Eskom's shocking R10bn loss: South Africa's power monopoly, Eskom, registered a R9.7bn ($1.27bn) loss last year, casting doubt on whether or not it will be able to repay its loans, roll out sorely needed infrastructure and keep the lights on.

The extent of the government-owned facility's financial tumble actually amounted to around $1.7bn before tax, while company debt soared to $6.56bn from $1.96bn a year earlier. A large amount of cash went into the hasty buying of coal on short-term contracts after the utility ran down its stockpiles to just a few days' worth. The price of short-term contracts can be up to three times higher than that of longer term ones, on top of which the price of coal soared in the face of massive Chinese demand.

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The news of Eskom's stunning loss follows the utility's call for $50.5bn to fund the building of 40,000MW in new generating and transmission capacity required to meet South Africa's energy demand in the next half a dozen years.

The government has promised $7.87bn and some institutional money is available, while the bulk of the funding will come from a series of jolting hikes in residential consumer electricity rates. Eskom has already secured a 31.4% tariff increase and is confident it can talk the regulator - National Electricity Regulator of South Africa (Nersa) - into two more similar hikes in coming months. It is doubtful, however, if even such draconian measures will raise sufficient funding to meet the entire programme.

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Eskom chairman Bobby Godsell says the utility will have no choice but to delay some of its infrastructure spend if it cannot beef up its access to cash. The deficit should not halt or delay the construction of four major power stations already under way.

"The causes of last year's power crisis are many," says leader writer Hilary Joffe in Business Day newspaper, "but there is little doubt that Eskom had lost the plot - as had its shareholders, policy makers and regulators, all of which failed to put in place the frameworks and incentives needed to manage South Africa through a period in which the margin between the supply and demand and electricity is way too low for comfort. The notorious coal stockpiles were the clearest evidence of that."

Whether because it was trying to conserve cash and boost profits, or through incompetence, or some combination of these, Eskom ran its coal stocks down to such low levels by last January that after two weeks of wet weather it simply did not have enough dry coal to keep the power stations running.

"So a crucial change in the wake of the crisis is that Eskom and its stakeholders have made 'keeping the lights on' the strategic priority," observes Joffe. "That was relatively easy to do in a year in which the commodity market crashed, big customers suspended production and demand for electricity declined more than 4%. But Eskom did buy millions of tons of coal to rebuild the coal stocks it had allowed to run down; it did boost its maintenance and its staff complement and improve the performance of its power stations."

The costs of doing that show in the operating losses for the year, but they are the centre, too, of the debate about how Eskom will raise the cash to fund the R385bn it requires over the next five to six years to build the power stations and transmission lines needed to keep South Africa's lights on more sustainably. However, Eskom has promised that no matter what happens, South Africa will have lights for the 2010 soccer World Cup. "There is still a risk in the power system, but we believe we should be able to deal with 2010 comfortably," says Eskom's chief executive Jacob Maroga.

Eskom stripped of its powers

As Eskom's dismal numbers laid bare the extent of the utility's woes, chief executive Maroga tried hard to portray his board as fighting a rearguard action against mounting odds, the government quietly and without warning stripped Eskom of its authority to award contracts to independent power producers and transferred them to energy minister Dipuo Peters.

It was a harsh and punitive move designed to accelerate the process of awarding licences to IPPs and concluding contracts for the sale of electricity generated by the private sector. It also signifies the new administration's understanding of the extreme urgency for additional capacity and the recognition that Eskom cannot do it alone.

The new regulations enable the minister to force Eskom to buy all of a private producer's electricity at a price determined by government and the National Energy Regulator.

To date, the concluding of an electricity-purchase agreement has been the biggest obstacle to making a start on a new power station in Botswana that will deliver electricity mainly to South Africa.

Peters' disempowerment of Eskom's authority over private electricity producers has brought new hope to 23 preferred IPP bidders selected last year from a group invited to submit proposals for private electricity generation.

