Analysis

The Decision to Split ESKOM Major Strategic Setback

By Lucky Montana

Introduction
I am not an Energy expert nor do I pretend to be one. However, I know quite a lot about the issues and challenges that had faced ESKOM over the past two decades and the various restructuring options that Government had considered for the entity at various periods. I am of the firm view that Government’s decision, as announced by our President during his State of the Nation Address (SONA) of 7 February 2019, is a strategic blunder and a major setback in the delivery of an affordable, reliable and mixed energy plan.
Government’s Restructuring Programme and its Key Objectives
Following the National and Provincial Elections of 1999, the Democratic Government under former President Thabo Mbeki, decided to accelerate its programme for the restructuring of State-Owned Enterprises (SOEs). To this end, the Office of Public Enterprises was upgraded to a fully-fledged Department. I joined the Department of Public Enterprises during this transitional period.
In addition, the team under the visionary Minister Jeff Radebe and able Director-General Dr Sivi Gounden played a major role in developing a Policy Framework for the Restructuring of State-Owned Enterprises (SOEs). We visited numerous countries such as the People’s Republic of China, Russia, Ghana, United Kingdom and others to learn from their experiences of restructuring and how they organised their SOEs.
The Policy Framework sought among others, to define the role of the state in economic development, to find the right balance between the roles of government and that of the private sector, to reduce SOE debt and foreign borrowing requirements, to strike the appropriate balance between social and commercial imperatives, as well as the introduction of competition into key sectors such as energy, transport, ports, telecommunication, etc.
Various Restructuring Initiatives
Among the key restructuring initiatives was the restructuring of Transnet and its pension fund, the possible sale of 30% of Denel to British Aerospace (BAE), the sale of 20% of SAA to Swissair (with an option for an additional 10%), the Telkom IPO, sale of Aventura, restructuring of the forestry sector, restructuring of ALEXCOR in Alexander Bay as well as the restructuring of SASRIA.
The major weakness with the Government’s Restructuring Programme of 1999 – 2004 was that the proceeds from these initiatives were deposited into the National Revenue Fund instead of being re-invested back to strengthen the Balance Sheet of the SOEs.
Unlike the view advanced by the President Ramaphosa, who explained the crisis facing Eskom and our state-owned enterprises in terms of malfeasance or corruption, I wish to argue that underlying causes are found primarily in the “failure of policy” or lack of strategy. In particular, we tend to pursue the introduction of competition like a religion (at all costs) even if this is not commercially-viable, increases costs of doing business and not in the long interests of the country. For example, the introduction of competition on routes where passenger numbers do not support a highly-competitive airline industry is a case in point. It has destroyed the ability of SAA to recapitalize itself and has increased its costs to levels that are not sustainable. The crisis of Eskom has everything to do with the failure of government policy since the 1990s. My little experience in Government has exposed me to some of these issues and the difficult choices the President and Government have to make.
National Framework Agreement
The Minister of Public Enterprises then, Radebe, charged me, among others, with the responsibility to coordinate the National Framework Agreement (NFA), a mechanism through which Government consulted and negotiated with the trade union movement on its restructuring plans. Together with the late Andile Nkuhlu (May His Soul Rest In Eternal Peace), we would convene the NFA where Government restructuring plans were presented and discussed with the unions.
It was through the NFA that some of Government’s initiatives such as the plan to sell the long-haul coal (Coal-link) and iron ore (Orex) lines of Spoornet to the private sector or ports restructuring, were set aside. The strategy to bring Independent Power Producers (IPPs) was also discussed with the unions.
We had many battles with the trade union movement. COSATU viewed the conversion as a preparatory step towards the privatisation of ESKOM. COSATU had its marches demanding “an end to the privatisation of state-owned enterprises”. I remember the fiery speech by Zwelinzima Vavi during one of the marches to the Department of Public Enterprises in Hatfield, Pretoria. He also complained that Radebe did not meet with them directly but instead sent his “small boys, Andile Nkuhlu and Lucky Montana” to speak to the unions and they rejected this.
Eskom Restructuring
I spearheaded consultations with the unions on the introduction of the Eskom Conversion Bill in 2002, which converted Electricity Supply Commission (Escom) into a fully-fledged Company, ESKOM as we know it today, with a properly-constituted Board and good corporate governance. The new Eskom could approach the capital markets on the strength of its own balance sheet.
During the late 1990s and mid 2000s, Government stopped ESKOM from investing in new generation capacity because it wanted to introduce competition in the sector and hoped new investors would build new power stations. Government insisted on this position even though there was overwhelming evidence showing no investor and/or BEE player at that time, had the capacity to meet the huge capital requirements to build the new generation capacity. This proved to be an extremely erroneous position and has put us in the position we find ourselves today.
We should learn from countries like China on how they dealt with their challenges. In a number of books, Professor Joseph Stiglitz shows for example that the Chinese were able to achieve their economic and social objectives because they were able to strike that “delicate balance” between the role of the state and the private sector. They were able to develop and implement appropriate policies for this purpose.
The President’s Decision to Split Eskom 
The challenges facing ESKOM go beyond the servicing of its debt and the potential loss of jobs. This has to do with the development path we wish to follow as a country and the well-being of future generations. The decision announced by President Ramaphosa to split ESKOM into Generation, Transmission and Distribution will not work. Whilst some in the investor community and the Democratic Alliance (DA) have clamoured for the unbundling of Eskom for a while now, the President has granted them their wish instead of telling them they are wrong.
We need to study some of the detailed reports that were developed when the country was exploring the restructuring options for ESKOM from the mid 1990s. When I was still part of the Department of Public Enterprises (DPE), Government rejected some of the regulatory changes that some within the investor community had demanded at the time as well as the call to split and/or privatise Eskom.
