Eskom should do a Telkom
The woes at Eskom continue with the suspension of 4 senior executives, continuing load shedding and excessive spending on diesel. Eskom has also applied to Nersa to allow a further 25% rate in electricity tariffs. It is time for government and Eskom to admit that the parastatal has too much on its plate and that resolutions, if achieved, will take too long to deliver, while in the mean time consumers and the economy will continue to suffer. It is time for more private sector involvement. It is time for Eskom to do a Telkom.
In the early 1990s, two of SA’s largest public utilities, Telkom and Eskom chose very different routes for the future. Telkom involved the private sector in a meaningful way by starting Vodacom as a joint venture with Vodafone, while Eskom remained a state-owned enterprise with very little private sector involvement. There were meaningful developments on the telecoms technology front at the time and instead of rolling mobile telephony out itself, Telkom opted to bring in Vodafone.
Vodacom was formed and went from strength to strength. Run as a private company, utilising private sector knowhow (largely from Vodafone) and private sector skills (including long-running CEO, Alan Knott-Craig who was originally from Telkom) and suffering very little government interference in its day to day operations, Vodacom became a very successful business. Today, it is a company with almost R200bn market capitalisation, more than 57 million customers (32 million in SA) and 7 300 employees.
Telkom has also performed very well on the back of this and other developments. Telkom listed in 2004 at a share price of R26.60. Today, it is trading at R77.90 and has a market capitalisation of over R40bn (more than R100bn if you take its stake in Vodacom that was unbundled to its shareholders in 2009 into account). It made R4bn in profit in 2014 and employs 21 000 people. The government now only owns 40% of Telkom with the rest owned by the PIC, institutions and retail investors.
Eskom, on the other hand remained government owned. This strategy worked well during the 1990s and into the early 2000s, with the company making good profits, the executives earning healthy bonuses and the consumers receiving relatively cheap electricity. The company was however riding on the coattails of meaningful investments in the preceding decades. It neglected capital expenditure, spending only R48bn in the 5 years running up to the load shedding of 2008, which is only 13% of what it has spent subsequently. Up until 2006, the company’s budget for future capital expenditure was very low (rising from R6bn in 2002 to R79bn in 2006). It then jumped to R217bn in 2007 and has continued rising, driven by cost overruns at Medupi and Kusile amongst other things.
The problems within Eskom increased substantially in the years following the 2008 loadshedding on both the construction and maintenance front. For example, Eskom approved the construction of Medupi in 2005 and finally started construction in 2007. The initial target was to get Medupi’s first units online by 2011 and was initially budgeted to cost R87bn. The deadline was missed by 4 whole years and by some estimates, the project is going to cost twice the original budget.
On the maintenance and outage side, there has also been a deterioration over the past number of years. Peak production has been declining consistently since 2012 when Eskom generated up to 4.94GWh. It is currently only generating 4.55GWh, which is a decline of 8% from the 2012 peak. The company’s planned and unplanned outage factor has similarly increased from 21% in 2012 to 28% currently. There is press speculation that more generating units have to be switched off due to breakdowns, limiting the utility’s ability to do planned maintenance.
Government and Eskom are trying to address the issues by setting up a war room, doing internal investigations and doing what they can to retain and attract skills. However, by all accounts this is going to be an uphill battle and Eskom’s track record is poor. An alternative solution is needed.
In a previous blog, I suggested that government should promote more private generation to address the electricity crisis. I now would like to go a step further. I think it is time for Eskom to admit that it may not have the ability to deliver on its promises (increased generation and maintenance), that the risk of attempting to do so is too great for SA’s energy security and that it is time to call on more extreme private sector involvement. I suggest that Eskom brings in a private sector partner to help shoulder the load.
Eskom should find at least one large private sector partner and form a 50:50 joint venture (JV) with it. This JV should house all new generation capacity building, potentially also housing existing projects such as Medupi and Kusile. In the medium-term, routine maintenance could also be outsourced to this JV. Over the longer-term, Eskom would retain its existing generation capacity, which it will maintain and manage. Its main focus would be traditional electricity generation (largely coal power plants). The JV will house new generation capacity, which it will maintain and manage. Within the JV, there will be a focus on renewable energy and over time, this should become its main business. The JV would be allowed to sell directly to end-users, including municipalities and industry. It would be in direct competition to Eskom.
Eskom’s contribution to the JV could be Medupi, Kusile and other building projects, whilst its JV partner would inject capital to match. The capital that the partner injects can be used to fund the completion of these projects as well as new renewable energy projects. If further money is required for projects, the JV could go to the debt markets and likely get better interest rates than Eskom currently. In the medium-term, the JV could also earn revenue from maintenance contracts on some of the power plants that will remain within Eskom.
Such an arrangement would reduce the pressure on Eskom, it would allow for a welcome capital injection from the JV partner, it would allow the introduction of new skills and technology into the SA electricity industry and it would reduce the financial pressure on Eskom.
The welcome breathing space that such an arrangement would provide, could give Eskom the opportunity to resolve its internal problems and improve its financial position. The increased competition in the market, as well as the financial breathing room that Eskom will obtain, may also encourage them to take another important step to reduce our energy needs, namely to buy BHP Billiton’s aluminium smelters (which use 5% of SA’s power and pay less than generation cost for it) and mothball them (as I discussed in a previous blog).
As a partner in the JV, Eskom will also benefit from its financial success. A successful JV may be able to walk a similar path as Vodacom in gaining more business from the rest of the African continent. If this were to come to pass, Eskom and its sole shareholder, the SA government, could benefit handsomely.
At the moment, there are polarised views on the future of Eskom. The one side sees Eskom as a national asset and excludes any possibility of privatisation. The other side believes that Eskom has to be privatised to have a successful future. My suggestion offers a middle ground where the majority of current electricity generation will continue to reside in Eskom, but new generation will reside in the JV, in which Eskom will have a 50% stake. This is not unprecedented in SA as we have seen with the Telkom/Vodacom model, which has been very successful.
Will government go for this solution? If the question was asked a year or two ago, the answer would be no. However, due to the immense and building pressures on Eskom, this may just be the elegant solution they need. They would not have to give in to wholesale privatisation, but can solve many of their problems, whilst still retaining 50% of the upside from new generation.
What do you think of my suggestion? Do you think we need more private electricity generation in SA? Do you think government may finally change its mind and allow more private sector involvement? Do you think that allowing such a competitor to Eskom would lead to lower or higher electricity costs? I would love to see your feedback.
In the mean time, keep your talking straight!