ESKOM’s revenue application outcome and impact

Meeting report

Opening Remarks, Apologies and Meeting Agenda
The Chairperson opened the meeting and welcomed the ESKOM Board. First, the Committee would hear the apologies from absent meeting. Second, the Committee would hear the ESKOM presentation.

Regarding the ESKOM presentation, the Chairperson stated the Committee had asked the ESKOM Board to appear before it. The Committee had resolved to hear ESKOM’s presentation before the short Easter recess. Two weeks’ previously, the National Energy Regulator of South Africa (NERSA) had appeared before the Committee. NERSA had informed the Committee about why it had refused to grant ESKOM’s revenue application for a 30% electricity tariff hike. At the NERSA meeting the Committee had resolved that ESKOM should also be given an opportunity to make submissions regarding the refusal from NERSA. A key issue of concern for the Committee is ESKOM’s future financial stability and how it will continue to finance its operations in future. This issue became more apparent following NERSA’s refusal to grant ESKOM’s revenue request.

The Chairperson asked whether any representatives from the Department of Public Enterprises (DPE) were present.

No response was forthcoming, and the consensus was that no DPE representative was present.

The Chairperson expressed his dissatisfaction that no representative from the DPE was present. An official from the DPE should have been present. This could have been Mr Pravin Gordan, the Minister, his deputy or another representative.

The Chairperson noted recent changes to the ESKOM Board. He requested the Board members – who were present at the meeting – to first introduce themselves and their position on the Board before proceeding to give their presentation.

The Committee Secretary noted the following apologies had been received:
Mr M Matlala (ANC) was unable to attend as he was on sick leave.
Mr Jeff Radebe, Minister, Department of Energy (DoE) was currently attending a court hearing in Pretoria was unable to attend.
Mr Pravin Gordan, was unable to attend. He was attending the launch of the Youth Employment Services Initiative.
Ms Thembi Majola, Deputy Minister, DoE was unable to attend as she was currently attending official government business abroad.
Mr Thabane Zulu, Director General (DG), DoE was unable to attend who was attending various meetings in Pretoria.

The Chairperson requested a point of clarity. What is the DG of Energy currently doing in Pretoria?

A delegate from ESKOM replied the DG was currently attending the same court proceedings as the Minister of Energy.

The Chairperson accepted the response and noted the court hearing. The Committee was eagerly awaiting the outcome of those proceedings. The Chairperson did note the Minister – since his appointment to the Energy Portfolio – had not appeared in person before the Committee. Various developments had occupied his time, and this was acceptable in explaining his non-appearance at various other meetings of the Committee. However, the Chairperson was hoping the Minister would make an appearance at the next meeting. Representatives from the DoE were requested to inform the Minister that – following the Easter recess – a long and important meeting of the Committee would take place, and that it would be highly beneficial if he made a personal appearance.

Briefing by Eskom
Ms ​Nelisiwe Magubane, Board Member, ESKOM introduced herself and the Board Members present. An apology was offered on behalf of Mr Jabu Mabuza, Chairperson, ESKOM who was unable to attend.

The following ESKOM Board members were in attendance:
Mr Phakamani Hadebe, Interim Group Chief Executive (GCEO), ESKOM.
Mr Calib Cassim, Acting Chief Financial Officer (CFO), ESKOM.
Ms Hasha Tlhotlhalemaje, Senior Manager: Regulation, ESKOM.

Ms Magubane – on behalf of the ESKOM Board – thanked the Committee for affording ESKOM an opportunity to present on the proposed tariff increases. This is an important step not only in building public confidence in the institution, but also to enable ESKOM to fulfil its vital role in facilitating the growth of the South African economy. The Board was confident it would be able to execute its core mandate of returning ESKOM to financial stability and overall sustainability. The appointment of the new Board on 28 January 2018 – led by Chairperson Mabuza and supported by the Executive appointment of Mr Hadebe – is widely regarded as a positive step to fulfilling and executing that mandate both in terms of financial and leadership stability.

As had been indicated in a statement by the President of the Republic, the Board had been tasked with the duty of appointing a permanent GCEO and GCFO. The Board anticipates it will be able to finalise that appointment within the next month.

A core part of the new Board’s mandate is to stabilise the financial stability of ESKOM, in particular various serious concerns regarding ESKOM’s liquidity and its ability to continue to operate as a going concern. However, of equal priority are objectives to address poor corporate governance practices, especially in so far as such practices relate to maladministration and malfeasance. In the first two months following the Board’s appointment, a core focus had been to create a culture of effective and transparent corporate governance. This is inclusive of – but not limited to – ensuring that those engaged in fraudulent, corrupt or otherwise criminal activities at ESKOM are brought to account. The prioritisation of that process had since resulted in the departure of five members of ESKOM senior management inclusive of an executive member, on grounds of allegations of serious misconduct. Four other executives continue to remain on suspension. Two of those suspended executives will be facing independent disciplinary hearings in April 2018. The other two members will face similar disciplinary proceedings in early May 2018. The Board is of the view that the decisive action already taken against ESKOM employees, executives and board members – within its first 90 days in office – demonstrates the new Boards’ commitment and seriousness to executing its mandate of rooting out corrupt, criminal and other irregular or poor corporate governance practices. This however is only the first step, in a number of initiatives to correct ESKOM’s governance practices and root out corruption. Additional measures and interventions will ensue to correct and/or punish such misconduct within the confines of South Africa’s legal framework.

The Board does recognise that irregularities do not operate only at the Executive level. As such, the Board is in process of implementing mandatory lifestyle audits of all ESKOM employees who are two levels below that of the GCEO. The Board is firm in its belief it must – and can – turn around the current dire financial and governance woes which ESKOM currently finds itself in. The Board had been informed that a number of ESKOM employees were doing business with the entity. To address that potential – or real – conflict of interest, the Board had instructed ESKOM employees that they had a choice. Either they could remain as ESKOM employees or they could continue to do business with ESKOM but would then not be permitted to remain within the employ of ESKOM. It was strongly stressed that ESKOM employee or official would be permitted to both do business with ESKOM and simultaneously remain an ESKOM employee. ESKOM employees and the public have also been encouraged to utilise ESKOM’s whistleblowing facilities and to talk opening of any information they have regarding misconduct, irregularities or other violations of the law. This borne much success and currently 239 matters are been investigated.

