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Eskom Identified as a Laggard
Eskom, South Africa’s unlisted, state-owned electricity company, generates about 95 percent of the nation’s electricity and about 45 percent of the electricity generated on the entire continent of Africa. Coal-fired generation produces 90 percent of South Africa’s electricity.
In recent years, South Africa has run a successful but limited renewable energy procurement program: 2.2 GW of renewable capacity has been completed, attracting more than US$14 billion in investment. Enel and Engie are among the international investors in South African renewables, and developers are waiting on Eskom to sign further offtake agreements for the next round of approved projects, which total 2.4 GW.
Eskom, unfortunately, has recently stonewalled on this front, refusing to sign the deals while claiming that renewable energy is too costly.175 The company makes this assertion in spite of the fact that Eskom has benefited financially and operationally from its renewables program176.
One result of this intransigence is that an electricity utility has effectively been determining national energy policy.
With solar PV and wind now significantly cheaper than new coal-fired generation in South Africa, Eskom may have unspoken motives for blocking additional renewables development177. One clue as to why the utility is resisting is that Eskom has an institutional commitment to a major coal generation build-out in the face of a declining South African electricity market. The utility is building two huge coal-fired plants, Kusile and Medupi, each with 4.8 GW of capacity and at a combined cost to completion estimated at ZAR448 billion178 (US$34 billion).
Meanwhile, higher electricity prices and sluggish economic growth have resulted in declining electricity demand. In its 2017 financial results, Eskom disclosed a 3.7 percent drop in electricity sales to the industrial sector and a 5.7 percent slide in sales to the agricultural sector. Eskom now has more than 5 GW of excess capacity179 — even before most Medupi and Kusile units become operational. Expansion of competing renewable energy will further increase the utility’s coal-fired overcapacity, which is slated to grow needlessly as Eskom add another 8 GW of capacity by 2022 when all Medupi and Kusile units come online180.
Eskom’s growing overcapacity and its failure to grasp the role of renewable energy in the new energy economy places the utility at serious financial risk, especially since its hugely expensive new coal plants must be paid for regardless of how much electricity the utility can sell from them. Eskom reported total debt securities and borrowings of ZAR355 billion (US$26.8 billion) in its March 2017 annual report, with finance costs increasing 82 percent to more than ZAR14 billion. In addition, ZAR18.2 billion (US$1.4 billion) of deferred finance costs relating to continuing project construction were capitalized, a figure that dwarfs the net profit for the year of just ZAR888 million (US$68.3 million)181. Clearly, Eskom’s financials are set to deteriorate significantly as Kusile and Medupi are commissioned and as currently capitalized interest and depreciation costs start to be expensed even as Eskom’s overall utilization rate declines materially.
Figure 15: Generated Power Sent Out by Eskom 2006-16 (GWh)
Source: Eskom, Bloomberg
In its latest annual financials, Eskom also reports an 83 percent decline in net profit to ZAR888 million (US$68.3 million), on an asset base of ZAR710 billion (US$54.6 billion). This has meant significant value destruction for shareholders, which in essence are households and business in South Africa. These results are complicated by a threat by the Development Bank of South Africa to recall a ZAR15 billion loan. Barclays Africa and Rand Merchant Bank are also seeking more accountability from Eskom182. In addition, a ZAR2.4 billion (US$184 million) loan from the New Development Bank (formerly the BRICS Bank) has been put on hold, and the only New Development Bank loan to South Africa so far was meant to finance transmission lines to connect new renewable capacity projects (even though Eskom’s antirenewables stance has stymied completion of the loan until 2018).183
Eskom has said it will take on an additional ZAR327 billion (US$25 billion) of debt up to 2021184. With its debt set to double, then, over this period, the utility’s interest expenses will also see a significant increase. As electricity demand declines and as renewables take up market share, Eskom stands a good chance of generating too few sales to be profitable. Furthermore, because the South African government has provided guarantees on Eskom debt of ZAR350 billion (US$27 billion), of which ZAR210 billion (US$16 billion) has been drawn down185, Eskom is in position of slipping into a default that would create a major burden on the state. This would only worsen the problems the South Africa economy faces already for being so dependent on Eskom electricity.
The rise of rooftop solar is creating additional trouble for Eskom. South African rooftop solar stands to grow by 8 GW of capacity over the next decade, further eroding the utility’s sales186. Eskom could respond by increase electricity tariffs, if the government allows it to, and it may begin to address its overcapacity problem by closing older generating capacity in favor of expensive new plants. Such moves would only undermine Eskom’s assertions that coal-fired electricity is the affordable alternative in South Africa.
Eskom is maintaining its resistance to renewables despite the Council for Scientific and Industrial Research (CSIR) having shown that wind and solar are now 40 percent cheaper than new coal-fired power in South Africa.187
Eskom’s campaign against renewables and its insistence on building out coal-fired capacity in a market with declining demand will see Eskom’s borrowing and interest costs balloon, eliminating profits and crippling the utility’s ability to generate cash188. Efforts by Eskom to rectify management missteps through large tariff increases will mean yet more financial pain for the South African public, for whom electricity prices have quadrupled since 2007189.
As Eskom begins to lose that public, more customers will seek other sources of power in a scenario that is already starting to play out. The city of Cape Town is now seeking permission to purchase electricity directly from private producers.
Eskom has stated that its financial ratios will improve over the next few years, letting the company achieve an investment-grade credit rating within five years190. There seems to be little in the way of fact to support this narrative, though. In April 2017, Standard and Poor’s downgraded Eskom’s foreign and local currency long-term corporate debt, moving it deeper into junk status, to B+, with a negative outlook on concerns that the South African government’s ability to support Eskom’s huge debt has weakened191. Moody’s downgraded Eskom to the second rung of junk status in June 2017.192
Eskom in fact is likely to be in deep financial trouble in five years.
Electricity utilities around the world are in varying states of readiness for sea changes that will see markets continue to shift toward the uptake of renewable energy and that will continue to be affected by energy-efficiency initiatives.
Figure 16 below summarizes the financial position and outlook for the utilities in this report. The two renewable-energy leaders in this group have outperformed the market and are in the strongest current positions. At the other end, companies that have failed to recognize or act on the technology disruption spreading across the industry have negative outlooks, by IEEFA’s lights (these conclusions are for public-interest purposes only; IEEFA does not offer investment advice.)
Figure 16: Summary of Current Financial Position and Outlook
Electricity utilities still considering how and when to embrace the global shift toward renewables would do well to accelerate their transition if they are to avoid the financial damage typically incurred in stranded-asset write-downs of late movers. Electricity markets of the future will be dominated by renewable energy.
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