Eskom on its 2011/12 Annual Report

Meeting report

Mr Brian Dames, Chief Executive Officer of Eskom, said he wished to preface the presentation with his personal assessment of the utility company’s current situation.  Eskom was in a fundamentally better position than it had been before. A new strategy had been put in place in 2010 with the intention of shifting its performance levels and putting in place the building blocks for future growth. A key focus had been on ensuring “we keep the lights on”, and the organisation had worked day and night to achieve this. The funding problems of Eskom had been overcome, not only from a revenue point of view, but also with regard to significant cost savings, and funding for future projects had been secured. The labour problems at Medupi power station had been resolved, and the new built programme was progressing favourably. Eskom was fulfilling its developmental role through its skills training, by physically creating jobs with its infrastructure projects and by providing business opportunities for South African companies. The operations side of the business had been turned around, with R4bn in cost savings being realised. Manpower numbers were being increased, particularly in its distribution arm. There had been concerns about the way in which Eskom motivated its staff, but it had been crucial to address this aspect, as staff were required to work at all hours to ensure electricity supplies were maintained. There were many issues that still needed to be handled, but fundamentally, Eskom was in a very healthy position.

Turning to the presentation itself, Mr Dames said there had been no load shedding since April, 2008, the only disruptions being power distribution issues. One disappointment, however, had been its safety record, and a lot of effort would be directed to improve this. Eskom had had three years of very good financial performance, and it was important to realise that all surpluses were reinvested into the business to help fund its capital expansion programmes and to service its debt. This was the only way to avoid being a drain on the government. The National Energy Regulator of South Africa (NERSA) had approved a revision of its proposed tariff increase of 25,9%, down to 16%, and this would provide an economic benefit to the economy of R11bn this year. During the review period, R72.1bn had been spent with Broad-Based Black Economic Empowerment (BBBEE) accredited companies. Significant progress had been made in capital expansion projects, with 535MW of additional generating capacity, 631km of high-voltage transmission lines and 2 525MVA of new transformer capacity being installed during the 12-month period. There was a total learner complement of 11 953, of which 5 715 were engineering, technical and artisan learners, and 5 159 – mainly unemployed matrics and under-graduates – were in the youth programme.

The presentation provided the Committee with details of Eskom’s “strategic pillars,” its corporate structure, its performance against its shareholder compact and its success with its integrated annual report, which had been highly commended by the Johannesburg Stock Exchange. During the financial year, 155 213 homes had been electrified, bringing the total since the inception of the electrification programme in 1991, to over 4 200 000.  This meant 83% of households were electrified. 

Black employees accounted for 53,9% of senior management positions, and 65,7% of professional and middle management positions, while women made up 24,3% of senior management and 32,4% of professional and middle management. People with disabilities accounted for 2,49% of the total workforce. Eskom had invested R87,9m in corporate social initiatives which impacted on 256 organisations with over 530 000 project beneficiaries.

There had been 25 fatalities during the year, 13 of whom were employees and 12 were contractors. The majority were vehicle accidents, and five were due to electrical contact. Other causes were tree-felling accidents, falling from heights, and an allergic reaction to bee stings. The company was adopting a zero-tolerance approach to safety issues.  Eskom’s carbon and sulphur dioxide emissions had increased, but particulate emissions had decreased, water consumption had dropped, and there had been fewer legal contraventions.

Mr Dames said that although electricity sales had increased by only 0,2%, the increased tariff had resulted in revenue growing from R91.4bn in 2010-11, to R114.7bn in 2011-12. Since March, there had actually been a decline in sales, reflecting the impact which the world recession was having on the South African economy. Profit amounted to R13.248bn, giving a 3,7% return on average total assets. It cost Eskom 41,3c to produce a kWh unit of electricity, and its revenue per unit was 50,3c. Its capital expenditure for the year was R58.815bn, and its gross debt at the end of the period was R182.567bn. This level of debt made it essential for Eskom to remain viable, as borrowings over the next five years would increase the debt to over R300bn, with a repayment period stretching to 2040.

He referred to the special tariff agreement with aluminium-smelting company BHP Billiton. He said this had originally been entered into at a time when Eskom had excess capacity, and the company was currently engaged in discussions to renegotiate the terms of the agreement.