While sound corporate governance practices continue to remain a key priority, the Board has embarked on formulating a revised business strategy which will ensure the continued sustainability of ESKOM. It is hoped this process will be completed by the end of September 2018. The Board will share the outcome of that process with the Committee when it is finalised. However, it does remain important to ensure clarity on a number of other issues such as outstanding Municipal debt and tariff increases from the regulator. The Board subsequently is honoured for been afforded to present their views on that matter, inclusive of the proposed tariff increases. The finances of ESKOM continue to remain under considerable strain, but it hoped that further engagement with the Committee will lead to amicable solution on the tariff increase matter.

Mr Hadebe reiterated the remarks of Ms Magubane. The Board greatly appreciated the opportunity to appear before the Committee. It is hoped that ESKOM’s engagement with the Committee will be regular and continuous going into the future. He would primarily cover the strategic aspects of ESKOM’s governance while Mr Cassim would deal further with other issues.

The new Board had been in office for little over two months. In those two months a number of successes had been achieved. However, the Board themselves are the first ones to acknowledge a number of serious challenges remain and that the road ahead is a long one which must still be travelled. In this respect, a primary challenge is to create, formulate and inculcate a sustainable strategy for ESKOM to deal with their challenges. The importance of creating such a strategy cannot be underemphasised. In part, that process has focused and revealed the core areas which the Board must focus on to restore public confidence and ESKOM’s financial health.

The first point of business for the ESKOM Board was to announce its interim financial statements. Those financials should have been announced after September 2017. However, because a number of challenges ESKOM was facing at the time, that announcement could not take place. Those challenges included the 2017 audit report which was qualified. The release of that qualified audit report had severely undermined investor confidence at ESKOM leading to a number of investors their finances out of the entity. As a result, ESKOM faced severe challenges in sourcing further funding. This created a huge challenge as following the release of the qualified audit in July 2017 up until January 2018 – when the current Board was announced – access to funding for ESKOM had been severely limited. In fact, ESKOM could only fund itself through the Development Finance Institution. As such the operations of various institutions at ESKOM had been negatively affected by those developments.

The Chairperson interrupted Mr Hadebe. He requested further details regarding how ESKOM finances its operations.

Mr Hadebe replied that ESKOM normally operates to a weekly borrowing. In July 2017, ESKOM could not release its financials as a result of the qualified audit opinion. Due to that qualified audit report, investors were no longer willing or interested to buy ESKOM bonds. This meant ESKOM could no longer operate as a normal going concern as its ability to source regular funding had, as result, been significantly curtailed. ESKOM therefore had to reduce its funding. Fortunately, multilateral and other financial institutions did provide some funding to ESKOM to ensure its operations could continue. As the previous years’ financial had not been timeously released, the new Board accordingly came under a high amount of pressure to finalise its interim financial results which should have been announced at the end of September 2017.

ESKOM had received a qualified audit opinion for a number of reasons. First, there were – and are – substantial concerns over ESKOM’s liquidity. As a result of those liquidity issues, the Auditors had found it very difficult to declare ESKOM a sustainable going concern. Second, a number of activities took place during the 2017 period, which left an impression both in financial markets and in the minds of other stakeholders that ESKOM was failing to implement sound corporate governance processes and consequence management. Those two issues were the primary problems which the new Board faced when it was instituted at the beginning of the year. The first thing the Board then had to do was to attempt to convince investors to fund ESKOM or extend further money to ESKOM. When the Board was appointed ESKOM was expected, within the next three weeks, to raise an amount of R20 billion, failing which ESKOM would default on its financial obligations. The Board had engaged on an extensive consultation with market participants and other stakeholders in order to source that R20 billion figure. It had therefore becoming immediately clear that before any investor or financer would provide further capital, those investors would require ESKOM to implement various reforms in order to address poor corporate governance and a lack of consequence management. To that extent, the Board had suspended some six executives implicated in serious allegations of corruption, irregularities or other poor corporate governance practices within the first two weeks of its appointment. Only once poor corporate governances had been rectified and Eskom officials and executives implicated in corruption and financial mismanagement had been suspended could engagements with financiers and investors properly take place. As a result of those negotiations the Board managed to raise more than R30 billion over a two-week period, R10 billion more than the initial required figure.

Presently, ESKOM is proud to have raised the amount of approximately R40 billion from the market. However, in net terms ESKOM has raised an approximate borrowing of R32 billion. This indicates two important things. First, the financial markets and fund managers have begun a process of welcoming ESKOM back into the financial markets. Second, it highlights that ESKOM can begin a process of diversifying its funding due to the fact that it can now attract a broader diversity of investors. Notwithstanding those positive developments, it is necessary to highlight that for the 2018/19 financial year, ESKOM has an approximate total borrowing of R72 billion. All of this must be seen in context; however it is necessary to highlight that excessive borrowings and liquidity issues do raise fundamental problems regarding the ability of ESKOM to continue to operate as a going concern. The aspects regarding the potential of ESKOM to remain as a viable going concern were deal with in more detail later in the presentation.

Overall it is necessary for ESKOM to formulate a viable strategy to ensure the continued viability of ESKOM going into the future. Discussions with Minister Gordan had already taken place and all parties were in agreement that ESKOM continues to face a number of serious challenges. The current board had inherited a corporate plan from the previous Board, which was identified as problematic in several respects. Minister Gordan had been requested by the current Board only to approve a one year corporate plan. This was necessary in order to ensure that the current Board gets to grips with ESKOM’s financial operations and to ensure the necessary flexibility so that ESKOM’s underlying problems can be properly addressed. Importantly, the primary consideration is to ensure that ESKOM does not trade recklessly, a consideration which Minister Gordhan agreed with. It is hoped that by September 2018 ESKOM will have an integrated strategy both to turn ESKOM around and to prevent reckless trading. It was emphasised that the decisions which will be made on that strategy will be closely informed by the tariff increases and relationship of ESKOM with NERSA.

Mr Hadebe then dealt with ESKOM’s understanding of the tariff increase request and application from NERSA. This aspect would be dealt with Mr Cassim.

