Department of Public Enterprises Quarter 4 performance: hearing

Meeting report

Department of Public Enterprises: Briefing

Mr Richard Seleke, Director-General (DG): DPE said that the presentation outline would focus on areas of under/over expenditure, 2016/17 Departmental performance information, reasons for non-achieved targets, progress on medium term strategic framework (MTSF) and National Development Plan (NDP) targets, and progress on Auditor General of SA (AGSA) findings, State Owned Companies’ (SOCs’) key risks and opportunities, and the progress on the Standing Committee on Appropriations’ (SCOA’s) recommendations regarding ESKOM.

The DG said that to date, the Department had spent of 94.7% (R253.78m of R267.98m) of its budget. The underspending of 5.3% was due to vacancies as a result of the re-alignment of the organisational structure.  

The Department’s overall 2016/17 performance was 82%, with the achievement of 18 of its 22 targets. The reason for the non-achievement of all targets was due to delays in procurement processes. The SharePoint project was already in the testing phase. The Department had not received adequate proposals from the market on the services required to deliver on the project. The request for proposals had been re-issued. The Department had lost human resources critical to the achievement of the target in the middle of the financial year.  Service level agreements were being fast-tracked for tertiary institutions to assist in developing the concept for the project. Further consultation was required on the capital structure optimisation strategy, and in order to ensure that the project progressed, periodic sessions on investment and funding had been put in place as a platform to achieve the desired goal.

Regarding progress on the MTSF impact indicators, 6 244 MW of electricity had been procured and 2 904 MW was already being supplied to the grid through the Renewable Energy Independent Power Producer Procurement (REIPPP) programme, and 2 127 MW through Eskom’s build programme. Currently there was excess power in the grid due to suppressed demand and the delivery of the build programme. The draft Road Freight Strategy had been completed and approved by the Economic Sectors, Employment and Infrastructure Development (ESEID) cluster. The strategy was on its way to Cabinet.

Mr Seleke reported on the progress on AGSA findings, which had said that all current matters as at 31 March relating to litigation and claims should be included in the contingent liability note. The Department had to ensure that the information included as part of the contingent liability note in relation to state guarantees had been reviewed at an appropriate level prior to inclusion in the annual financial statements. It should implement adequate controls and processes to ensure compliance to laws and regulations. The Department had obtained a clean audit opinion for the financial year ended 31 March 2017.

Regarding the SOC’s key risks, proactive cost-containment measures had been implemented, with the Eskom  business productivity programme target being savings of R60 billion in five years. Capital investment programmes had been deferred to manage borrowing costs, to a maintain positive cash flow and to earn a return on assets; SOC specific strategies were being implemented to pursue sales volume opportunities by diversifying nationally and across the border; DPE was critically assessing the competitiveness and validity of each of the SOC's current business models and monitoring the pursuit of opportunities in Africa. Initiatives were being implemented to meet energy demand and to enhance collaboration with other state organs to address the risk.

The DG said SOC opportunities were as follows:

• Improving the partnerships with SA Airways (SAA) as a STAR alliance member;
• Achieving an increase in international traffic;
• Identifying and exploiting cargo carrier opportunities;
• Restructuring of the state-owned airline’s asset portfolio;
• Marketing product innovation and differentiation;
• Greater collaboration with different spheres of government and other SOCs;
• Participation in the Denel South African Regional Aircraft Development Programme;
• Partnerships with local and provincial governments on tourism opportunities;
• Possible maintenance, repairs and overhaul partnerships with Denel;
• Network expansion – new domestic routes to grow the local economy and increase revenue;
• Collaboration with other state organs that had the capability to develop information communication technology (ICT) solutions;
• Exploitation of existing underutilised infrastructure, such as municipal airports;
• Network expansion - new regional routes.

