Unbundling Eskom is like shifting chairs on Titanic
Unless structural changes are made to its market design the utility will continue to lurch from crisis to crisis
The government’s plan to unbundle Eskom into three separate companies focusing on generation, transmission and supply under a holding company, and sell old power stations, does nothing to solve the utility’s main problem. To understand that problem one needs to appreciate the existing electricity market design and government funding of state-owned companies.
In SA the electricity market design means power is generated, transmitted and distributed by a vertically integrated monopoly. Some municipalities are also monopoly electricity distributors, buying electricity from Eskom and selling it to households, with the attendant risk of causing a debtor management problem for Eskom.
In an electricity monopoly market a single vertically integrated company owns power plants (generation) and the electricity grid (transmission) and supplies to consumers (distribution or supply). Such an electricity monopoly poses three major risks: monopoly pricing — pricing above marginal costs, also called price gouging; systemic risk to a country’s economy when such a monopoly is mismanaged; and systemic risk to government finances where such monopoly has government guaranteeing its debt. The proposed Eskom unbundling does nothing to address these systemic risks.
To mitigate price gouging, governments often create a regulatory body to approve tariff increases. In SA that is the National Energy Regulator of SA (Nersa). It is inevitable under this market design that the regulator and utility will get into disputes over requested tariff increases, as they will have different views of what reasonable tariffs are. Eskom’s past tariff increase applications have almost always seen Nersa pushing back, at times leading to court cases.
A competitive electricity market offers pricing transparency with no need for a regulator to approve tariffs. The electricity price for each settlement period (usually 30 minutes) is set through auctions in the day-ahead market and intraday market by generators bidding the price at which they will produce to meet the demand in that settlement period. In this market, an electricity generator that set its bidding price higher than its marginal cost to meet demand risks not dispatching, and losing out to those that price at their marginal costs.
The distribution of electricity by municipalities means they become monopoly electricity distributors, each contracted to purchase electricity from the generator and sell it at a margin to households and businesses within its jurisdiction. Municipalities have bylaws that give them powers to bill consumers and to cut off those that do not pay. However, there is no law specifically compelling such municipal monopolies to pay their bills to the electricity generator on time.
The incongruence of the powers municipalities have over retail customers (granular), and the powers Eskom has over its municipal customers (aggregate), means if Eskom cuts off its municipal customers the households and businesses that have paid their bills are also cut off. The consequence is that businesses that can leave will, and households that can afford to go off-grid will also do so.
Mismanaged vertically integrated electricity monopolies often pose a systemic risk, which leads to erosion of reserve margin (electricity capacity less than peak demand) from underinvestment in new capacity or maintenance, resulting in electricity consumers being forced to do without electricity either indiscriminately through “load-shedding” or targeted heavy users being forced to shut down (mines, smelters, processing plants).
It also leads to bailouts by the state to keep creditors at bay and/or ensure sufficient funds to pay suppliers to continue to supply goods (coal, fuel, oil, diesel) on a normal credit cycle, otherwise the country risks being plunged into darkness as no bank will extend credit, nor supplier supply, without payment upfront.
Mismanagement over the past two decades has seen Eskom underinvest in new capacity in the early 2000s, when the government put a hold on new projects, and maintenance funds diverted to other uses, which led to rolling blackouts from 2008. Industrial electricity consumers such as mines were forced to shut down or reduce production to reduce the load. Furthermore, Eskom has since 2008 relied on government bailouts in excess of R100bn to continue to operate. Without these bailouts it would have long been declared insolvent, with dire consequences for the country and government finances.
Mismanagement of power companies is not unique to SA. Big energy companies have been mismanaged and even collapsed elsewhere, including Enron and Pacific Gas & Energy. The same with construction delays. An coal power plant owned by Eon (now Uniper) in Datteln, Germany, and Finland’s Olkiluoto-3 nuclear plant were delayed by as much as 10 years. A government does not bail out any company in a competitive market, nor does it need to guarantee debt.
In an electricity monopoly market, the state-owned vertically integrated monopoly is often forced to enter into unprofitable contracts to pursue government policy. In this regard, Eskom was forced to enter into renewable energy power purchase agreements that it repeatedly protested would lead to higher tariffs.
Any company that has bank debt, with the loan agreement based on the Loan Market Association (LMA) standard, will probably have default clauses such as those below, which are essential to protect lenders but can be devastating for wayward borrowers:
Insolvency: to ensure lenders can call default if a company is either balance sheet insolvent (assets less than liabilities) or cash flow insolvent (inability to pay debts as they fall due). While many lenders could hold back action on balance sheet insolvency, lenders act on cash flow insolvency as waiting could disadvantage them.
Insolvency proceedings: to ensure lenders can call default if a company or any creditor takes any action to initiate insolvency proceedings.
And cross-default to ensure lenders can call default where an affiliate of, or major party related to, their borrower is in default. This ensures lenders are not left out on any bankruptcy proceedings or restructuring that may affect them.
Eskom has outstanding bank debt as well as corporate bonds. If the 2019 financial statements are anything to go by (R180bn revenues less R182bn expenses), it is cash flow insolvent and the government has no choice but to bail it out or face debt restructuring.
A breach of insolvency clauses by Eskom will cascade into all outstanding bank loans and corporate bonds being accelerated and becoming payable on a few days’ notice. In addition it will mean:
- Eskom being unable to pay for fuel or salaries;
- Eskom being unable to honour debt obligations (banks and bondholder trustees will demand guarantees of Eskom debt or refuse to roll over any debt);
- Creditors of other state-owned companies with state guarantees calling their debt by invoking cross-default clauses;
- The government suddenly having debt restructuring negotiations to minimise cash outflows and satisfy these sudden obligations and debt service to avoid drastic expenditure cuts and/or tax rises; and
- Expensive power purchase agreements signed under the renewable energy regime being open to termination on Eskom insolvency. If the government guaranteed Eskom performance under the power purchase agreements the lenders to those debt financed renewable projects will look to government to honour the guarantees, queuing up in the debt restructuring.
The restructuring of Eskom, other state-owned enterprises and government debt seems inevitable, but doing so while also redesigning the electricity market is a tall order. The proposed unbundling does nothing to avoid these issues. It is simply rearranging deckchairs on the Titanic.
• Nongena is an engineer who has worked in banking in the City of London since 2006, including project financing electricity plants (wind, solar, biomass and gas) in various European markets.