Mr Cassim stated the next part of the presentation would also deal with a snapshot of ESKOM’s interim financial statements which was released in the previous two weeks, once the new Board was appointed on 20 January 2018. ESKOM had to release those financials as a matter of urgency, as a failure to do so could have resulted in ESKOM’s bond and ability to trade on the Johannesburg Stock Exchange (JSE) being suspended. This would have had serious ramifications for ESKOM going into the future. The interim financials indicated that all of ESKOM’s financial ratios are currently on a negative trend for the current financial year. This is based on a combination of factors, namely, the tariff and an effective decline of 9% of sales volume in the current financial year. As noted by Mr Hadebe, ESKOM’s cash balances from the beginning of March 2017 had been decreased substantially up until December 2017, which in turn meant ESKOM had to effectively deplete their cash reserves in order to meet their financial obligations. When it came to the release of the interim financials in January 2018 – with the support of National Treasury and the DPE – ESKOM had to implement urgent interventions in order to obtain the R20 billion figure.  Interim relief had been secured at the beginning of February, which did ensure that ESKOM could meet their immediate financial and other obligations.

The management report – which was unaudited – was released at the beginning of December 2017. That report effectively indicated that ESKOM was operating at a break even financial position. As ESKOM operates in a cyclical business market, they make their profits in first half of the year – up until September – and then the next half of the year results in ESKOM incurring various financial losses. This is explained by the fact that ESKOM generally sells less electricity during the summer period and because they usually do maintenance during the second half of the year. The tariffs which are charged is a contributing factor as ESKOM’s tariffs are usually lower during winter, which also impacts on their revenue inflow during that period. There is a short-term facility which is provided to ESKOM. However, according to that agreement, ESKOM is required to pay back that amount during the March period which required ESKOM to raise the R72 billion figure as indicated by Mr Hadebe, within the next 12 months. The first R20 billion would be used to pay back the bridging loan and the remaining amount would be used for ESKOM’s capital expenditure. Effectively, ESKOM’s financials – at the current time – do not permit them to contribute towards their capital expenditure with the result that they effectively borrow 100% of that figure in order to meet capital obligations.

The auditors had raised concerns regarding the ability of ESKOM to continue as a viable going concern. Those concerns arose because of a number of factors, one of which was the 2.2% price increase while the next year would require a 2.5% increase. That is an effective average of 2.3% which is below the rate of inflation which has implications for ESKOM’s cash flows.

All three major rating agencies have downgraded ESKOM in the recent past. Notices issued by those agencies indicated that there was no firm tangible government support to enable ESKOM to address the recent tariff announcement. The rating agencies however have welcomed the appointment of the new Board. However, those agencies do scrutinise ESKOM’s core financial statements and – according to their position – it will be a challenge for ESKOM to reach all of their financial requirements within the next 12 months. It is however important for ESKOM to ensure both financial and operational sustainability, a consideration which the rating agencies do take into account.

Mr Cassim stated that the total allowable revenue of R190bn for 2018/19 year -a 5.23% nominal increase. This corresponds to R22bn less than Eskom revised application (due to revised IPP costs). For 2018/19 -of 5.3% (3% for IPP costs) -2.3% increase on Eskom costs, on the back of 2017/18 -2.2% (> 1% for IPP costs) –results in nominal average increase for two years of 3.75%. This results in increases over the two years of less than inflation. The price increase 5.3% for 2018/19 covers the growth in IPPs which equates to a 3% price increase for IPP costs alone. Hence, Eskom own costs and returns receive a total of 2.3% from the 5.3% price. The prices increases granted over the last two years exerts enormous pressure on Eskom’s sustainability, liquidity and ability to continue providing electricity. The financial ratios by NERSA (debt service of 1.05 times, interest cover ratio of 1.37 times) requires cost reductions of almost the entire employee costs 

It is important to understand that ESKOM makes applications to NERSA under legislative requirements such as the Electricity Regulation Act. Under the Electricity Act, NERSA must enable an efficient and cost-effective revenue collection which must also allow for a sufficient revenue margin. Undue discrimination between different customers must also be avoided. The methodology must ensure that ESKOM remains sustainable as a business which must also limit the risk of excess and inadequate returns, whilst simultaneously ensuring that ESKOM can attract new investment. The framework however does permit a consideration of the socio-economic objectives of government when considering those applications or formulating policy. This must be set at a level where there is appropriate commercial risk, which must be shared between ESKOM and the customers. Some of the commentaries – especially from the rating agencies and lenders – appear to be uncomfortable with the current level, in so far as those levels are too one sided in favour of the consumer. In turn the low increase could affect ESKOM’s ability to meet of its financial commitments.
The Multi Year Price Determination (MYPD) methodology states that the most recent information must be used when decisions are made. ESKOM’s interpretation of the methodology indicates that – when the application was made to NERSA – ESKOM’s projection for the 2017/18 financial year required ESKOM to base their application on their financials for the 2018/19 financial year. Those costs should then be taken into account by the regulator when they make their decision. NERSA’s decision for their refusal is not consistent in this respect. NERSA utilises various different reference points in terms of that timeline. When it came to core costs, NERSA made reference to what had occurred in the 2014/15 financial year which was around four to five years. ESKOM does provide NERSA with a large amount of information regarding expenses such as coal contracts and the costs which are incurred as a result. NERSA’s decision and reasoning for those coal costs made reference to the 2014/15 year -without allowing for revised projections due to inflation – which then influenced their decision. In the last two years, NERSA made use of the current information. However, for maintenance and other costs NERSA utilised the actual costs. From ESKOM’s perspective, it was unclear then why NERSA was using a different methodology to calculate costs than that used by ESKOM. The interpretation used in deciding the application should have used the latest information and not the information going back as far as the 2014/15 financial year.

ESKOM maintains that the regulator – in its analysis – had recommended that in terms of employee costs, ESKOM should reduce its staff complement by around 6000 employees. This equates to around a 10% cut from April 2017. The basis that NERSA applied under employee costs is different from their reasoning under MYPD 3. MYPD 3 uses a ratio of the number of employees per a capacity of megawatts which ESKOM currently has in store. NERSA appeared to hold the view that the staff complement of ESKOM of 38 000 in 2017 should be reduced. ESKOM struggled to understand why NERSA had then decided to apply a different methodology. This creates a problem not for only for ESKOM – in their interpretation of NERSA application decisions – it also creates issues of uncertainty both for lenders and rating agencies which is negative for ESKOM’s overall operations generally. This uncertainty is partly reflected in the reasoning for the rating agency downgrades of ESKOM generally.

