Eskom’s strategy to keep the lights on

By Nedgroup Investments

A reliable and cost effective electricity supply is a critical success factor for the performance of the South African economy.

Lack of a reliable electricity supply was probably the key factor behind the poor mining and manufacturing performance in Q1 2020, placing us firmly in a recession and contributing to the economy contracting by 2% on a quarter on quarter basis. The Reuters consensus forecast for Q2 GDP is an economic contraction of more than 40% quarter on quarter annualized. In the midst of such economic disaster, where demand undoubtedly collapsed, we were still faced with stage 2 loadshedding and power outages.

Nedbank Chief Economist, Nicky Weimar, and Eskom CEO, Andre de Ruyter, discuss loadshedding, the road ahead for Eskom and what this means for South Africa.

You can listen to the full conversation on Google Podcast, Apple Podcast or Spotify, or read a summary of the conversation below. You can also watch the webinar on YouTube.

Eskom’s key challenges
Eskom’s debt of R480 billion, which is now part of the financial challenge that the fiscus faces, cannot be serviced from its own EBITDA, forcing it to borrow to service their debt. Volume has been declining by more than 1% per year. From a revenue perspective, this is compounded by tariffs that are not cost reflective and R30 billion in outstanding debt from municipalities and the Soweto debt of more than R9 billion. Eskom’s costs are a known problem and include large increases in employee and coal costs. Eskom’s opex has increased 30% over the last five years, reaching R151 billion in FY19. Procurement costs are also above the market norms. Eskom’s energy availability factor (EAF) is unacceptably low at 65%, which they have to address within their current generation system. This has led to increased loadshedding, costs and lost revenue. Eskom also has significant environmental challenges from an emissions perspective. They have reached the end of the road for their vertically integrated, monolithic business model and due to some significant changes in the energy landscape, have had to move to a different business model.

In addition to these challenges, four of Eskom’s eleven critical risks manifested in March 2020, namely severe supply/demand constraints with stage 4 loadshedding, a catastrophic IT system failure, the Covid pandemic and lastly, climate change challenges and environmental compliance.

The turnaround strategy
The organisation is at a cross roads and is taking decisive and rigorous steps to drive its turnaround plan. This includes developing and effecting plans to achieve operational stability; driving activities that improve their income statement; focused actions to address their balance sheet; a decisive journey towards restructuring with divisionalisation as a first step; and improving the culture and management of people.

Operational stability: Reliability maintenance has been introduced to catch up with maintenance that was deferred over the last decade. While Eskom tries to avoid loadshedding, there is a fine balancing act between protecting the overall national grid from a catastrophic blackout and keeping the lights on. Demand for electricity is expected to reach pre-lockdown levels by September 2020. Eskom’s maintenance recovery programme aims to improve EAF to 74% by 2023, drive midlife refurbishment and reliability maintenance. Medupi is currently fully operational except for unit 1, which should come online in February 2021. Kusile’s unit 1 is fully operational with units 2 and 3 coming online in September 2020 and November 2020 respectively. Units 4, 5 and 6 are forecast to be operational from June 2022 onwards with full operational capacity by November 2023.

Improving the income statement: At a significantly reduced debt balance of R200 billion, a closing cash balance of R30 billion and EBITDA margin of 35%, financial modelling shows that Eskom can achieve independent financial sustainability. Key elements of progress towards improving the balance sheet include avoiding loadshedding, resolving NERSA tariff disputes, managing municipal debt, renegotiating coal and fuel oil costs, reducing diesel consumption, IPP renegotiations and addressing procurement via SAP.

Strengthening the balance sheet: Progress toward this goal includes cutting capex from R38 billion to R20 billion, renegotiating the environmental capex, saving on decommissioning costs, including extending the life of their assets, driving working capital hard and trying to create a new income stream through the Just Energy Transition transaction. Their funding plan is also well developed.

Restructuring: Eskom’s end state structure has been clarified and good progress is being made in this regard. Three divisional boards have been set up, 8 500 employees have been re-linked, i.e. are back in the business and not based at head office, non-core assets are being disposed of and public private partnerships (PPP) are being investigated.

People: Eskom’s people plan aims to build critical capabilities, drive a culture of performance and accountability and increase employee productivity.

The opportunities that the climate change crisis presents for Eskom
Climate change and the decreasing cost of renewable energy have proven the case for the need to shift to clean energy. Eskom is the largest emitter of greenhouse gases in the country and has a fleet of old power stations. Over the next decade, Eskom will be putting into retirement 8 000 to 12 000 megawatts of capacity and need to start rapidly enabling the investment in new generation capacity by the private sector, a very important strategic objective and hence the corporate restructuring and focus on the Just Energy Transition. The latter intends to provide a future for communities that are heavily invested in and dependent on coal by involving them in renewable energies. Eskom’s Just Energy Transition vision can also address significant socio-economic challenges at a national level by reigniting local manufacturing, creating jobs and improving emissions.

What can we expect in the next 12 months?
Eskom is in a tough space - the solutions are challenging and will not be fixed overnight. They are on track to achieve the targets set out in the roadmap and are looking at ways to accelerate the legal separation of their transmission business in order to attract private investors and generation capacity - a critical step in order for new investments to take place. Despite their challenges, Eskom is on the cusp of a major opportunity to take advantage of significant changes in the energy landscape that can be leveraged to their benefit. Direct foreign investment will, however, be needed to enable this opportunity to become a reality.

With the implementation of reliability maintenance, South Africa faces an increased risk of loadshedding until the end of August/September 2021. The maintenance programme is being co-ordinated with demand forecasts in order to limit and minimize the risk of loadshedding. Eskom is looking to enable significant investments in additional generation capacity and is in the process of issuing an RFP for about 2 000 megawatts of capacity to be added to the grid.