INVESTMENT INSIGHT: Eskom must bring restructuring forward, the risks are just too high.
Opinion / 2 September 2019, 06:30am / Ryk de Klerk
CAPE TOWN – My analysis of Eskom’s financial reports indicates that Eskom has entered the debt “death cross” where total debt exceeds shareholders’ interest in 2008. It was further exacerbated by significant losses on embedded derivatives linked to aluminium prices and forex on the back of electricity supply to aluminium smelters in 2009.
Despite higher borrowings to increase generating capacity the utility managed to grow shareholder wealth from R60billion in 2008 to R119bn in 2014. But further significant borrowing needs led the company to be recapitalised in 2016 by its parent, the SA Government.
We are all aware of the wrongdoings and mismanagement at Eskom in the past, but it is clear that Eskom in on the mend.
According to energy analyst Chris Yelland in an excellent article in BizNews Eskom chief executive Jabu Mabuza in a vision and strategy document recently admitted that the power utility is in a death spiral with an outdated and unsustainable business model.
What is certain though is that the restructuring process at Eskom has already started. Hopefully Eskom’s divisions will be structured to attain maximum efficiency, financial stability and add value for the taxpayer and government.
Time is not on the government or Eskom’s side though.
A major thing that is kept out of the public’s eyes and has been a major factor in Eskom’s financial woes was to go green, yes, to reduce the carbon footprint and replace it with renewable energy sources.
In 2013 energy purchased from renewable Independent Power Producers (IPPs) cost 83cents per kilowatt-hour (kWh ) compared to Eskom’s other primary energy sources of 27c per kWh, yes, 200percent more.
In the past year the cost of renewable energy for Eskom was 205cts per kWh compared to 37c for Eskom’s other primary energy sources. Worst of all. About 5.5percent of Eskom’s primary energy comes from renewable IPPs, but accounts for nearly 27percent of Eskom’s primary energy costs.
The impact of renewables in Eskom’s mix is that primary energy costs are now 48c per kWh compared to 37c if the renewable IPPs were not brought into the mix. Yes, a massive 30percent higher.
The outlook is even worse.
Assuming that energy sales recover to 2018’s levels after 2019’s disastrous performance and grows by 1.8percent per year for the ensuing 2 years, renewable energy’s contribution to total primary energy is expected to increase to 7.7percent over the next 3 years as energy bought from IPPs will increase from 11344 Gigawatt-hours to 16972 - an increase of more than 14percent per year. The money spend on it will increase from R26.7bn to R40bn.
If the cost of Eskom's other primary energy sources increase by 7percent per year over the next 3 years, the basket of the total energy mix, including renewables, would increase by more than 7.7percent per year. The total cost per primary energy will therefore increase to 60c per kWh three years down the line from 48c in 2019.
The effective burden of renewable energy sources was therefore more than R22bn in 2019 and is expected to rise to R33bn over the next 3 years.
The cost of renewables is a real risk to the utility.
Interest on Eskom's existing debt portfolio, taking into account capital repayments and Eskom's capital needs over the next 3 to 5 years will amount to R41bn per year for the next 5 years.
Given the assumed electricity sales, it means that interest paid will range around 20c per kWh per year over the next 3 years.
In addition, capital expenditure is forecast to about R45bn per year or just over 22c per kWh sold.
Base cost before other costs will therefore amount to 102c per kWh in 2022. Other operating costs amounted to approximately 24c per kWh in 2019.
Even if those costs are slashed by half and remain constant in nominal terms, it will mean that the total cash cost after interest will amount to 114c per kWh in 2022.
This compares to the company forecasts of revenue of 102.44c per kWh in 2020 compared to 90.01c per unit in 2019 and to escalate to 116.9c over the ensuing 2 years.
If Nersa allows only a 5percent tariff increase per year the company's forecasts are in deep trouble as significant shortfalls will occur.
More funding will be needed than forecast, cost cuts will need to be deeper. If 5percent is applied only capex of more than 22c per unit and interest charges of more than 20c per unit together with primary energy costs of 60c per unit will be covered. It will leave a shortfall of more than 20c per unit or nearly R50bn 3 years from now or nearly R100bn on a cumulative basis.
In addition, Eskom's upping of energy purchases from renewable IPPs are crowding out Eskom’s own power generation. Some balance has to be reached much sooner than later otherwise electricity inflation will continue to outstrip consumer price inflation. More nuclear must undoubtedly be added to the mix as the cost of nuclear energy is only 5percent of renewable energy. It leaves no room for error or disaster as the taxpayer or consumer will have to cough up.
The sooner parts of Eskom are privatised the better. I agree with the company's board of directors. Cash flow analysis indicates that the company should not have borrowings exceeding R150bn. The restructuring of the utility should be brought forward. The risks are just too high.
Ryk de Klerk is an analyst-at-large. Contact [email protected] His views expressed above are his own. You should consult your broker and/or investment advisor for advice.