At Transnet, the transformation opportunities included enhancing the participation of black-owned businesses in rail, pipelines and port project opportunities, as well as the development of small and medium enterprises (SMEs). The DPE would facilitate engagements with provincial and local governments in order to address spatial planning challenges that affected Transnet’s operations. It would enhance collaboration in the development of an integrated government incentive framework and other benefits that would support job creation. There were opportunities for manufacturing and maintenance in the areas of rolling stock (for freight and passengers), ship repairs, boat manufacturing and cranes manufacturing. Transnet International Holdings would form part of the Transnet Group, and would focus on international businesses such as the manufacturing of rolling stock (locomotives, coaches and wagons) the development of ICT logistics solutions, and the development of infrastructure (pipelines, railways, ports and terminals) in other Southern African Development Community (SADC) countries and the rest of Africa in order to foster greater regional integration.

The DG said that in terms of the Committee’s recommendations regarding Eskom, the entity continued to present both financial and non-financial presentations to various committees of Parliament to provide updates and to highlight the various strategies to monitor both the operational and financial sustainability of the entity. A business productivity programme targeting a saving of R60 billion had been introduced over the Multiyear Price Determination Period (MYPDP), and since inception Eskom had saved R48.7 billion against the target. The entity remained on course to achieve the target by March 2018.

All vacant positions had been filled in the 2015/16 financial year, with the appointment of the Chairperson, CEO and CFO. The CEO had resigned in December 2016 and an interim CEO had been appointed.

Eskom was implementing the SMS (Sandton, Midrand, Soweto) strategy for prepaid electricity. All stakeholders had been consulted throughout the process.

The Minister and the DPE monitored the adequacy of all the internal controls at Eskom on a continuous basis. Where gaps are identified, these are communicated through various structures including, but not limited to, the Chairpersons’ Forum, investor briefs and one-on-one engagements between the Minister and the Chairperson, as well as the DG and the CEO. The Minister was in the process of filling all vacancies at Board level, to strengthen the functioning of the Board and its committees.

The build programme continued to contribute towards skills transfer. A total of 3 048 learners had been supported in the 2016/17 financial year. R1.54 billion had been spent on training and development.

Eskom communicated to the public through its quarterly ‘state of the grid’ address.

The Eskom Board had approved a turnaround strategy in September 2015, and had presented an update on its implementation to the study group on public enterprises on 2 March 2016.

Eskom continued to prioritise the strengthening of its transmission lines. An amount of R3.9 billion had been spent in the 2016/17 financial year to ensure compliance with the minimum network redundancy requirements of the N-1 code. From inception to date, Eskom had delivered 6 898.4km of transmission lines and installed and commissioned 34 390MVA of transmission transformer capacity.  At the distribution level, 1 661km of lines, 287km of cable and 1 322 of MVA had been completed at a cost of R5.1 billion.

The entity had a dividend policy in place which was based on a forward-looking cash flow/modified residual approach, in respect of which excess cash accumulated would be returned to the shareholder. The Energy Regulator had approved Eskom’s revenue requirement. It had subsequently submitted a suite of tariffs for various customer categories. The Regulator had approved the tariffs for implementation.

Eskom: Briefing

Mr Johnny Dladla, Interim Group Chief Executive Officer: Eskom said that key highlights and issues included the new build programme being on track, surplus operational capacity being available, a significant improvement in generation plant performance, an improved financial performance with a healthy liquidity position, and a qualified audit opinion. Governance and contract management issues were also coming on well.

Eskom’s financial, operational and socio-economic performance had improved in the 2016/17 financial year. Earnings before interest, depreciation, tax and amortisation (EBITDA) were R38 billion, representing an increase of 14.4%. Revenue had increased by 7.9% to R177 billion. Own generation costs had decreased by 8.5% to R60 billion, with total primary energy costs down by 2.3%. Cash generated from operating activities had increased by 23.1% to R46 billion. Cost savings of R20 billion had been achieved against a target of R17 billion, and 53% of funding for 2018 financial year had been secured.

In terms of operational performance, generation plant performance had improved significantly from 71.1% to 77.3%. The Medupi Unit 5 (794MW) had gone into commercial operation on 3 April 2017. The following units had been synchronised to the grid: Medupi Unit 4 on 31 May 2017, and Kusile Unit 1 on 26 December 2016, achieving full load in March 2017. All Ingula Units were in commercial operation, adding 1 332MW installed capacity. 585.4km (2016: 345.8km) of lines had been constructed and 2 300MVA (2016: 2 435MVA) of transformers had been commissioned. A 765kV network to the Western Cape had been completed.