NERSA had mentioned that ESKOM would build 3000 km of lines in the 2018/19 year, but in actual fact ESKOM would only build only around 500 km. NERSA does provide a free cash flow analysis and in their calculations, there is R32 billion worth of fee cash flow to ESKOM. ESKOM took issue with that calculation as when the revenue and costs are taken together, NERSA made the assumption that ESKOM’s capital expenditure would be around R29 billion. This does create issues between regulator versus non-regulatory based capital assets. On average ESKOM incurs around R50 billion out flow capital per year, whilst NERSA found that figure to be R29 billion. It is thus unclear how that divergence occurred and how ESKOM then is supposed to source that extra R21 billion under NERSA’s calculations.

ESKOM does have an element of fixed and variable costs. Where an item is variable then the costs will fluctuate depending on whether the asset is moving up or down. NERSA interprets a large number of ESKOM’s items as variable which can be changed within a short space of time. ESKOM however does not believe that conclusion is correct or possible. As ESKOM embarks on its expansion project – especially with regards to the Medupi station – the ESKOM interpretation is that costs should not be factored in, until those power stations are fully operational, in so far as employee costs are concerned. It is not possible to cater for that component in projects which take a long time to become fully operational.

ESKOM does acknowledge that – under MYPD3 – ESKOM must strive to ensure an efficient cost basis overall. ESKOM has aimed to reduce their costs even further. ESKOM had targeted – within the past five years – to achieve an overall cost reduction of R60 billion. At the end of year four ESKOM had achieved R47 billion, and it is hoped that the R60 billion figure will be achieved within the five-year window. The disallowances for the next financial year however are quite steep from a regulatory perspective and achieving it will be quite challenging. Several stakeholders – during the last application – had raised the issue that technological advancements, such as the introduction of PV solar, the studies which ESKOM had seen and quoted had indicated 5% of their overall penetration would be impacted by 2021. PV solar therefore would not have a substantial impact overnight and therefore generation would continue to largely be done by traditional means.

ESKOM believes that NERSA should use the latest methodology regarding coal costs and interrogate the underling costs and implications in terms of those contracts. NERSA therefore should not utilise old information to determine coal costs according to an inflationary increase. Effectively, NERSA had requested ESKOM to drop its coal cost by around 20% in the current financial year. NERSA had stated that ESKOM has excess capacity. ESKOM’s production plan – submitted in their application – had indicated that various stations had to run in the 2018/19 financial year, and could not simply be removed on the assumption that ESKOM has excess capacity. While ESKOM does have excess operational capacity at certain times during the year, but depending on the time during the year other stations may be required to run which is indicated in the production plan. The IRP also requires further interrogation regarding the decision of the regulator to be consistent with the new IRP. NERSA had included development costs under operational expenditure. In ESKOM’s analysis however it was not possible to determine how that amount was calculated and included in the final decision. The number of ESKOM customers had significantly increased as well as ESKOM’s generation capacity. The only decrease was in the area of sales. The point is that various other factors have increased which explains why the staff complement of ESKOM grew during that window.

On the way forward, Mr Cassim stated that the new Board has generated a large amount of positive market sentiment, especially within the domestic market. However, lenders almost always require guarantees that their investments and/or loans will be repaid when they become due. Those guarantees are necessarily contingent on ESKOM’s cash flow and the amount of that revenue. The volume and the tariffs do raise concerns regarding ESKOM’s ability to meet those debt commitments. At the end of the day it is paramount for ESKOM to meet its debt and programme commitments, to ensure continued operational and financial stability in the future.

Mr Hadebe made a few additional comments regarding the presentation. It is important to highlight that ESKOM has a difference of opinion with NERSA regarding the calculation of certain figures and their methodology in respect of certain conclusions. The Board is confident that an amicable solution can be reached for all parties concerned. As noted by Ms Magubane – regarding corporate governance at ESKOM – a proper strategy is been implemented. Regardless, it is important to reach an equilibrium with the regulator to ensure ESKOM’s sustainability going forward.

The Chairperson asked whether Mr Hadebe was confident a solution could be reached on the 2018/19 application?

Mr Hadebe responded he hoped that the 2018/19 application was not yet a closed issue. Even if the application is refused, then another solution will be found.

Ms Magubane, responded that it is not necessary – or even realistic – to expect ESKOM and the regulator to be the best of friends. However, it is required that both entities enjoy an amicable and friendly working relationship. At the time when the current application was made, the atmosphere was such that it was not very conducive to such a working relationship. She was confident however that a friendly and amicable working relationship would persist going into the future.

Discussion
The Chairperson stated that when NERSA made their presentation two weeks ago, he had mentioned that context is very important. While ESKOM may take issue with NERSA basing their decision – in part – on information and events which had occurred around three to four years ago, it is important to keep the overall context in mind. He refrained however from expressing a firm view on the
disagreement – in this respect – between ESKOM and the regulator. He asked Ms Magubane whether it was correct to conclude that all outstanding Board appointments would be finalised by April 2018.

Ms Magubane responded that the majority of the work around the outstanding appointments had been finalised and the remaining appointments should be finalised by April 2018. An announcement would be made at that time.

The Chairperson stated a number of events had occurred in the past regarding ESKOM. Different Portfolio Committees of Parliament have different mandates and concerns in respect of ESKOM’s management and governance. The mandate of the Energy Portfolio in this respect is concerned with the ability of ESKOM to ensure the ability of the entity to continue to provide energy going into the future. All entities – falling within the mandate of the Committee such as ESKOM and NERSA – should all attempt to reach a consensus as far as possible. It is inevitable that different people and entities will reach different conclusions on different issues, but all should strive to reach consensus and operate according to the same information, standards and principles as far as possible. It is very important – going forward – for further engagements with the DPE to take place in the future on this issue. The Executive should also appear before the Committee. When miscommunication or disagreement does happen, it is important for those who oversee the work of NERSA and ESKOM, to ensure that decisions are arrived at on a consensual basis, not based on a different premise where different entities operate according to different information. At this stage, he would refrain from putting questions to ESKOM which he would address at a later meeting when other relevant parties would be present before the Committee.

