LONDON – We believe that the South Arican government will begin to go down the route of a broad social compact view but then balk at the actual or prospective labour backlash and possible accompanying sabotage that will greet the 16 000 redundancies – that appear to be in the draft plan – and so will quash such an idea and we will end up with a bumble along with banks – under intense political pressure – forced to close the gap through the election.
We believe there are also political and ideological red lines for National Treasury accepting a debt swap when job cuts are unlikely to happen. Put simply we do not believe a “real” plan is politically possible before the elections bar a major cash shock.
However, the risk of Eskom running out of cash as the EAF gets worse and lost revenue from load shedding mounts means that a shock point is a fat tail risk to be cognisant of. We are also concerned that Eskom suppliers could start to cut payment terms like occurred at SAA which would exacerbate the cash burn rate. We should stress there is no evidence of this at this stage.
After the elections we believe a broad social compact that is deeply politically unpalatable will be forced on government by local banks and other creditors refusing to lend further without a proper plan in place and this will result in such a plan including significant job losses of the order of 16k redundancies over three years currently contemplated combined with political pressure on NERSA to hike tariffs significantly (with the proviso that they are cut in future as Eskom become more efficient and the wage bill falls), DFI debt restructuring and the possibility of market debt restructuring being debated (for political reasons rather than balance sheet ones).
Another press conference
Eskom had a third press conference in as many weeks, this time with DPE Minister Gordhan in attendance. However, Eskom still is struggling to communicate a credible short run turn around plan or the nature of its longer-term corporate plan. It has also yet again gone off-piste on its communications strategy around debt restructuring despite been continually asked the same question.
The market confusion around debt restructuring yesterday became acute and was caused by Minister Gordhan refusing to answer questions on the type of debt that would be restructured which gave the strong impression that market debt restructuring was on the table given headlines earlier in the week (and as we referenced in our last piece) referenced only DFI debt. However then more strangely straight after the press conference he told Reuters that market debt would not be haircut. Overall debt sold off by around 75bp to the peak and pulled back by around 25bp then.
The problem with the press conference was that the reasons for loadshedding are so deep and structure that it is difficult at root to turn them around in the short term especially as the EAF is set to fall anyway for the next six months. We should be cautious however that given seasonally low demand over Christmas there is unlikely to be loadshedding then but that does not mean the system has structurally stabilised.
As such the cancelling of executive holidays, the new feedback system on conditions in individual plants and other things announced today are unlikely in our view to significantly alter the electricity supply issues in the coming six months.
Overall we do not believe there is a politically feasible plan at this stage and that whilst panic over Eskom is building in the business community and within Government that is not the case in the ANC more broadly and particularly the NEC – a precondition to political capital being deployed and a ‘real’ plan being possible.
We would also caution investors that we have been here so many times before in recent years with endless plans that have been unable to effectively made an impact.
Root-cause
State capture was mentioned a lot yesterday but we think it has very little at all to do with why there is loadshedding.
Structural inefficiency within the company, poor maintenance quality, poor coal quality (not the volume of coal), inefficient resource management, poor time management and planning as well as the sheer backlog of issues – combined with bad luck in terms of the random timing of accidents and random breakdowns have all contributed. These are the core issues. The company has also slowed down massively under new management as stronger control systems are put in place. Cost recoverability is also an issue – Eskom knows there are limits to how much it can recover from OCGT usage via the tariff mechanism and so whilst they are being run they are not at maximum capacity.
We do not believe from our understanding of how the company operates internally that Eskom has a serious issue with knowing centrally what is going on at a plant level. It is true that more accountability needs to be passed down and that there is a need for better and faster decision making processes (through a vastly bloated middle management) based on that information but this is ultimately cultural and will be slow to turn that ship around.
Put simply there is very little that can be done in the short term. Wet coal, limited coal supply and Eskom struggling to find sufficient quantities of diesel are all major concerns but not the marginal cause of loadshedding in the short term. They may well become so however in the new year as coal stocks risk running out at some plants and if diesel supplies locally dry up.
Gupta related State Capture is to blame for bloated contracting and unnecessary consultants and middle men and is behind the debt burden in part but even there we think Gupta related State Capture is too easily blamed and is only a small fraction of the ballooning ZAR45bn/year debt service costs. Most of that deterioration has been caused by explicit developmental state policies designed to place politically connected contractors and middle men as well as the ballooning cost of new-build at Medupi and Kusile, together with poor build quality there (which was raised yesterday by the Minister). It is also responsible for the bloated workforce and the productivity-busting wage increases that have built up. It is also responsible for the fact Eskom will pay over the odds for fuel and parts etc to stimulate BEE even when blatant fronting with no content value added from empowerment partners is given (on average we believe a third more in the case of coal). These issues are so fundamental to government policy however that they will never be touched as long as the state owns Eskom.
Similarly splitting out Eskom into functional parts will have no impact if these policies and a monopolistic mindset continues. It will simply be rearranging within the same envelope.
Eskom needs a serious shock in terms of large scale redundancies, significant tariff increases, debt restructuring and an opening up of a deregulated energy market and new private generation capacity to come onstream and then allow the slow shrinking of Eskom over time as fleet is taken offline. Cancelling remaining units of Medupi and Kusile would be a start to this process.
Debt swap maths
A large number of people have asked us to do some maths on the impact of a R100 billion debt swap. We do not know the DFI debt that would be swapped or its terms but can do some rough calculations.
Looking at all known Eskom loans there R339.4bn of facilities of which it appears about R169bn has been drawn. Of this about R105bn is guaranteed loan paper. Conveniently this number matches the headlines. The plan may well not totally be this debt but we use it for now for illustrative purposes.
Of that R105bn some R95.9bn is in FX and R9.3bn is in local currency. These loans are of relatively long remaining maturity, averaging around 12.6 years. We believe a majority is amortising and make the assumption that two thirds are.
Taking all this together and assuming that this paper, as it is guaranteed, has coupon rates of 50bp over the sovereign, we can calculate the impact of it coming on to the sovereign balance sheet.
The result we believe would, by a 1.9 percent GDP increase in debt to GDP and a 0.3pp increase in debt, service costs. This may not sound huge and indeed it is theoretically absorbable. But the question would be if it can really be done in a deficit-neutral manner (we doubt it would all be absorbed) and then the impact – we outlined in the last piece – on other SOEs and creditors wanting government to take over their debt. We also see it as more an issue of NT red lines (and likelihood of associated conditionality on jobs being followed through on) and the attitude of Minister Mboweni, than just the pure numbers.
These numbers could well push Moody’s over the edge, but at the moment we think that Moody’s is completely off-piste and it is hard really to impute a reaction function from them on this.
Overall we see this steepening the SAGB curve and being ZAR negative, obviously exacerbated if there were to be a Moody’s downgrade. The path, however, could well be volatile with the market split between a short-term view of “something being done” on Eskom vs an assessment of underlying, real, sustainability.
Peter Attard Montalto is head of capital markets research at Intellidex.
The views expressed here do not necessarily reflect those of Independent Media.