The list includes some of the world's biggest power companies, such as AES, Aldwych International, Aviva and China's Shenzhen Energy. The process has been at a standstill since October last year. The projects they proposed building include a commercial solar-power plant, a liquid natural-gas power plant, and a hydroelectric scheme. Should all of the 23 projects proceed, they would increase the country's generating capacity by 2014 - when most of them would be completed - by 20,000MW to around 60,000MW.

Eskom between an aluminium ingot and a hard place.

The Eskom board has backed itself into a corner by wanting to make South Africa an attractive investment destination because of affordable energy on the one hand, and by now seeking to up the electricity rates on which earlier investments were negotiated on the other.

According to mining insiders, Eskom now wants to renegotiate the electricity supply contracts it signed with BHP Billiton in the late 1990s, at a time when it had large volumes of surplus generating capacity.

"It was because of those contracts that BHP Billiton agreed to invest R6bn into building the Hillside aluminium smelter at Richards Bay, followed by the Mozal smelter in the Mozambique capital of Maputo," reports researcher Brendan Ryan on MiningMix.com.

"Without them, BHP Billiton would not have built the two new smelters. Any changes to those contracts must have implications for Rio Tinto's proposed Coega aluminium smelter in the Eastern Cape, which has negotiated a similar electricity supply deal."

As recently as the end of last year, Rio Tinto expressed interested in developing Coega, provided Eskom could guarantee power supplies.

At the time, Rio Tinto's chief executive, Tom Albanese, said that "any renegotiation of the contract signed between Eskom and Rio Tinto to supply low-cost electricity to Coega would make Coega less attractive".

The paper value of the contracts is affected by movements in the dollar aluminium price as well as in the rand-dollar exchange rate.

In previous years - when the rand was weak or the dollar aluminium price was high - the supply contracts were reflected in Eskom's accounts as assets.

IPP's contribution

Inevitably South Africa's neighbours will feel the pinch as well, although their only sin was to place too much reliance on their neighbour's ability to keep supplying electrical power at a price that removed all incentives for them to install adequate capacity of their own. Everyone woke up too late, and South Africa found itself in a pickle barrel: its neighbours started waving contracts with price-stability clauses, as did big industry lured years ago to investing in South Africa by promises of sustainable cheap power. Contrarily, a greenfields power station project in Botswana on the verge of moving off the drawing board to begin construction has been forced to mark time until Eskom could tell the Mmamabula facility how much it could afford to pay for its power. With such decisionmaking processes now in the hands of the ministry, such independent power producers (IPPs) as the Canadian ICC corporation contracted for the build have new hope for speedier resolution.

"This is very good news for us because we see that the policy change supports an IPP role and how it would work," says CIC Energy president Greg Kinross of the South African government's resolve to relieve Eskom of IPP decision making.

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Two Botswana power generating projects were the first in the SADC region out of the blocks to contend with the electricity vacuum - Mmamabela and a doubling of the capacity at the existing coal-fired Morupule power station near Palapye in the north of the country.

The South African power sector is suffering the aftershocks of a massive calamity. The resulting catharsis is showing signs of bringing the utility back to a level keel and sensible policies from here on in could return Eskom to its former glory.

Downturn

Eskom's fall from glory

"Eskom produced some great balance sheets, but it is now clear that they concealed more than they revealed," says Albert Schuitemaker, director of the Cape Chamber of Commerce. "The $1.27bn loss posted by Eskom was the result of years of bad management. In the five years before the blackouts started, Eskom made a profit of R33.5bn [$4.39bn at current exchange rates]. The $1.27bn loss posted in 2008/09 Eskom was the result of years of bad management."

According to schuitemaker, most of that money had gone to the government in taxes and dividends instead of being used to improve maintenance, train staff and preserve coal stocks. The picture became one of declining reserve margins of electricity, while stocks of coal were run down to the point where the country was been plunged into darkness.

Year  Profit (loss)

2002   R5.45bn
2003   R5.28bn
2005   R7.79bn *
2006   R6.65bn
2007   R9.46bn
2008  (R9.70bn)

* 15-month year
Reference: Cape Chamber of Commerce