In terms of socio-economic performance, 207 189 (2016: 158 016) households had been electrified. Procurement from Broad-based Black Economic Empowerment (B-BBEE) compliant suppliers had been 98% (2016: 82%), and spending with black-owned suppliers had increased from 34% to 41%. Local content contracted from the new build programme had been 86%. Procurement from black women-owned suppliers had been 15%, exceeding the target of 12%. Employment of female employees in senior management positions had increased from 28% to 37%.

Mr Dladla said that Eskom’s financial performance was gradually improving, with most key indicators being positive. Electricity sales were declining, especially among the large power using customers. Primary energy costs had decreased by 2.3% from 2016.  Independent Power Producers’ (IPP’s) production volumes had increased by 44%, and costs had increased by 37%.

Overdue debt was amounted to R17bn, and the main contributors were municipalities and Soweto. Arrear debt by municipalities, including interest, had increased from R6 billion to R9.4 billion. Payment arrangements (PAs) had been signed with 60 municipalities, with 20 fully honouring the PAs, and 11 partially. During the year, 15 494 split meters had been installed in Soweto and Kagiso, with 13 255 converted to prepaid. 14 105 smart meters installed in Midrand and Sandton would be converted to prepaid meters.

Mr Dladla said that 53% of funding for 2018 financial year had been secured. Generation plant performance had significantly improved, and as a result there was surplus capacity. The Energy Availability Factor (EAF) had improved to 77.3% from 71.1% the previous year, exceeding the target of 72%. Unplanned breakdowns had reduced from 14.9% in 2016 to 9.9% in 2017. Both Koeberg units had set performance records. There had been reduced reliance on Open Cycle Gas Turbines (OCGTs), with a total of R340 million spent on OCGTs compared to R8.7 billion in 2016. A total of 13.2Mt of coal had been transported by rail, in line with the previous year. Since inception, a total of 5 027MW of IPP’s power had been connected to the grid, with 3 110MW of renewables. The transmission and distribution reliability performance was within the acceptable limits.

To address the audit findings, the recovery plan would consist of a three-tier process, with the focus areas including documentation management, contract management and consequence management. This would be dealt with through the verification of all the findings, corrective measure to ensure the findings were closed, internal assurance throughout the process, external assurance prior to the year-end audit, and continuous monitoring by management of the improvement plans.

A focus had been placed on specific leadership initiatives to aid in addressing the audit findings. The Interim Group CEO and the Acting CFO would drive leadership compliance with the Public Finance Management Act (PFMA) through initiatives that instilled discipline, ethical behaviour and professionalism. Eskom would continue to implement consequence management and remedial measures for contraventions, in line with current policies. Awareness training would be rolled out with the procurement tender committees. Reporting to Treasury and the Department of Public Enterprises would be improved to ensure alignment with the Preferential Procurement Policy Framework Act ( PPPFA). The Eskom Board audit and risk committee would continue to provide oversight over the process to deliver an unqualified audit opinion.

Mr Dladla concluded that in respect of the assessment of major risks and treatment plans, various risks had been identified with proposed treatment plans.

Discussion

Ms N Mazzone (DA) said that the Eskom presentation had referred to one of the qualified audit opinions, which was the governance of contracts with management issues. For a long time, the Committee had expected full disclosure facilitated by the DPE’s complete contracts assessment of management, and also the procurement process being made fully transparent. However, Eskom had fallen short in terms of transparency, and it came down to the fact that no one knew how people were employed at the entity. The most issue recently had been that of the CEO, where the contract had not been released. She asked when they would get full disclosure of the contract arrangements and full disclosure of the procurement processes, and that this was done according to the law through the DPE.

Mr B Topham (DA) asked the DPE to explain the R267m which could not be tracked as to where it had been spent, and which had been completely fruitless and wasteful expenditure. He asked Eskom what its average price increase for its customers was, because there had been a 7.9% revenue increase at Eskom. What was Eskom asking the NERSA for over the next five years? In terms of Eskom’s EBITDA of R38bn, what had the actual net profit been? What was Eskom going to do to bring down the price of electricity, which was a big concrn for the country?