Mr G Davis (DA) hoped the new Board would lead to a new era at ESKOM. The Board should be given the benefit of the doubt and hopes it will succeed in achieving the difficult task ahead of it. Regardless, the Committee Members had only received the presentation at 21:19pm the previous night, which was not acceptable. Some members – including himself – had therefore been unable to properly scrutinise the presentation and prepare for the meeting which should not occur in the future. It was also disappointing that the various Ministers did not attend. It is understandable that they have very busy schedules but is very difficult for officials to answer political questions, which properly fall within the knowledge of the Executive. This constrains the ability of the Committee to properly ask questions, but it was noted the Chairperson had expressed a similar sentiment at the beginning of the meeting. In summary, ESKOM is facing dire straits in respect of its finances. ESKOM’s earnings had declined by R2 billion, net profit was down by R4 billion, cash assets are down from R32 billion to R22 billion while liquid assets are down from R32 billion to R9 billion. This is a very bleak picture as far as finances are concerned. The Board had given an undertaking to have a remedial plan in place by September 2018. In his opinion, September 2018 is too far away for such a plan to be finalised and implemented. What is the embryo of the plan at present? What direction is ESKOM heading in? It is imperative that ESKOM move away from a situation where its continued financial stability is dependent on government bailouts and ramping up tariffs on consumers. Surely ESKOM is already working on that plan and September is too long to wait for additional information on that point to be provided. ESKOM is owed around R13 billion from municipalities. If that money was paid back tomorrow, that would go a long way to improving its financial position. What steps is it taking to recover that outstanding municipal debt? What is going wrong – in the Board’s experience – that it can allow its debt to balloon so spectacularly? The presentation noted ESKOM had received a R20 billion loan. Is that loan inclusive of the R5 billion from the government employees pension fund or is it separate? An undertaking had been given to repay that loan by August. Is ESKOM confident that amount will in fact be paid by August, and if not, then what will be the implications of that failure? Media reports had indicated ESKOM had proposed a 30% tariff hike for the next financial year. ESKOM had asked for 20% for the current financial year. Reports largely indicate that the reason for such a drastic hike was directly caused by the R66 billion of corrupt, wasteful or irregular expenditure which state capture inflicted upon ESKOM. Will ESKOM ask for a 30% tariff hike in the future? If yes, how can such a hike be justified given that NERSA has already rejected an application for a 20% tariff hike? NERSA’s record for decision stated a primary reason for the refusal was due to ESKOM’s debt spiral. A debt spiral is defined as a situation where a utility needs to recover costs from an ever-diminishing customer base. NERSA argues that increasing tariffs will increase that debt spiral and therefore ESKOM should focus instead on reducing and recovering outstanding costs. What is ESKOM doing to reduce its overall costs? A related question is that of salaries of bonuses paid to ESKOM employees, especially senior employees. Last year, ESKOM had paid R4.2 billion in bonuses to staff and R5.5 million was just for three executives. Namely, Mr Brian Molefe, Mr Matshela Koko and Mr Anand Singh. It is unacceptable that R5.5. million worth in bonuses could be paid by an entity which is barely able to maintain itself as a going concern. Would the Board be willing to give an undertaking that they will forego their annual bonuses until ESKOM is returned to financial health and stability? The notion of elasticity featured quite prominently in the NERSA record for decision. In his view, this is at the heart between the dispute between ESKOM and NERSA. NERSA had stated that electricity is price elastic for three reasons. First, because consumers can choose to consume less electricity if prices become too high. Second, because some consumers – where they have the means – can generate their own electricity. Third, large firms will relocate their operations to countries where electricity is cheaper if the price raises too high. As a result, NERSA argues that increasing electricity will result in a debt spiral as mentioned above. NERSA noted ESKOM disagreed with the conclusion that electricity is price elastic and instead holds the view electricity is price inelastic. Namely, that people will continue to buy electricity in the same amounts, regardless of the increase in price. On what basis that ESKOM argue that electricity is price inelastic? If electricity is price inelastic, that does that mean ESKOM can then charge whatever prices they wish because people will continue to pay for it? On a moral level, such a position is unacceptable, and it is not morally justifiable or correct to continue to ramp up the electricity price beyond what people can afford to pay. Minister Radebe had been unwilling to give a firm commitment that nuclear procurement is off the table. The President had also not given a firm commitment to that effect. The general consensus appears to be that it is unaffordable, but no firm commitment has been forthcoming that nuclear is no longer a viable option at all. The IRP is going back to Cabinet. In ESKOM’s view would nuclear add to ESKOM’s financial liability and could ESKOM realistically embark on – or implement – nuclear procurement given its current financial situation? An internal ESKOM report had stated that nuclear is both unaffordable and unnecessary. Does the Board stand by the views expressed in that report?

Ms G Nobanda (ANC) asked if NERSA had granted ESKOM’s requested tariff increase, how that increase would affect people on the ground and municipalities which have outstanding debt to ESKOM. Will that not multiply municipal debt even further? The effect of such an increase for the majority of people, municipalities and ESKOM’s ability to collect revenue will be detrimental for most parties concerned, in her view.

