Unbundling Eskom didn’t work in the 90s, so why should it now?

The solution to Eskom’s financial woes and misfortunes is not in its unbundling, but rather in dealing decisively with managerial and business process inefficiencies, tightening the hard budget constraint, or perverse incentive for fiscal imprudence and reducing political meddling. Eskom is constantly in the news for the wrong reasons, be it about lacking the necessary operational capital; insatiable demand for debt; corruption; entering into loss-making contracts; and asking for ridiculous tariff increases.

Any proposal for resolving Eskom’s unremitting delinquencies should commence with taking few steps backwards to understand the mishaps that led to the current malaise.

Less than a decade ago, in 2011, Eskom turned a profit of R13bn and has, remarkably, been able to maintain good surpluses, sustained in part by the unreasonable electricity tariff increases. The utility’s debt levels have also risen rapidly over the years, financing construction of additional power-supply capacity backed by the generous government guarantees. Interestingly, revenue growth has kept reasonable pace with the rising debt, ensuring revenue to debt ratio levels at 50%.

This short, and perhaps selective, financial description is not indicative of an organisation that needs extensive restructuring. Of course, the idea is to illustrate that the Eskom business case and model, barring its internal malfeasance, remains commercially viable.

What, then, are the challenges besetting this strategic national utility that warrants its unbundling as proposed in various government quarters. The truth is that Eskom is affected by an intricate web of mutually reinforcing challenges. Executive positions have been the subject of serious instability with 12 CEOs at the helm in 10 years. This leadership weakness has led to a ballooning of the staff complement while productivity — crudely measured as units of electricity produced — remains constant. Project management and design deficiencies have resulted in cost overruns and delays in completion of the Medupi and Kusile coal-fired power stations.

Rolling blackouts have become endemic due to years of maintenance neglect, aging infrastructure and delayed commissioning of the new power plants. A combination of unreliable supply and escalating tariffs are pushing the utility into a death spiral as customers resort to alternative energy sources. Financial challenges are further exacerbated by overpriced input cost for coal and renewables.

Consumers (mainly municipalities and Soweto residents) are seemingly unable to pay their bills and Eskom is unsure about how to enforce credit controls. The utility is unable to generate sufficient cash to fund its operations and debt-service costs and, lastly, the balance sheet has deteriorated acutely because of the poor capital structure. The government has not helped the situation with its granting of open-ended access to guarantees.

Cracks are showing

Years of papering over the abovementioned cracks have culminated in a dire financial situation in which the entity is teetering on the verge of debt trap with a projected R20bn loss for the year ending March 2019. Above-inflation tariff increases, bailouts, and guarantees that have masked the losses over the years can no longer be sustained and the debt situation presents a severe risk to macro-economic stability. Notwithstanding, this predicament, Eskom continues to rake in large sums of debt to keep the lights on.

With this deteriorating situation in mind, the government has appointed a task-team to consider options to rescue the embattled entity. Although the task-team is yet to reveal any proposal for restructuring, there are two options being considered: a possible bailout, and unbundling it into three separate parts, namely generation, transmission and distribution. The Eskom CEO is on record pleading for separation as a means to improve sustainability. In his view, Eskom is way big to be managed as a single entity.

The bailout route would seem the most appropriate option in the short to medium term given Eskom’s strategic position in the economy as a single source of electricity. Such a decision should be accompanied by extremely stringent conditions, including linking executive pay to various elements of organisational performance. This would be necessary to ensure that executives internalise the cost of their decisions.

However, the SA budget is in no position to carry Eskom’s additional debt burden as it may trigger downside social, fiscal and macro-economic risks, that is, a reduction on social spending, a call on debt, and a further downgrade of its sovereign credit rating. After all, bailouts are never desirable because they create perverse incentive for poor performance and accountability.

Is unbundling the way?

This, then, explains why unbundling would seem an obvious and apposite option for reform. But is it? Conglomerates the size of Eskom in SA and the rest of the world are embracing vertical integration to reduce costs and improve efficiency and yet the national utility is pulling in the opposite direction.

If the overall aim of Eskom’s unbundling is to open the electricity market, independent power producers (IPPs) can be granted access to the transmission infrastructure through contracting arrangements, in the same way as telecommunication companies share networks.

The development trajectory of developed economies was anchored on state ownership of strategic resources which were later disposed when such economies reached maturity. SA, with its poor socio-economic record and its claim of being a developmental state, should be using its natural coal endowments to build a competitive advantage and finance development. 

Besides the strategic vision underpinning Eskom’s unbundling, the government needs to consider the practical actions required to make the reform a success. The proposal to separate Eskom is certainly not new. In 1997, the cabinet approved the restructuring of the electricity distribution industry into six regional distributors spread across the country.

The process to establish these regional distributors was besieged with teething problems. Foremost among these challenges were legislative constraints; disagreement between Eskom and municipalities over electricity distribution roles; compensation for assets; as well as billing- and revenue-sharing arrangements. The proposal was abandoned in the late 2000s, notwithstanding the substantial amount of resources allocated and used for the restructuring process.

In revisiting the unbundling of Eskom again, the government should appreciate the complexity associated with restructuring and care should be exercised not to create uncertainties that may further exacerbate the current situation. In the interim, the only hope for Eskom’s sustainability should be commitment to quality management, governance and accountability. Without these three simple elements, there is no amount of bailout or unbundling that can turn Eskom — and perhaps other state-owned enterprises in a similar situation — onto a sustainable and profitable trajectory.

• Rakabe is an independent research consultant on economic development, public finance and the informal economy.