Ms D Senokoanyane (ANC) asked for an explanation for the electricity generation reserve margin increase, as currently there was excess power in the grid due to suppressed demand and delivery of the build programme. She asked how big the problem was with regard to prepaid customers that were supplied electricity directly by Eskom, and what the challenges were in those areas.

Ms Senokoenyane asked what the challenges were in terms of the AG’s report in slide 14 of the Eskom report where the AG raised concern on financial statements.

Mr A McLoughlin (DA) asked whether the Department had achieved what it was supposed to have achieved with the money it had received, because the Appropriations Committee was responsible for dishing out the money and had to look back at what the Department had done with that money. The problem with the DPE presentation was that the overall impression was it had spent 94.7% of its budget, but achieved only 82% if its targets. Obviously something was not quite right, because it was spending too much money in relation to its achievements. This 94.7% was a reduction from the 99% of last year. Why was the Department spending more money with less achievement, and yet it had not spent money as it had in the past.

In the ESKOM presentation, it was mentioned that the new build programme was on track, and that the Kusile and Modupi plants were operating on their finishing dates He asked for clarity regarding the exact dates of finalisation, what the final costs of these programmes would be, and how far they were looking into the future. He objected to the change of the R60bn to equity because he did not know what they had done with the R60bn. Shortly after that, Eskom had borrowed more money from the Chinese -- around R20bn. What were they doing with all this money? However, in slides 17 and 19, Eskom complained of a shortfall, which brought them back to square one. What kind of funding they were looking for from government?

Mr N Gcwabaza (ANC) echoed what had been said by Mr McLoughlin, that the spending patterns of the Department had fluctuated in the past two years down to 94.7% currently, but at some point they had been high at 99.3%. He asked what the reasons were for such inconsistencies, and what the Department was doing to correct them. What had been going on with the infrastructure project, which had been budgeted at R300bn between 2009/10 to 2016/17, with regard to road freight moving to rail since the draft road freight strategy had been completed and approved, and on its way to Cabinet? If that infrastructure project had been delayed, at what costs it had been delayed? Why was this draft road freight strategy taking place only now, and not during all the periods up to this point? What was the total budget currently of the infrastructure project?

Regarding the improved operational performance of sea ports and inland terminals, why had the old airports project been suspended? Where was it now, and at what cost had it been suspended, and when did they plan to proceed with the project and complete it?

He asked where the Department was in terms of the minimum set aside of 30%, what the budget of set aside for SMMEs and cooperatives was, and to provide details of the number of SMMEs and cooperatives that engaged with the Department -- their profile in terms of women, youth and people with disabilities, and the geographic spread. The Department should give a breakdown of the 60% achieved on youth employment and the monetary value of the infrastructure jobs for the youth.

He asked the Department to explain the irregular expenditure, and what steps it would take to correct it. The Committee would no longer accept any explanation by the Department and its entities on irregular expenditure, fruitless and wasteful expenditure.

What steps had Eskom taken to correct the qualified audit findings, specifically where the AG had stated that Eskom did not have adequate systems to identify and correct irregular expenditure? What was it doing to stamp out illegal connections, meter tempering and so on? What was being done regarding local content procurement to strengthen local industries, which was critical for the country’s economy and job creation? What was going on with the ‘green’ contracts?

Mr N Singh (IFP) asked the Department who the tenants of the dug-out port in Durban were, and how much they were paying, because millions had been spent on that acquisition. What was long term vision for that project? He asked where the Department was with the Shareholder Management Bill. Was there was an end in sight to the rising Eskom debt, because in Soweto communities were complaining about the prepaid meters? Had there been any interaction with other Ministers, local government or Treasury? Should there be a point when one had to say, write off all this debt and start paying for whatever one was using going forward, because this would not end. He asked what the background was with regard to Independent Power Producers reaching an agreement with Eskom, so as to bring them on board. What was the status of Eskom’s investigation of some officials who were implicated in irregular expenditure?