Mr J Esterhuizen (IFP) reiterated it was false for ESKOM to state – as was indicated on page eight of their presentation – they had achieved a net profit of R6.3 billion. That profit belongs to the ESKOM group, not ESKOM itself. ESKOM itself is technically bankrupt. Projected sales indicated a figure of R175.6 billion towards a budget of R196 billion which is 4% lower. That figure is dropping is everyday as demand for ESKOM products is decreasing. ESKOM also has a large exposure to South African banks of more than R218 billion. South African Airways (SAA) is also technically bankrupt but – in comparison – only by a figure of R20 billion. The Pension Fund loan appears to have been paid back with interest, or at least he hoped. As noted by Mr Davis, credit control at ESKOM is extremely poor. Municipal debt is rising every day. Regardless, he is very happy with the composition of the new Board and hoped that the new CFO would not sing the tune of a certain family. Municipal debt had ballooned to over R12.5 billion, indicating a complete lack of credit control. That needs to be urgently addressed and how does ESKOM propose to control that ballooning municipal debt? Page 15 of the presentation itself does not make complete sense. R345 million had been awarded for open cycle gas turbines. Why on earth does ESKOM need to invest money – which it does not have – on such expenditure? It is that kind of expenditure which is contrary to the approach of implementing budget cuts, controlling expenditure and rather focusing on the maintenance of increasing infrastructure. What does ESKOM propose to do with R345 million of open gas turbines to produce diesel? R245 million had been spent on market participation which was inexplicable and unacceptable. Of the IPP’s NERSA had awarded R66 billion. Of a budget of R444 million, ESKOM has only used 18% of that on independent power producers. Now they want R34 billion for IPP’s. Trade Unions had objected which now effectively has resulted in a situation where trade unions make decisions for all taxpayers. The Energy Minister later gave an undertaking that IPP’s are now going ahead. The World Bank as a result had threatened to withdraw its loans – with disastrous effects for the economy – and it was only then that ESKOM had signed off on the IPP’s. That is a complete disgrace. The multi-year price determination is also an issue of concern. That may be NERSA’s fault but municipalities now use that determination to increase their revenue sources, all at the expense of the taxpayer. NERSA had indicated it expected ESKOM to build 3000 km of lines but ESKOM only committed to build 500km. In his understanding, NERSA sits on the Board of the grid planning committee. ESKOM however has made no planning for the grid or for renewable energy. What does ESKOM then budget and how then can they request that additional funding? Under the integration resource plan, transmission was mentioned but not in any meaningful detail. The expansion of the grid cannot be used as an afterthought. In his view nuclear procurement is completely off the table as indicated by various court cases. However, ESKOM had already used hundreds of millions in anticipation of nuclear roll out. What had happened to that money? The general consensus – which was concurred in by NERSA – is that ESKOM is completely ‘top heavy’ in that employ far too many people in relation to their capacity.

Mr Hadebe stated that the context of the questions raised by Mr Davis and Mr Esterhuizen were similar. It is important for the Board to be clear – at a high level – where they envisage ESKOM going into the future which will address their concerns. In the past 18 years, ESKOM’s expenditure had increased by 17.5%. In the same period of time – up until 2018 – revenue had increased by approximately 13-14%. The essence of the questions raised by Mr Davis and Mr Esterhuizen, was how ESKOM could increase its cost above its revenue? ESKOM is able to bring down its costs. The largest percentage of costs comes from primary energy generated from coal. Coal generation costs is around R85 billion per year, with employee remuneration around R30 billion per year. The Board had come to an agreement, where the business should be looked at holistically not only from the tariff side. Namely, how ESKOM can both maintain – and minimise – its costs whilst simultaneously increasing revenue. A plan to that effect had been formulated which aimed to reduce costs by around R10 billion over the next three years. The various measures to reduce revenue – if properly implemented – will result in ESKOM by 2021/2022 generating more income and revenue than total debt. Further work however must be done to achieve that goal. It must be highlighted that in terms of the OPEX, the R150 billion is envisaged to be reduced to R105 billion. If that is implemented ESKOM will be in good financial health by 2021. That however is not enough as ESKOM is facing severe challenges, which requires it to reduce its costs even more. In essence, the proper question is that initiatives or interventions are required to reduce expenditure and render ESKOM a viable going concern within the next three years. On the OPEX side, the main decision had been taken to reduce primary energy costs and employee remuneration. This however needs to be put into concrete numbers so a proper plan can be presented to the Minister and all other relevant stakeholders. The overall plan is to turn ESKOM around within the next five years, however at the same time sufficient revenue needs to be generated to maintain ESKOM in the next two to three years. Reducing costs of coal however also needs to be balanced with the interests of employees. Receiving the 16% application from NERSA would not solve ESKOM’s problems. However, if that tariff is granted – together with costs reductions and increases in revenue – it would place ESKOM in a fundamentally different position. Presently, the cost sustainability revenue of ESKOM is very bad at around 70%. The major issues at ESKOM are around costs and the aim is to reduce that figure to 65%. Painful and difficult decisions may have to be taken to reach that goal. The approach is not only to use tariffs to increase revenue, but to adopt a holistic approach of finding other ways to increase revenue and reduce overall costs.

The current municipal debt is unsustainable. ESKOM had written letters to the Ministers of Finance, DoE, DPE and Department of Public Works (DPW). Those communications highlighted that municipal debt continues to remain at an unacceptable level and drastic interventions may have to be undertaken by ESKOM. For example, ESKOM may have to cut off power to defaulting municipalities for a number of hours every day as an intervention. Initially ESKOM would cut of the power for around two hours a day from around 06:00-08:00 in the morning. Most people had learnt to cope with that situation, but such cuts are not enough. ESKOM may then have to increase the number of hours from two to four hours per day for example. If no positive response is forthcoming then the number of hours will have to increase. This may be a tough response, but if that debt is not recovered then ESKOM investors will refuse to place further capital into the business. Only if ESKOM indicates they are serious about debt recover will investors keep their money in ESKOM. For example, in Soweto there is a total debt of around R5 billion owed to ESKOM. ESKOM will require further political support in that regard. When ESKOM had endeavoured in this direction before, political support had not been forthcoming due to the harshness of such measures. However, ESKOM has reached a point where such drastic interventions are required if investment into ESKOM will be forthcoming going into the future. In short, ESKOM needs to increase its revenue and be very strict in reducing its costs. A plan had been implemented to deal with outstanding Municipal debt. Such interventions had resulted in some successes and payments had improved but more needs to be done. Tough decisions will have to be taken, and if they are not taken ESKOM will continue to face the same problems. A form of equilibrium or compromise has to be reached between all the different stakeholders. Until now, ESKOM has not been forward looking in drafting and implementing proper strategies to achieve their targets. The way ESKOM has been run in the past needs to be urgently addressed. ESKOM should be in a better position. The Board has only been in office for two months and further time will be needed before the work of the Board as a whole will begin to show further positive results.

Ms Magubane responded to the issues regarding ESKOM strategy. ESKOM had implemented measures for the short and medium term, but it also needs strategy to address long term goals and policies. On the debt spiral, ESKOM firmly believes they have a central role to play in South Africa’s energy transition in line with the National Development Plan. It is not a question of ESKOM operating alone. Rather, ESKOM is part and parcel of all stakeholders in the National Development Plan and must actively participate in the implementation of that plan. This will require a buy in from society as a whole, inclusive of organised labour and business. At this point in time, all stakeholders must buy into ESKOM’s strategy and implementation plans to turn the entity around.

