the road.
Politicians have tried to run an electricity generation company and we can conclusively say that they have failed spectacularly. Let’s not blithely add to our excessive national debt so that they can try yet again.
We argue that the solution lies in something that is not being mentioned or discussed because it is politically very uncomfortable. A controlled default of Eskom on its debts is, in our view, the most appropriate tool for restructuring or addressing all three obvious problems – the balance sheet, Eskom’s operations and the legislative environment in the country.
An Eskom default does not mean the lights go out and that it ceases to exist. Instead, it is put under curatorship with a view towards restructuring its operations, payroll and balance sheet structures. Under such a business rescue scenario it would be essential to ensure that suppliers continue to be paid on time, while the business is being fixed. This is a remarkably similar exercise to that which was undertaken for African Bank, just on a far grander scale. We are advocating that Eskom undergoes a negotiated business rescue.
Politicians are quick to talk about how a default is untenable because SA will be locked out of the debt market with a big black mark against its name forever. So, let’s talk about African Bank’s default in late-2014. About 18 months later, in March 2016, the restructuring was approved, and it is broadly expected that after another 36 months the company will be in a position to issue new bonds in 2019.
Let’s be clear, African Bank is likely to be able to access the debt markets a mere 36 months after restructuring its debt. We therefore do not accept the political argument that Eskom will be locked out of debt markets forever, when African Bank is able to recover.
International investors shunning Eskom after a default is another argument being raised. This argument conveniently ignores the fact that African Bank bonds traded freely with buyers for its US dollar-denominated debt as soon as the restructure was completed back in 2016. In fact, Nigeria has defaulted on its offshore bonds five times and has still been able to go back to the market to secure new investors.
Getting locked out of financial markets just isn’t an argument that holds water, in our opinion.
What politicians really are saying is that there will be a newfound sense of accountability in SA after an Eskom default. Financial markets will in future only make funds available to the state and to SOEs when their houses are in order. After an Eskom default we can expect that financiers will take a dim view of SOEs with poor corporate governance or opaque reporting. In other words, to secure funding in future, a SOE will need to be ethical, properly run and transparent. Perhaps it’s just us, but we say bring it on!
Restructuring Eskom will be about the legislative framework as much as it will be about the SOE itself. We know from the rolling blackouts (in SA we call it “load shedding”, in the US it is referred to as “rolling blackouts”) in California during 2000 and 2001 that a pure free-market system also risks failure and corruption (think Enron). Instead, it makes sense for power generation and distribution to be based on a public-private partnership (PPP) model with a sensible regulatory framework. The model of generating electricity with the objective of making a loss has reached its inevitable outcome and the SA government will need to embrace the private sector in order to decisively deal with this problem.
Government has indicated that the time has come to re-evaluate the distribution model. The national electricity grid should be split from its generation operations and should be independently managed. We are of the view that this should be housed in a separate entity with private participation.
There is a massive transformational opportunity here (if the government manages this process) to give some shareholding to employees and to empower some of those who have worked at Eskom for much of their lives. Clearly a significant portion of the SOE should be listed, just like the success we have seen with Telkom. This ensures transparency and, with good governance, will allow for future access to debt markets.
The government should also reconsider the current residential distribution model whereby electricity is supplied to municipalities in bulk and then on-sold at a markup to residents. Clearly, municipalities are benefitting from this revenue source (and from failing to pay Eskom), but perhaps allowing the private sector a role will be transformational and will also give the consumer more transparency in their electricity pricing?
As for generation, we are of the view that individual plants should be sensibly grouped together (a few at a time) and spun-off into their own generation companies – baby Eskoms if you like. Each of these will provide electricity into the national distribution grid based on an offtake arrangement, while allowing some element of both natural market forces and regulations to drive prices and volumes. Each company will create transformation opportunities and should also be listed.
A significant advantage to this model, whereby a number of power producers all supply the grid based on natural market forces, is that it allows competitors to enter the market. If the Russians want to build a nuclear plant in SA and provide power into our grid at prevailing prices, then we should welcome them (with some regulatory oversight). Taxpayers should not have to pay for the creation of the plant but, instead, we should encourage private capital to create our power sources. We should welcome with open arms the Russians to invest in our economy and produce electricity at fair prices. The issue here is just that we do not want the South African state to buy the plant from them at inflated prices and to take the power-generation risk and responsibility on behalf of citizens.
Where does this restructuring leave Eskom’s current debt holders? Well, each of the baby Eskoms should be established with a high, but sustainable, debt load (making the equity pricing attractive from a transformational perspective). Existing Eskom debt holders will also hold the debt from the baby Eskoms and the national distribution grid, either through a debt-swap mechanism or, more likely, through a pooling structure.
Debt holders will also want a portion of equity in these new companies to compensate for some of the loss that they are going to take on existing debt. Debt holders will also require some of the proceeds from listing the new companies on the stock exchange. However, make no mistake, these debt investors will likely also suffer losses of 10% to 25% to their debt investments.
The SA government has already guaranteed a significant portion of Eskom’s debt. These guarantees would shift across to the debt that is issued by the baby Eskoms, leaving the holder in a position where he is no worse off on that portion of the debt. To the extent that Eskom debt is written off, this debt will then be shifted to National Treasury. This is still not an ideal outcome, but the cost will probably be less than half the costs associated with the current plan of transferring R100bn of debt to National Treasury.
As for the government’s stake in Eskom, giving some of that up in order to reduce the contingent liability that is spiraling out of control seems like a massive win for National Treasury.
Perhaps, what was once unthinkable is now a bold step into a brighter future with the lights on and the economy working.