Ms S Shope-Sithole (ANC) congratulated Eskom for taking the country out of load-shedding, because investors had regarded South Africa as a country which did not have a reliable energy supply. She asked the Department to provide its internal audit statement so that the Committee knew what the internal auditor thought about the Department. It was asked to provide a list of ‘green’ contracts in each State Owned Company (SOC). How much had been set aside by the DPE for women in each SOC? What was the relationship between the Department and Treasury. Did the DPE comply with the law and abide by the rules of the PFMA, the procurement rules and Treasury regulations? How far had the Department and its entities gone with radical economic transformation, as promoted by the President?

DPE’s response

Mr Seleke responded that oversight was a very important function of the Department, and it realised that it did not have sufficient capacity to deliver on the oversight role. A lot of policy decisions had been made in the past, and they could not refer back to some of them. With the required oversight, some of these decisions could have been avoided. Last Thursday and Friday, the DPE had had an intensive meeting with the transport regulator, which had wanted to stop the trains from moving on 1 September because the permit had expired. They had explained to the regulator what would happen if Transnet stopped for one day, pointing out that OR Tambo would not function, airports and harbours would stop. In reality, the transport regulator had made a decision on their own compliance, so the Department had intervened on behalf of Transnet, as there had been a breakdown in the relationship with other sector departments. Special people were needed to address whether the company had been at fault, or whether there was a problem with regulation itself, so that a remedial report could written for the DPE to make a direct submission to the Minister of Transport for inputs to the regulation to be corrected. If one looked at other sub-sectors with the core responsibility in this area, one would realise that four people were not enough do this work. More capacity was needed to see some of the issues that fell between the cracks.

Another challenge was the realisation that in last 12 months there had been intensive communication among civil society around the issue of SOCs. They had analysed this deeply and concluded that this was because the space was congested -- there was no more competitive space left for other businesses to grow. They ended up seeing the only opportunity for growth was to acquire the space that was filled by SOCs, and this created a plethora of problems. The Department’s strategy to resolve this challenge was to create new markets on the African continent, and it had established a task team to advise how best they could link up the local private sector and the SOCs, and come up with the plan to enter into the continent. This would provide a solution for both parties, instead of each one eating the other for their own survival. Therefore, this was the role of the Department going forward into the future -- building new capacity, a capacity that would see Transnet building infrastructure into the continent.

What did the DPE expect the Department of International Cooperation (DIRCO) to do in this regard? Which countries were of interest at the moment? What was the Department of Trade and Industry (DTI) supposed to do to optimise the relationship between the private sector and SOCs? The issue at hand was on localisation, because as much as they were talking about localisation, the greater portion of local companies were multi-national companies. Therefore they had realised that for them to create local companies that were based on local people, it required another approach altogether. So they were sitting down and applying their minds to a ten-point programme, which was why Transnet had been at that meeting on localisation to explain the challenges they were facing on a day to day basis. Although they could not source some of the components they needed right now, they could develop a three-year plan to get them. However, they could run the risk of giving a small company a contract to supply them with wheels, but then find they did not meet the standards they needed, and the next thing the company would incur a huge loss. Which parts could be considered for localisation and which ones still needed to be imported, was the dilemma they faced.

On the issue of the transparency of procurement, they had held a meeting with National Treasury and set up a standing committee where they were working together. They intended to come up with new and creative ways of ensuring that transparency was there for major contracts. They realised that Transnet played a key role in creating the major companies in the mining sector today. However, they were located among communities, and this was a big debate which required consideration by Members of Parliament. The minerals were underneath where people lived and were there for the rest of their lives, but the Department of Mineral Resources was giving a permit to somebody else for other reasons, which created difficulties. Therefore, the Department wanted get rid of this situation and begin to assist small mining companies who were locally based, to mine and supply coal to Eskom, which in their view was localisation that stimulated economic growth and made sure that the money spent by Eskom remained in the community. That was more or less a strategic intervention going forward, because they had learned lessons from what they had been dealing with in relation to the mines, and all the trouble that came back to Eskom. Eskom was currently discussing with Treasury what was needed to build locally-based enterprises.

The DG said that the irregular expenditure of the Department had been for the previous financial year. In the current financial year, they had had no irregular expenditure.