Mr Hadebe noted that the power utility’s debt is currently at a high level. ESKOM will only be able to address this debt if its costs are properly brought under control. It has to be accepted that a number of issues which ESKOM is currently facing can be traced back to the past, such as poor energy projections in the past. Presently, the fundamental problem is addressing the root causes of ESKOM’s performance such as low revenue intake, selling underperforming assets in their portfolio and other interventions of that nature.

Mr Cassim addressed the question regarding the R5 billion Public Investment Corporation (PIC) loan. That loan had been repaid with interest.

On the 30% tariff request, ESKOM is of the understanding that there are three outstanding regulatory clearing account applications which total R66 billion. NERSA is currently in the process of scrutinising those applications and reaching a final conclusion on those applications. It is correct that ESKOM revenue is currently at around R190 billion. If a R160 billion was given as a once off determination, the methodology does allow for the regulator to phase that figure in over a period of time. ESKOM however is not expecting a once off adjustment beyond the current adjustment to the economy which NERSA had considered.

On the issue of methodology, Mr Cassim is not fully apprised of all the issues regarding elasticity and inelasticity. From a factual perspective of a 2.2% average price increase, a reduction in sales volume in the current financial year is expected.

On the issue of nuclear energy, it was noted ESKOM was asked about this issue when they released their interim financial statements. At that time Mr Cassim had indicated that if ESKOM is currently experiencing difficulties in meeting their current financial commitments – especially in relation to their existing asset base on Medupi and Kusile - then it would not be possible to place further costs onto ESKOM’s financial commitments at the current time. ESKOM would await the outcome of the revised.

Regarding salaries and bonuses, the ESKOM financial situation is quite dire in terms of its bottom line. If ESKOM makes a loss, then it would be hard to justify paying bonuses. Discussions would have to be had with unions but if bonuses impact on ESKOM’s bottom line it would be difficult to justify the payment of any bonuses to ESKOM employees.

Mr Hadebe expanded on the question regarding elasticity. It is not the position of ESKOM that electricity is inelastic. ESKOM will do as much to reduce the cost of electricity, but this must be done within the current economic and regulatory framework.

Responding to Ms Nobanda, it is necessary to be honest regarding the challenges ESKOM is facing in relation to municipalities. The challenges with municipalities are partly about debt, but are largely an issue of not having a proper control and enforcement mechanism in place to enforce debt collection and payments. For example, he is from a small township in Estcourt which suffers from unbearable levels of poverty. The people however accept they must pay for electricity on a pre-payment system. When a community like that is compared with a community in Soweto – which comparatively has a high per capita income – and still refuse to pay on a pre-payment system then problems arise. This is largely a political problem and a problem of enforcement. The financial and economic situation is dire, but hard questions need to be asked regarding why that is the current situation. Largely, there is a perception that people – in such situations – simply refuse to pay because of a perception that other communities do not pay.

Mr Cassim dealt with the question raised by Mr Esterhuizen, regarding the revised IRP’s. In the 2018 application, NERSA made the allowance of R22 billion for IRP’s. IRP bid applications would be dealt with in future applications. Regarding Open Circle Gas Cycles, the determination only assumes the open circle gas cycles only have a baseload capacity to meet hourly demand when required. ESKOM does make use of the demand market participation. This also helps achieve technical requirements in terms of frequency requirements on the grid.

An ANC Member noted that Mr Hadebe had consistently stated that the solution to the municipal debt issue lies in improved political will and enforcement. Does this mean that ESKOM does not have a comprehensive debt collection system? In her view, a political system – in itself – will never ensure that debts are comprehensively collected without such a payment or debt enforcement system. ESKOM should take responsibility for this issue. Is there a proper payment system in place at ESKOM in this respect? NERSA had argued the 5.2% tariff increase is in alignment with government policy to reduce poverty, inequality and unemployment. To that end, she supports the decision of NERSA. At the end, the tariff increase requested by ESKOM would hurt poor consumers the most while the focus of ESKOM – in her view – almost appears to be concerned largely with large industrial or commercial consumers. She aligns herself with NERSA’s decision and this is not the first time that ESKOM has requested a double-digit increase. The last request for a double-digit increase was also rejected and ESKOM should learn a lesson from those rejections.

Mr Esterhuizen wished the new Board the best of luck in turning ESKOM around. The entire country and the country is dependent on their success in rolling out affordable and efficiency electricity.

Mr Davis stated the Committee did have a joint meeting with the Portfolio Committee on Cooperative Governance and Traditional Affairs on the issue of municipal debt owed to ESKOM. There was a commitment that an inter-ministerial task team report would be conducted to that effect, but the release of that report was subsequently extended until the end of January. That report however has not been forthcoming. Another joint meeting should be held with the Portfolio Committee on Cooperative Governance and Traditional Affairs as well as with the Ministers who sat on that inter-ministerial task team. Part of the problem is ESKOM’s credit control; however those issues affect government and other stakeholders as well. The broad outline of strategy did appear promising but further details would need to be fleshed in that respect in the future. Regarding restructuring of ESKOM, consideration should be given to breaking down its monopoly on electricity generation and transmission. This could make ESKOM more efficient. Are those discussions currently being had? He had read media reports that ESKOM is maybe heading to court, to compel NERSA to revise its decision to refuse the tariff hike application. Can ESKOM confirm or deny, whether such a court application is still on the table?  The CFO had stated that ESKOM would have to borrow a further R72 billion rand. Does ESKOM intend to apply to government for any further bailouts in the current year, and if yes, how much does ESKOM intend to ask government for? He agreed ESKOM does have to make tough decisions regarding cost reduction. His question regarding the foregoing of salaries and bonuses was partly answered by the CFO, but specifically, would the senior management of ESKOM forego their bonuses this year? This would send a strong and positive message to ESKOM employees and the country that – in making tough decisions – ESKOM senior management would themselves be willing to put their money where their mouth is, by also taking tough decisions in respect of their own pocket. On the elasticity question, the GCEO had stated that ESKOM is not of the view that electricity is inelastic. However, that response contradicts what appears on page 29 of the NERSA record for decision which stated that ESKOM argued against stakeholder comments by arguing that electricity demand is inelastic in South Africa. Which position is correct: the view taken by the old ESKOM or the new ESKOM? If electricity is elastic, then surely higher tariff increases will place ESKOM in a worse position, because a higher tariff will mean less sales, which in turn will mean less revenue. Therefore, has ESKOM calculated what would constitute an ideal tariff, taking all of those considerations into account? Namely, what would be optimal price where ESKOM could maximise its revenue, and if yes, would be that figure? Would that be the figure which had already been granted, the figure requested or rather something into between those two figures?

