Eskom: Desperately seeking (a new) direction

While Treasury Director-General Lungisa Fuzile says that Eskom is revisiting policy from the 1990’s which would allow the private sector to hold stakes of up to 30% in generating assets, Gwede Mantashe says that the ANC has decided not to privatise Eskom. However, he then mentioned approvingly the “Chinese model” of listing state-owned assets.

The ANC’s tripartite alliance partners, Cosatu and the SACP, are dead against any such proposals. The SACP struggles to issue any statement which does not rage against the “96 Class project”. This is code for anything to do with the Mbeki administration. Apparently the ANC’s economic sub-committee, headed by Enoch Godongwana, is with Treasury on this one. It is all very confusing and would even be amusing if not for the fact that the matter under discussion is our country’s electricity supply.

The problem is that Eskom, in its present form, cannot be privatised. Thundering on about how you will not invite someone to your party when that person doesn’t have the slightest intention of attending even if the invitation were forthcoming just makes you look very silly.

Everyone knows the direction that Eskom should go. It was clear in the 1998 White Paper adopted by Cabinet all those years ago. Here’s an extract (p42):

To ensure the success of the electricity supply industry as a whole, various developments will have to be considered by government over time, namely:

• giving customers the right to choose their electricity supplier;


• introducing competition into the industry, especially the generation sector;


• permitting open, non-discriminatory access to the transmission system; and


• encouraging private sector participation in the industry.

Here’s another about industry finances (p46):

The entire industry (generation, transmission and distribution) must move to cost-reflective tariffs with separate, transparent funding for electrification and other municipal services.

Our government failed to implement its own energy policies, and that is exactly why we are where we are. Why it has failed appears to have something to do with the inherent distrust of markets and competition. This is strongly in evidence when one looks at efforts to transform the economy. Our government looks to do this with complex and bureaucratic B-BBEE legislation and regulation. When this intervention does not produce the desired outcome, there is no re-examining the issue – instead we see the push for further interventions. Arguments made in good faith, pointing out the obvious problems, are dismissed often by people who frankly appear to have no clue about how economies and incentives work.

The same distrust of competition is evident in our corporate sector, where concentrated and pyramidal ownership structures are a distinguishing feature. Another distinctive characteristic of South African firms is the degree of concentration in our product markets. Strong evidence shows mark-ups by South African firms, and therefore profitability is higher than that observed in peers elsewhere. This being the case, placing our (largely unappreciated) Competition Commission at the centre of efforts to transform our economy, in terms of its racial composition, its inequality and its growth potential, might be a better strategy. But we don’t work like that: promoting BEE objectives is one of the permitted reasons why normal pro-competition rules may not be applied. BEE, then, is about rearranging the deck chairs, not changing course.

Perhaps the oblique mindset required to use markets to regulate our economy does not exist to any extent. Our Apartheid past, which combined Bantu education and a suppression of ideas and debate, has served to reduce our current debates to sloganeering. Think about it like this. If a splinter group emerged with the name “Economic Freedom Fighters” in just about any other country, the assumption would be that they were some sort of extreme libertarian movement wanting to get the government off their backs. Here? Precisely the opposite.

You don’t have to be in thrall to the market to use the tools of a capitalist economy. The social democracies of Scandinavia, where the government sector is close to half the total economy, a share much larger than ours, makes extensive use of markets. Consider the Norwegian electricity sector, which uses markets extensively.

Taming the profit motive requires an appreciation of how it all works. If you make it difficult, capitalists just see increased risk and then, in return, require higher returns. It a self-perpetuating cycle, and some governments (like our own) say this is proof that capitalists are greedy and so change the rules, thereby creating more uncertainty. The capitalists, seeing more risk, up their return requirements for investing. This is a pity, since there are enormous pools of savings in this world looking for yield, any yield, in a low interest rate environment. Take a look at South Africa’s Renewable Energy programme. It is run on clearly established rules in an open and transparent fashion, and it is designed to orchestrate competition. The result is a real taming of capital. Banks are lending to renewable projects at rates a smidgeon above what they would buy government issued bonds.

Why is this important for Eskom? It is important because sometime soon, Eskom is going to need a huge capital injection far, far greater than the R20-odd billion it is offering the utility via a sale of certain undisclosed state assets. Decisions will need to be made quickly, and bad decisions will be felt for generations to come.