Whilst this may be good for competition, will enable us to understand the true cost of each business and may result in the entry of new players in the sector, it will however come at significant cost to the fiscus. In addition, it will increase the costs of doing business in the economy and may undermine the financial position of our Metros and municipalities when distribution is taken away from them. It would seem the advise given to the President has ignored the role of local government in the generation and distribution of electricity. I suspect this may require amendments to Schedule 4 and Schedule 5 of the Constitution.
The proposed split of Eskom into three separate businesses under Eskom Holdings does not make any strategic sense. This will not solve the immediate debt and cash challenges facing Eskom today as well as the massive operational challenges and poor maintenance of power stations, including the reasons Eskom is giving for its latest Stage 4 loadshedding.
The concerns of many that the unbundling is in preparation for a potential sale of the business of Eskom or parts thereof, as well as job losses, cannot be dismissed out of hand. The splitting to ensure that each business reflects its true costs does not add value in itself unless this is in preparation of privatization. The unbundling suggests that the decision to unbundle is to allow private sector investors to cherrypick on one of these and looking at current arrangements – investors wants to own energy generation. They will not be able to make money from transmission and distribution and the risks are just too huge for the private sector.
The cost of generating electricity has increased tremendously over the past few years. The cost structure and arrangement between ESKOM and coal producers seem to be at the centre of the many of the challenges this vitally-important SOE is facing today. Brian  Molefe, former CEO of Eskom,  spoke at great lengths at the Parliamentary Inquiry into Governance at Eskom, about the relationship between ESKOM and coal producers. He made a call for this to be reversed in favour of ESKOM. It would seem Government is afraid to face this situation and make the most critical decision required to save Eskom from collapse.
The government is unable to take bold and decisive steps to address the coal supply issue in favour of our long-term economic development. The Eskom Task team announced by the President last year to advise him on Eskom comprised of highly-conflicted individuals and was clearly not representative enough of the diverse skills, knowledge, experiences and views in our society. The Task Team was unable to analyse Eskom holistically and seemed to be keen to address concerns of rating agencies, foreign investors and companies that own coal mines than the sustainability of Eskom in the long-term interest of South Africa. The Task Team may have failed the President in this regard.
The President and cabinet should also acknowledge that the Eskom Board of Directors and Executive Management they appointed last year may not be the right leadership team. The team seems lacking of the appropriate mix of skills, knowledge and experience to run Eskom. They are seemingly not in control of the operations of Eskom and therefore incapable of making the necessary decisive interventions and deploy the necessary resources to address the immediate problems.
What Is To Be Done?
The President delivered a great State of the Nation Address last Thursday but we tend to allow “our love” for the man to cloud the long-term vision. The problem is that the President started at the end and not at the beginning. If our energy strategy is sequenced properly, we will realise that what the President announced could in fact be the “End-State” and not the start. Government will need to implement a number of measures and strategic interventions first before we arrive at a point where splitting Eskom is supported and matched by the level of economic development and demand in society.
The ESKOM model is, in my view, still suitable for our environment as a developing country and our current stage of economic development. South Africa needs a “vertically-integrated public entity” to drive its Integrated Energy Plan, including the energy mix Government seeks to achieve. Splitting ESKOM into three will satisfy the short-term demands of rating agencies and some within the investor community but cannot solve the immediate problems of Eskom and will not be in the long-term interest of the country.
There is a need to sequence our strategies and fulfil a number of critical tasks before splitting ESKOM. First and foremost, Government needs to ensure that ESKOM is appropriately capitalised.
Secondly, we need to strengthen the current ESKOM model so that we increase, in the short to medium term, cross-subsidisation between generation, transmission and distribution. This will also mean Eskom’s legal mandate should be redefined more broadly so that it continues to be the driver of the long-term energy mix plan we seek to develop over the next 30 years.
Thirdly, Government should consider nationalising the coal mines and bring them under Eskom Holdings and/or introduce price controls in respect of coal in the best interest of the economy. Alternatively,  Eskom could take a 51% majority stake in coal mines in lieu of its massive capital investment already made over the years or take ownership of key, strategic mines that could guarantee security of coal supply to Eskom over the next 30/50 years. Again, if we follow the testimony of Brian Molefe at the Parliamentary Inquiry into Governance at Eskom, evidence which was never challenged, many of the coal mines in fact belong to Eskom. There is a case for the nationalization of these mines, which will be in the long and best interest of the country.
Fourth, Eskom’s  “non-core” assets should not be disposed-of as advanced by Government but recognised that in the medium term these remain key to protecting the current financial (balance sheet and cash) position of Eskom. Whilst some in the investor community may not like thIs, but Eskom needs these assets in the medium-term to cross-subsidise some of its costs and its huge debt.
Fifth, a vertically-integrated structure for Eskom could reflect the following primary business  activities: Mining & Generation, Transmission, Distribution and Eskom Enterprises (Engineering, Property and serve as the custodian of Third Party Agreements in the rest of Africa).
Finally, the President and Cabinet should strengthen and/or replace the current Board and Executive Management of Eskom. The management team should be lead by women and men with huge operational experience and that are able to comprehend and bring together various aspects of the Eskom business together when they take decisions.
I am convinced that this is the right energy path for South Africa which our President should adopt to deliver on his vision for the country. It will require courage to deliver on it.

 

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