Mr Hadebe responded to the female ANC member. ESKOM does have a recovery plan in place. By political solutions, he noted that it is not the first time that ESKOM has undertaken this privilege and political interventions have occurred in the past. ESKOM had discussed this issue in detail with the Standing Committee on Public Accounts (SCOPA) three weeks ago. ESKOM had explained in detail the challenges in that respect to SCOPA. Further engagements and political interventions can assist ESKOM in doing their work. ESKOM does encourage municipalities to adhere to payment recovery plans. It is however more complicated than it appears at face values. For example, ESKOM had installed prepaid meters in some communities which had subsequently been destroyed. The resolution to this issue requires an equilibrium to be struck between all stakeholders. Personally, he does agree that NERSA should take into account the interests of the poor when determining tariff increase applications. However, the issue is not as simple as it was framed. If ESKOM is unable to operate as a viable and sustainable entity that will affect all South Africans and not only the rich. Everyone has to play a role in turning around ESKOM inclusive of NERSA and South Africans as a whole.

Responding to Mr Davis, the DoE Minister, Finance Minister and COGTA Minister had sat on the inter-ministerial task team to find a way to resolve the issue of municipal debt. The Chairman of ESKOM had met with that task team several times and their work is currently in progress, and the outcome of those deliberations would be reported to Parliament. Decisions however need to be taken before that process is complete, as ESKOM unfortunately is not in a position where time is on their side.

Ms Magubane responded to the question as to whether ESKOM would break up its monopoly over electricity generation and supply. This does definitively require serious consideration however a number of options would be put on the table. At the end of the day, a number of stakeholders would be affected, not only ESKOM. Presently, it would be premature to make a firm commitment in that respect, but ESKOM is open to considering every option to turn ESKOM around.

Mr Hadebe added that unit in ESKOM would have to be considered. Each unit must be held accountable for its performance individually. Currently, each unit has been grouped together which does make it difficult to determine efficiency on a more individual and micro-basis.

On the issue of litigation against NERSA, ESKOM is currently in further engagements which have been noted by Minister Gordan. Minister Gordan and Minister Radebe are of the view that the impasse between ESKOM and NERSA should ideally be resolved at the ministerial level. Further discussions between DPW and DOE would take place. Overall, ESKOM and NERSA are involved in a partnership which involves – and affects – a variety of different stakeholders, all of which need to be taken into account going forward.

ESKOM aims not to approach government for any bailouts or other inventions in the 2018/19 financial year. An articulate and clear plan would be implemented – going into the future – to properly determine how ESKOM will source the R72 billion figure and the payment of its debt going forward. ESKOM’s primary engagement with government would be to commit on the reduction of its business costs. At present, there is every intention not to approach government to seek any financial bailout in the 2018/19 financial year.

On the issue of bonuses, it was acknowledged that this is a tricky issue. The year is not over, and bonuses are paid according to the targets which have been set. At the end of the year, the targets would be evaluated and if they are met, bonuses would most likely be paid. If they have not been met, then bonuses will not be paid. The truth of the matter is that targets were set by the previous board, and the ultimate decision as to whether bonuses will be paid or not, will have be taken upon a proper evaluation of performance against the targets which have been set.

The sustainability of ESKOM is not informed only on the basis of what NERSA gives ESKOM in terms of tariff increases. The maximisation of revenue through several means and ways must be explored alongside the reduction of costs. Mixing all of those variables into the equation, the ultimate goal must be to maximise sales – in turn revenue – at an affordable price and containing cost. Electricity is not elastic, and a global and full picture must be adopted in that respect. IPP’s had resulted in a reduction of ESKOM’s total market share to approximately 90%. If the price of ESKOM products is not made affordable and competitive then further reductions in market share will likely follow the in the future. It would be naïve for ESKOM to assume that South African’s will pay for ESKOM products if their prices are not competitive. The business however must – overall – be ran efficiently and sustainable.

Mr Cassim responded to Mr Davis question around the optimal price for electricity. This is determined according to ESKOM’s regulatory methodology which is determined by cost plus return. This however is influenced by a number of assumptions such as ESKOM’s capital requirements in the long term. In the long term, the optimal price would be one that allows ESKOM to meet its debt service commitments when they fall due. At the bottom line, ESKOM has R367 billion worth of debt on the balance sheet, a large component of which is guaranteed debt through the national treasury. If ESKOM cannot meet those requirements, national treasury will have to be approached to moot those debt commitments. It is his understanding that the balance sheet of government itself is quite stretched at the moment. ESKOM however does not anticipate approaching government or national treasury. However, the price must take that consideration into account to avoid the eventuality of having to approach government to secure a bailout, which must then inform what would consist an optimal price for electricity.

The Chairperson noted that NERSA’s presentation – which was given two weeks previously – emphasised that electricity is inelastic. Mr Hadebe was correct to accept the price of electricity is elastic. Any economic argument to the contrary simply cannot hold. At the last joint meeting with COGTA, the Committees concerned had agreed to hold a later meeting to deal specifically with the issue of outstanding municipal debt. It is imperative that the issue of municipal debt is speedily and properly resolved. The Energy Committee did take the initiative on this issue on the previous occasion, but there is a general consensus that COGTA should take the lead on this process as it properly falls within their portfolio. Engagements with COGTA to that effect had already taken place to schedule a joint meeting to deal with this issue. It is best to bring all the committees involved – such as SCOPA, COGTA and the DoE – into one discussion so that this issue can be dealt with conclusively once and for all. The last page of the presentation stated ESKOM would use the provisions of the Electricity Act to resolve their issues with NERSA. It is hoped that the utilisation of those processes will resolve the dispute between the two entities. While the independence of NERSA cannot be compromised, all entities concerned should make their decisions based on correct information. At the end of the day when an entity makes a mistake, it has a knock-on effect to all other affected entities, which in turn directly negatively impacts on the consumer. When the DoE has finalised the revised IRP it should report back to the Committee to fully resolve this matter. These issues cannot be resolved through the back door and must be confronted proactively and head on.

The meeting was adjourned.