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Eskom monopoly rewards inefficiency

Alarm bells should be ringing regarding state-owned monopoly Eskom’s plans to nearly double the price of electricity from the level of 50c a kilowatt-hour at financial year end 2012, to 97.5c in 2017. These targeted increases amount to 14 percent a year, well above the Reserve Bank’s inflation target of 3 percent to 6 percent and have to be seen in the context of three important factors.

First, energy prices are collapsing globally as a result of weak economic growth and technological advances. The price of Brent crude has fallen from $125 (R1 050) a barrel to $90 in the last three months, and coal prices have fallen off a cliff, following oil and gas prices down. These declines are a healing balm to confidence, inflation and job creation. South Africans, however, are facing a witch’s brew due to Eskom’s plan to double electricity prices.

Second, the dramatic 159 percent increase in electricity prices over the last four years to March 31 resulted in electricity now being a very significant cost for nearly all consumers. The so-called base effect makes consumers all the more vulnerable to the planned future increases. For example platinum producers, those that have not shut down, currently have electricity costs of up to 17 percent of total costs.

Third, much of the industrial base was premised on cheap energy. Eskom secured price increases of 159 percent over the past four years and is targeting further price increases of 94 percent to March 31, 2017 due to three factors. Eskom:

* plans to be profitable, targeting a return on equity (ROE) of 16.45 percent in 2017.

* has lost control over costs.

To cover its rampant costs and achieve its desired profitability and debt levels, Eskom has to secure dramatic electricity price increases. In the process the electricity consumer gets decimated and has no alternative as Eskom is a monopoly.

Primary energy costs have increased by 153 percent over the past four years to R46 billion. Dominant factors at play were the cost of coal burnt, which has increased significantly, and an environmental levy, which is paid to the government, has amounted to R14.9bn since it came into being in 2010. Employee benefits have increased by 76 percent over the past four years to R20bn. They would have been significantly higher had R11bn of costs not been capitalised to fixed assets since 2010.

Employee numbers increased 23 percent to 43 473 in 2012. As electricity sales were flat over this period, employee productivity fell by 23 percent, yet average total cost per employee increased by 60 percent to R500 000. Eskom rewards poor productivity with massive increases.

Looking ahead to 2017, Table 1 shows that Eskom is planning for operating costs per kilowatt-hour to surge by 73 percent. Profitability will, however, be significantly enhanced as prices charged will surge by an even greater 94 percent. Eskom’s ROE target of 16.45 percent will be met.

Economists often debate the risks posed by monopolies. SA Breweries (SAB) ran a tight ship and beer price increases were consistently kept below the inflation rate. SAB was a benign monopoly and its inherent discipline was instrumental in the brewer becoming a global success story.

Eskom has secured and is targeting monster electricity price increases which dwarf the inflation rate. Eskom is pushing for cost-reflective tariffs to cover its rampant costs. Eskom is a toxic monopoly.

Here are some ideas on how Eskom could become benign:

* Focus on productivity and unit costs of production.

* Abandon cost-reflective tariffs, they reward inefficiency.

* Utilise the markets rather than consumers to finance capital expenditure.

* Encourage competition.

This sort of focus has been instrumental in transforming SABMiller into a model 21st century competitor.

Chris Logan is a chartered accountant and an investment manager.

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