The National Treasury’s Sunday press release confirmed a multifaceted approach as expected, but did not contain enough information for us to assess the exact impact on sovereign or company ratings, or specifically on tariffs, except to say they would be higher.
While we know that the cabinet’s main aim with the Eskom support package is to backstop both Eskom’s rating and its balance sheet, while maintaining the sovereign’s rating to ensure the security of the new build programme, there is simply not enough information yet to judge whether this balance is successful.
As expected, the package had to take the form of multiple smaller interventions – including equity injections, debt raising, tariff increases, increased demand management, “refinement” of energy policy, support for poorer households, greater use of independent power producers (IPPs) and increased efficiency within Eskom. However, no details are given beyond the R50 billion increase in debt issuance over the current regulatory period.
We will only find out the exact form the equity injection will take at the medium-term budget speech on October 22.
Given this lack of clarity, the rating agencies have already said it is impossible to say what the effect of the announcement on the rating will be. We can only surmise, therefore, that the rating agencies, particularly Standard & Poor’s, will not be satisfied with the details offered on Sunday.
But because the government’s announcement is precisely to avoid Eskom being downgraded before the speech, we think the agencies must be receiving non-public information on the matter. The one exception is the shift to promote tariff increases, though we must see the extent, which should be credit positive for Eskom.
Components of the package:
Tariff increases: The cabinet appears to be making a surprisingly strong statement, in line with the Treasury’s view, that tariff increases are the “key mechanism” to make Eskom sustainable. While the cabinet is “backing” Eskom to ask for more tariff increases, we doubt there is meaningful upside from, say 15 percent hikes over the medium run to the 26 percent pencilled in originally during the current pricing period due to political constraints.
Equity injection: No number is mentioned and this would be key for securing the rating and the balance sheet of Eskom. We estimate that a minimum of R5bn will be required in additional capital within the current funding cycle, but to cover the entire medium-run hole in Eskom’s balance sheet we believe closer to R20bn of additional equity will be required. It is far from clear what “leveraging non-strategic government assets” is. We doubt this is code for privatisations, but it may be some form of securitised lending.
One possibility is to sell off part of the government’s stake in Telkom and Vodacom, which are already majority private owned. Their combined market value of holdings is R3.5bn, though we doubt they would be entirely sold off. We originally suspected a kind of debt-for-equity swap, but there is no mention of this, which may suggest this will have too much impact on the sovereign rating. It is also not clear who is doing the leveraging – the statement seems to imply it is the government rather than Eskom.
Demand management and Eskom efficiency: We are sceptical of how much additional efficiency is possible on either side. Eskom has made major strides internally already, and certainly after the previous downgrades of tariff increases. Limiting cost overruns of the new build programme is, given the way they are generally structured, unlikely in our view. We need to wait for details. It is hard to think of demand-side management moves that will not affect growth given the cuts already undertaken by heavy industrial users.
Greater use of IPPs: We are puzzled by the statement that greater use of IPPs is required. Yes, there has been an expansion of green energy IPPs, but this is on a small-scale compared with the overall size of energy supply. There have been many mixed messages on the use of conventional fuel IPPs recently from the government.
We believe the government is happy to use conventional private sector IPPs to import electricity from neighbouring countries, but we still doubt there is major backing in cabinet for a wider allowance for private sector conventional fuel base-load production within South Africa.
The one exception may be nuclear where the cabinet is taking other, independent, steps that tell us a lot about the backstop for Eskom. It seems increasingly likely that the government will look to remove both ownership and running responsibility from Eskom for future nuclear build, with that instead resting separately with the Department of Public Enterprise and Eskom acting only as purchaser and distributor of that energy. There are two informal bids on the table from France and Russia, though we think the Russian bid is ahead for a number of political reasons. Taking such future projects away from Eskom may well be an additional way of reducing the size of the hole and stress around Eskom’s balance sheet.
Overall, then, there is very little new information available and we will await the medium-term budget speech next month for details. Nevertheless, rating action before this date should give a better idea about what is going on behind the scenes. The structure announced so far seems to indicate no major increase in overall contingent liabilities for the state or direct drag of on-balance sheet fiscal, if the equity injection is done off the central government balance sheet as a financing operation.
It is also important to consider what was not announced: there was no explicit widening of the existing guarantee scheme to cover new external debt issuance.
While still an implicit guarantee, we thought this might be an option, though the lack of movement here may indicate concern on the part of the Treasury that such a move could have a greater impact on the sovereign rating.
As mentioned above, a debt-for-equity swap or more complex form of debt financing was not proposed. Nor was a more complex route opened up to funding through local development banks.
For now we can see that the Treasury is clearly taking a lead on the issue, even ahead of the Department of Public Enterprises within cabinet – not only reflecting the financial nature of the problem and that the Treasury is ultimately the one with the solutions, but that in the post-election cabinet, the Treasury still holds considerable power.
Around the sovereign rating, we should remember, as highlighted yesterday by Moody’s, that the sovereign rating relies on a more complex set of issues, including in particular the current account deficit, as well as the labour market situation and medium-run growth potential on top of the “usual” suspects of fiscal and debt which the Eskom issue fits into.
Peter Attard Montalto is an emerging markets analyst at Nomura International.