Mr Paul O’Flaherty, Eskom’s Finance Director, provided a breakdown of the company’s audited financial results, comparing them to NERSA’s targets for the period, and while operating profit had been below target because of falling sales, cost savings of R4bn had enabled the net profit figure of R13.248bn to exceed the target by almost R1bn.  Eskom’s contract with BHP Billiton, involving embedded derivatives, sat as a R5.5bn liability on the balance sheet, representing the forward price of what Eskom could sell the electricity for, until the end of the contract period, taking into account the expected Rand/dollar exchange rate and the price of aluminium. An important key performance ratio was gross debt to earnings before income tax and depreciation, which stood at 6,5:1, compared to under 3:1 for a standard investment grade company. Another indicator was funds from operations, which stood at 15,2% -- an investment grade company was around 25%. The cash flows, because there was not a cost-reflective tariff, did not support the company on a stand-alone basis – it had to rely on the backing of the government. Bad debts remained a challenge. As tariffs increased, this would become an issue, particularly at municipal level.

Mr O’Flaherty pointed out that coal made up a large proportion of Eskom’s costs, and if coal prices became unpredictable and rose above the rate of inflation – out of Eskom’s control – the consumer would have to pay. Coal costs had gone up by 29% during the year. Employee benefit costs had also increased, firstly because more were being employed, and secondly because of salary and wage increases. Eskom’s bargaining unit had negotiated an average increase of 8,1% for the workforce (about 85% of employees), while management received a 5,5% increase.

In the past, Eskom had valued its assets on a historical basis, depreciating them at their current replacement cost. NERSA had agreed that Eskom should cater for price increases in the future, and revalue its assets accordingly, allowing for a higher level of depreciation. The cost of replacing Eskom’s assets today would be R500bn, compared to the historical cost of R290bn. As its debt grew, its average annual net finance cost for the next six years would be R23.5bn. A significant portion of Eskom’s funding was in foreign currency, and the company’s credit rating affected its ability to attract investment and the rate of interest attached. Eskom’s rating with government support was “BBB+”, but on a stand-alone basis, it was “B” – just one notch above a “C” (junk) rating. So continued strong government support was critical, as well as sound ongoing financial performance.
There were no changes to Eskom’s build programme, which would deliver an additional 11 256MW by the time the Kusile coal fired power station was completed in 2019. There was no funding in place, and no certainty yet as to what would happen after the completion of Kusile, as a decision on the Integrated Resource Plan was awaited.

Mr Dames took over the presentation which dealt with the operational performance of Eskom. A major issue was to convert coal deliveries from road to rail.  The target was to move 8,2m tons by rail last year, and 8,5m tons had been achieved. A major challenge in ensuring no power outages occurred, was the need to balance maintenance requirements against the generation of electricity to meet demand.  There had been unplanned outages, and these were generally the result of poor performance by contractors.  Eskom needed more time for maintenance, particularly as most of its power stations were in their “midlife,” with some of them more than 30 years old.

Eskom was committed to facilitating the entry of Independent Power Producers (IPP) and acknowledged the role they had to play in the South African electricity market. To date, it had contracted 1 008MW of installed capacity from IPPs at a cost of R3.25bn, which represented an average cost, purely for generation, of 77c per kWh.  This was being sold at 50c per kWh, which indicated how far behind the cost of new electricity sources Eskom’s tariffs were. Challenges related to safety issues, the theft of equipment and electricity, illegal connections, the electrocution of birds on power lines, and difficulties in gaining access to properties for infrastructure installation. On the other hand, one of the successes had been the TV “power alert” campaign, flighted in the late afternoon, which had resulted in average demand savings of 261MW during “red” periods – between 5 and 9 p.m.  Another challenge was to manage the Soweto debt, which averaged R4.5bn at the end of the last financial year, and Eskom was working with the government to find a solution. Energy losses and theft represented 8,6% of total sales – at a cost of R1.2 billion. There had been an increase not only in the theft of copper, but also the steel from pylons.

Eskom’s priorities for the coming year were clear: improve safety; keep the lights on; ensure financial sustainability; delivery on the build programme; improve operations; and form a unit to investigate regional power opportunities.  Progress for the company translated into progress for South Africa.

Discussion
The Chairperson said the Committee needed to discuss the BHP Billiton contract more fully. How fair was the price BHP Billiton paid, compared to the rest of the country? He asked Eskom to provide historical details surrounding the deal.

He also sought reassurance that Eskom would be able to meet its project deadlines, as some “doomsayers” and the media were saying they were unrealistic. Would the ten-day work stoppage at Medupi not have an effect on the deadline there?

