KHULEKANI MATHE | Eskom CEO’s engagement on restructuring welcomed

In December the electricity & energy ministry and Eskom made significant announcements regarding the restructuring of the power utility and the future of South Africa’s electricity sector.

These announcements were met with considerable concern in the private sector, specifically that the plans may not go far enough in laying the foundation for the increased levels of investment and competition in the electricity sector that are so necessary.

Last week Eskom CEO Dan Marokane responded to these concerns in an article published on the Business Day website (“Eskom on a mission to lower electricity costs amid reform”, January 30). It is to be welcomed that Eskom’s leadership has decided to engage publicly on the matter, as the restructuring of Eskom and South Africa’s wider electricity sector is of critical importance, a policy matter with immense consequences for the country’s future economic development.

From an economic policy perspective the key question is how the restructuring of Eskom and the wider electricity sector should be designed to facilitate increased levels of investment in the country’s electricity infrastructure and industry as a whole.

Large-scale investment in generation and grid capacity is urgently required and must be done in a manner that ensures electricity supply security, provides the green electricity that businesses are demanding, sets the country on a competitive electricity price path, and ensures universal access. Such financing is unlikely to occur at scale within Eskom Holdings without significant Treasury support, and it is unclear whether government is willing to provide it. As such, the focus here is on funding for the new private electricity industry, as well as where guarantees are available.

Eskom’s restructuring plans are mandated by the Electricity Regulation Amendment Act, which requires, among other things, the separation of Eskom into distinct businesses and the creation of an independent Transmission System Operator (TSO).

If Eskom continues to own the national grid and also access to it while being the largest electricity producer, conflicts of interest will arise, and the crafting of a truly competitive market could be stunted

The December announcements were not in line with this mandate, particularly regarding the important point that Eskom Holdings, through its subsidiary the National Transmission Company South Africa (NTCSA), should retain ownership of the country’s transmission infrastructure, instead of transferring these assets to a TSO set up independently, outside of Eskom Holdings. Organised business made this point strongly based on legal advice it sought at the time of the Electricity Regulation Amendment Act Bill’s public consultations.

Given global technological changes, the economics of the electricity sector are evolving. Gone are the days when lower costs can be achieved by vertically integrated monopolies producing, transmitting and distributing electricity. Now, cost containment is rooted in a competitive market structure that includes multiple electricity generators, traders and distributors participating in wholesale and retail markets underpinned by a publicly owned and regulated national grid.

For this market structure to work, all competitors need to be treated equally and fairly in accessing and utilising the transmission grid. If Eskom continues to own the national grid and also access to it while being the largest electricity producer, conflicts of interest will arise, and the crafting of a truly competitive market could be stunted.

Eskom’s response to this is that even if it continues to own the country’s transmission assets within Eskom Holdings, a competitive market can still be achieved through the establishment of rules and regulations for the fair and nondiscriminatory operation of the grid by the National Energy Regulator of South Africa (Nersa) and through the work of an independently operating TSO.

In theory, it may be possible to set up a competitive electricity market in this manner, using Nersa regulations and an independent TSO to run an effective market. But for as long as the grid assets are owned by Eskom there is a significant risk that regulation may be ineffective and that the owner of the assets, through its relations with its subsidiary, will have a bias towards its own collective corporate interests, particularly as lower-cost rivals threaten the viability of older, less efficient power stations.

An additional concern is that if Eskom Holdings continues to own the transmission assets there will not be sufficient investment in the new transmission grid capacity needed to support new electricity generation projects. In recent years, the rate of building out South Africa’s transmission grid has not been sufficient, and grid access has emerged as a key constraint, with a number of wind power and other generation projects having stalled due to a lack of grid capacity.

One reason for this is that the bulk of customers’ electricity tariff payments have been used to fund electricity generation projects, while transmission projects have fallen behind. Worryingly, even amounts approved in the regulated tariff specifically for the maintenance and construction of transmission infrastructure have been redirected.

By housing the transmission assets in a separate entity outside Eskom Holdings, such as the TSO, tariff streams can be more effectively ring-fenced, attracting additional and cheaper finance for the huge upscaling of grid investment that is required. Such a structure will also create a conducive environment for raising finance for the planned independent transmission projects, through which private companies are being mobilised to build the transmission grid on a build, operate and transfer basis. It will also allow international funders to provide support through the credit guarantee vehicle.

Ultimately we need a phased approach that prioritises increased levels of investment in the immediate term while working swiftly with the holders of Eskom debt and the fiscal authorities to achieve the transfer of the transmission assets into the TSO within two years

In his article, Marokane stated that Eskom’s transaction advisers have warned that a “scenario involving the immediate and full separation of transmission assets” could result in a cross-default scenario concerning R400bn of Eskom debt. Clearly, a default scenario is one that must be avoided. Fortunately, Marokane also outlined an alternative scenario, which he describes as “ultimately achievable”, where “lenders approve the transaction” and the fiscus does not have to be drawn upon. He warns, though, that this scenario would be complex and take some time.

This strikes me as unnecessarily alarmist. State-owned enterprises, Transnet in particular, have faced situations of potential default and cross-default regularly in recent years due to loan covenant, ratings and other breaches, where advice was swiftly sought and creditor consent was quickly gained.

There is positive precedent for this approach, as similar discussions with a number of debt holders have already been successfully concluded regarding the separation of NTCSA as a wholly-owned subsidiary of Eskom Holdings.

It is important to get this restructuring process right and avoid the two primary risks:

• that conflicts of interest will compromise the creation of a competitive market; and
• that investment in electricity infrastructure will fall behind what is required.

However, it is not clear to business that with the correct transaction advice this process should take five years. We should not forget that the private and public sectors already undertook significant work on restructuring Eskom in 2019.

Marokane suggests that due to its complexity the transfer of assets to the TSO would “slow down independent and equitable access for all participants by years”. Again, it is not clear why this would be the case with a well-run process overseen by the Treasury and the Presidency.

Ultimately we need a phased approach that prioritises increased levels of investment in the immediate term while working swiftly with the holders of Eskom debt and the fiscal authorities to achieve the transfer of the transmission assets into the TSO within two years. In this phased manner, South Africa will benefit from the investment that is required as well as reap the rewards of a well-designed, competitive electricity sector that can serve as a springboard for economic growth for future generations.

Eskom Holdings would need to be compensated for the transfer of its transmission assets, the value of which is estimated by Marokane at about R100bn — but given the benefits to the wider economy, this would be a good investment and the transaction could be efficiently structured across public sector balance sheets — including support for transferring a fair amount of debt to NTCSA, cheaper refinancing support for the holdings company by entities like the World Bank, and other tools.

We have entered a critical period in shaping the future of South Africa’s electricity sector. Over the past few years Eskom’s leadership, supported by the fiscus and by changes in policy, as well as the government/business partnership, have facilitated private investment in electricity generation and have done a creditable job in helping the country overcome the crisis of load-shedding.

As Marokane puts it, the Eskom leadership “welcome(s) competition ... and ... we are ready to compete on a level playing field”. So the good news is that the principle is agreed, but as always the devil lies in the detail. To achieve competition, the private sector will need fair access to the grid and for it to be built as swiftly as possible.

In this spirit, a single whole-of-government plan, including Eskom and the electricity & energy ministry, as well as Treasury and the Presidency, should release detailed documentation, including advice they have received on the restructuring, so that there can be thorough consultation and proper engagement on the technical details.

• Mathe is CEO of Business Unity South Africa