What would a very bad decision look like? A decision where Eskom, as a whole, is partially privatised, like Telkom was in the 1990’s, would be disastrous. The Telkom privatisation made its initial investors, SBC and Malaysia Telecom, a lot of money. But their investment came at a cost – the extension of the Telkom monopoly. In this, we saw capitalism at is worst: SBC Communications Inc., itself a product of the pro-competition break-up of AT&T in the 1980’s, was lobbying hard for rule changes, restricting the businesses it could enter into in the US. It was at the very same time backing Telkom in preventing new Internet businesses from conducting their businesses. South Africa’s poor internet access and expensive broadband is directly attributable to that privatisation decision which left Telkom as a monopoly. It also prevented Telkom from doing what it needed to do. At one point, Telkom’s market capitalisation was a mere tenth of Vodacom’s (it is now a fifth). We can only imagine the opportunity costs. We do know that The World Bank calculated that a 10% increase in broadband penetration yielded 1.38% increase in GDP growth in developing countries.

Could there be an even worse partial privatisation decision? Sadly, yes. A worse decision would see a lack of interest on the part of private investors resulting in the government strong-arming the Public Investment Corporation (PIC) to invest a good part of the R1,6-trillion it manages, largely made up of the Government Employees Pension Fund (GEPF), into Eskom. Leaving aside the governance and conflict of interest issues, the GEPF is different from other pension funds. Most pension funds are of a ‘defined-contribution’ variety in which members carry the risk of failed investments. The GEPF is a defined-benefit fund. This means that government pensioners enjoy the benefit of performance above inflation but the government, as the employer, must make good any losses to the fixed pension amount owed to government pensioners. As such, losses at the GEPF fall on the country’s taxpayers. Taxpayers are then in a lose-lose situation. It amounts to a free option against the taxpayers. Either Eskom has to remain profitable via an extension of its monopoly (expect restrictions on embedded generation) and ever-increasing tariffs that harm the economy, or taxpayers pick up the tab (at best, government pensioners see a very poor performance in their pensions).

There is an alternative, and this would be good for everyone, but it takes a different orientation. Implement the 1998 policy, and separate each generator from transmission and distribution as a first step. No discussion about privatising is needed. Passing the Independent System Market Operator Bill into law, even in its present form, cannot be delayed any further. In conjunction with Eskom’s creditors, a process of allocating staff, overhead expenses and, yes, the debt itself to the different component parts can commence. It is only then that anyone can decide what to do about a recapitalisation.

If any privatisation is to occur, it will happen at generator level, but it will have to be a full sale or a sale of a majority stake in each of these. You don’t want private capital if it is to be passive (as in the case of Telkom) – you want its enterprise. You want to introduce efficiencies, inventiveness and flexibility that the private sector, with its own capital at risk, can bring.

A whole number of interesting things could be achieved. One option would be to auction off old generators nearing retirement age, but providing a Power Purchase Agreement (PPA) at a fixed tariff extending, say, a decade beyond planned decommissioning would attract specialists who know how to wring the last bit of value out of an old plant. Generating plants in mid-life could also be sold off against a fixed tariff PPA, but also potentially via a competitive tariff offering.

Medupi and Kusile? They present much tougher questions. At the tariff being offered for new independent base-load coal fired stations (around 82c/Kwh), they are likely entirely uncompetitive. Three years ago, Nersa estimated Medupi’s stand-alone tariff would need to be 97c/Kwh – it has certainly gone up since then. As the state has the lowest cost of capital, Medupi and Kusile would have to remain publicly owned. But examining them on a stand-alone basis would at least give Treasury (and the rest of us) an idea of what we are in for.

Restructuring Eskom in a manner consistent with official energy policy is harder to do. It requires a different orientation, an orientation for which there is little appetite. Eskom, when separated out into its different functions, and subject to market discipline, will have to employ far fewer people and pay market-related salaries. There would be very little scope to continue with any dubious supply arrangements with outside parties. But that is not a bad thing at all.

In the next little while, perhaps the most important decision our country has faced, post democracy, will have to be made. The decisions on recapitalising Eskom will live on for generations to come. They will affect the trajectory of our economy more than anything else. Looking on, as a spectator, there is little we can do other than to hope that the decision makers understand what is at issue. Short-term thinking held hostage by our current politics won’t cut it. DM

Photo: Eskom power lines are seen running in the southern suburbs of the countries biggest city, Johannesburg, South Africa, 29 January 2015. The country has been experiencing power outages as the national power supper,Eskom, struggles to supply enough power. EPA/KIM LUDBROOK