Ms N Michael (DA) said the lack of transparency about the BHP Billiton contract – currently subject to a Promotion of Access to Information Act (PAIA) appeals process – had raised suspicions in the media, and she asked if Eskom could provide the Committee with a written report on where the issue stood at the moment. She had heard that Eskom had been successful in renegotiating the contract with Mozal in Mozambique, and asked if the Committee could assist with local negotiations. As Eskom was not required to pay compensation to the smelter for power shutdowns, unlike the case with other companies, could power to BHP Billiton be cut more, so that the other companies – paying higher tariffs – were less affected?

She referred to the complaints that had been received from the media and communities about the holding of seven parties for Eskom staff at a cost of R36m, and said the public was seeing this in the light of higher tariffs while BHP Billiton was paying less, and people were battling to pay for a loaf of bread. It was a public relations “nightmare”.

Ms Michael said Minister Rob Davies (Trade and Industry) had recommended that NERSA put a cap on the level of excess charges which municipalities could impose, over and above the Eskom tariff. She understood NERSA had a standard of 16,6%, but some municipalities were charging up to 30%. Was there any way in which NERSA’s position could be strengthened to ensure municipalities could not add on exorbitant charges.?

She asked what it cost Eskom to provide a simple electricity supply to informal shacks, and expressed concern over the safety of Eskom workers cutting branches of trees among the supply lines. Were children climbing into the trees not exposed to danger?

Mr A Mokoena (ANC) said the electrification of Soweto had been initiated by the “community councils” of the 1980s, which had raised an overseas loan of R293m. Had this loan been written off?

Referring to the BHT Billiton issue, he asked if there was any “jeopardy” in “putting a gun to their heads” and insisting that they move to a higher tariff.  He also asked about the impact of Eskom’s carbon emissions, compared to the rest of the country.

Mr C Gololo (ANC) asked how far Eskom had progressed with the rural electrification programme, and what the utility’s current reserve power margin was. He suggested that the Committee would support Eskom if changes in legislation were required to ensure Eskom benefited from its special pricing arrangements.

Mr E Marais (DA) said that while the total complement of learners had been provided, it was more important to know what the success rate was.  With 83% of households now electrified, what were Eskom’s roll-out plans for the next five years, and which specific areas would be targeted.

Dr G Koornhof (ANC) said it was important for Eskom to be able to plan beyond the Kusile completion date, as 2018 was not far away, and suggested that the Committee should interact with Eskom ahead of its forthcoming application to NERSA.  The directors’ report had indicated losses through criminal conduct, irregular and wasteful expenditure, amounting to R162m, including strike damage. The report had stated that disciplinary action was being considered or had been taken, but this was very vague. The Committee would like more clarity on what had been done, and how it would prevent future occurrences.  He asked whether the problem of defaulting municipalities was under control, and said the R4,5bn Soweto debt was very worrying.

Mr K Dikobo (AZAPO) said that Eskom should have been aware of the problems at Medupi and done something about it, to prevent the work stoppage. It was mostly outside contractors who were responsible for disruptions, so perhaps it would be in Eskom’s interests to form more subsidiary companies, which it could control, to ensure its core functions were handled. He said he would have expected all state-owned companies to be sending their learners to Further Education and Training (FET) colleges, but this was not happening, perhaps because of a lack of confidence in these colleges. He asked whether Eskom, with its country-wide footprint, would not consider assisting with the training of FET lecturers, to raise the standard. He asked for clarification on the 50 legal contraventions in which Eskom had been involved, particularly who the victims had been, and what penalties had been imposed.  He also wanted to know what recourse Eskom had to reduce the risk of receiving low quality coal.

Ms G Bosman (ANC) agreed that the Committee needed to be proactive in assisting Eskom with its forward planning beyond Kusile. She asked whether the reduction in the tariff increase, from 25,9% to 16%, would have a future impact. Were there vacancies in top management, or had they all been filled? She questioned whether the 83% of households electrified, had included those which had had to undergo rectification, and the electricity supply had been disconnected and then reconnected. The number of women in senior management was only 24% of the total, and she wanted to know why the figure was so low. Did Eskom’s training include the “brilliant females” who were available?  She asked whether growth in the use of solar heating was having an effect on electricity sales, and what the impact would be as this trend gained momentum.

Eskom’s responses
Mr Dames dealt first with the BHP Billiton issue. During the 1990s, Eskom had significant excess capacity, and price increases were below the inflation rate. This was used to attract energy-intensive businesses, one of which was BHP Billiton.  Contracts had been structured so that the price of electricity was linked to the price of a commodity – if the commodity price rose, the customer paid more for electricity. The Rand-dollar exchange rate also had to be taken into account. Eskom had since been able to renegotiate contracts with Mozal and the Skorpion zinc plant in Namibia, so that they paid more for electricity than its cost of production. Eskom was now engaged in negotiations with BHP Billiton’s new management team. Government had been very supportive in this initiative, and Eskom was working very hard to achieve a solution which would benefit the country. Although Eskom had appealed the PAIA ruling over the media application for transparency regarding the agreement, it would abide by the court’s ruling.

Regarding the interruption of power supplies to companies, the contracts did provide for this to happen every week for a limited period of time, and Eskom was using this facility. In the case of BHP Billiton, however, this was carried out in consultation with them, and there was no question of adopting a “gun to the head” approach, particularly as there were large multi-national companies involved.

Mr Dames said Eskom would report back to the Committee on the Medupi work stoppage, but pointed out that major multi-national contractors were involved, and there was a need to work closely with them to help resolve their labour issues. Eskom needed the support of these contractors, as it could not carry out the work itself.

Responding to a suggestion that South Africa’s lack of experience might prove a disadvantage in completing major projects on time, compared to the situation overseas, Mr O’Flaherty said at that a recent conference attended by overseas representatives of 80% of the companies building coal-fired power stations, it had been clear that they had experienced the same problems with contractors, and similar delays in their ability to deliver. The ten-day delay at Medupi was a concern, because there were critical milestones to be achieved, but Eskom believed it could “claw back” the time lost.

Mr Dames said he was aware of the public concerns about the “family days,” but fully supported the way in which Eskom’s managers were looking after their staff. In the light of the public relations implications, he had urged his managers to be prudent.

Regarding the charges which municipalities were adding to Eskom tariffs, he said municipalities had a constitutional right to supply electricity, and needed the revenue to remain viable. It was a fundamental issue which needed to be addressed.

The supply of a simple electricity connection usually involved connecting the supply from a pole down to a house, the cost of which was around R10 000. The challenges facing Eskom were illegal connections and the danger to children of loose wires lying around on the ground.

Mr Dames said he did not know about the Soweto electrification loan, but assumed it had been repaid. Eskom was working with the government and the Soweto metro council to resolve the R4,5bn debt situation. He was also concerned that only 16% of electricity usage was being paid for in the township. Eskom was looking at the use of solar water heaters to save consumers money.

The payment situation at municipal level was under control. Eskom had worked closely with provincial premiers and municipal mayors, and everyone now had a clear view on how to handle matters – if a consumer did not pay, the supply was switched off.

The rural electrification programme required a large number of households to be connected, mainly in KwaZulu-Natal and the Eastern Cape. Funding for this needed to be provided by government.

The power reserve margin varied from single digit figures during the critical 5 pm to 9 pm period, to between
15% to 19% at other times.

Eskom’s plan for renewable energy was that this would initially be sourced (3 700MW) from independent power producers (IPPs). Eskom would start its own 100MW wind farm this year, followed by the solar facility in the Northern Cape.

The success rate in the learnership programme and details of the R162m losses through crime and strike action would be provided to the Committee in writing.

Eskom would look at how to forge stronger relations with FET colleges in order to enhance their role in the provision of skills training.

Most of the legal contraventions related to emissions from power stations, and water drainage and tree cutting issues.

Regarding the quality of coal, Eskom had very little recourse with cost-plus mines, but it could impose penalties on other mines. It was working on the problem by blending coals of different qualities.

It was important to ensure that the impact of the reduced tariff increase did not affect the long-term financial viability of Eskom. There needed to be certainty that the tariff would enable the utility to be cost-effective.

There were no vacancies in Eskom’s top management, as these had all been filled.

The 83% figure for household electrification was purely for new connections, and did not include reconnections.

Mr Dames conceded that Eskom’s gender equity performance was not adequate, and more should be done to improve the role of women in the organisation.

He agreed with the suggestion that the increased use of alternative energy sources, such as solar power, together with increased energy efficiency measures, had contributed to a decline in electricity sales.

The Chairperson commended Eskom for the quality of its presentation, and thanked the presenters.

The meeting was adjourned.