There were other creative issues that had been put on the table in front of the DDG responsible for energy. If the economic growth was less than 2%, and the unemployment remained at the level it was, they have to introduce a new model altogether in the form of a social safety network over and above than the one which was existing, including renewable energy sources to support communities.

Regarding the Eskom debt issue, the Department was aware of the need for a long-term solution, even though there had been comments that there was no hope of this happening. However, they were looking at it to find a solution.

Ms Benedicta Mogaladi, Chief Financial Officer (CFO): DPE said that in 2015/16 the Department had spent 99.8% and in 2016/17 it had spent 94.7%. The variance between the two financial years was because in 2015/16 they had had a transfer payment of R23bn which was made to Eskom. Although percentage-wise it looked as if the Department had spent all the money for 2015/16 financial year, in monetary terms they had returned R22m in 2015/16 to National Treasury. In 2016/17 they had under-spent by R14m, and that R14m had included compensation of employees. On goods and services, they had spent 99.6%.

The DG said the Department had several vacancies which had contributed to the under-expenditure trend. He agreed 100% with the view that in order for the economy to grow, they needed cheaper electricity, which was a principle everywhere else. At present, the emphasis was around the energy mix. They had to reach a decision on what they needed at this point in time of the economy -- whether they were going to push for an energy mix that was going to increase electricity costs, which would not be to the advantage of investors coming to invest. Electricity was a key part of investment decisions, unless there was an option of subsidising electricity in certain sectors. The coal base still provided the cheapest form of electricity.

Regarding consequence management, there were many cases where action had been taken at both at the managerial and departmental level where officials had been found doing wrong. Disciplinary action had been taken and some had been dismissed. Even in the SOCs, there were internal disciplinary actions to deal with these matters.

The DG said the DPE had reported to Parliament that they had recovered close to 12 months of the delay in the build programmes of the MEDUPI and KUSILE power stations, so the units were operational and the electricity had been put into the grid. This was a concern for them, because as the new unit came online it meant that their excess electricity was increasing, and what they did with it was what mattered. This was a conversation they were looking at as an ‘Africa strategy,’ and finding better ways of exporting this electricity to the continent. However, history told them that there were payment challenges in economies that were not growing around the continent. The Chinese were nevertheless profiting on the continent, and therefore the DPE should learn from them how they do it, and what kind of contractual arrangements they had in place. At face value, it seemed like a  ‘buttering system,’ and they had to find ways of doing that because by supplying the continent with electricity, the economy would grow and South Africa stood a better chance of benefiting. He was discussing these issues with the CEOs of Eskom and Transnet on a regular basis.

Referring to the dug-out port project in Durban, the DG said that where SOEs became pertinently important for the economy compared to broader private sector, was that they were able to make an investment in an area that would not give benefits now, but would give benefits in the future. That was why Treasury was pushing hard that SOEs should offload their non-core assets, because they were weakening their balance sheets. Offloading these other assets would allow them to fine tune their balance sheets so that they could begin to implement risky projects. Where they made losses they needed to start something else, and if they studied the Chinese SOCs, all of them were diversifying in multiple sectors purely to give them the rigour to withstand any shock when they implemented. Transnet was faced with the same situation, so they were having solid discussions around offloading non-core assets.

Regarding ‘green’ contracts, it was justified in the past to give companies 60-year contracts to supply coal to Eskom because they wanted certainty and continuity of supply to maintain the economy. However, at the moment it might not be justified. It was something the DPE was looking at and was part of the conversation it was also having with Treasury, because there had been a lot of public discussion about issues that could have been dealt with internally. Those issues had affected investor confidence and also affected the relationship of private companies and the SOEs, because companies compete with one another. Therefore, they were looking at those issues together with Treasury, and there would be benefits coming out of that.

Mr Dladla replieed to the question about how people were employed at Eskom, saying that it was a normal process, where jobs were advertised and people applied for them.

The Department had put corrective measures in place to deal with the issues that had led to the qualified audit. These would be monitored and regular feedback given to audit risk committee of the Board of Eskom.

Mr Calib Cassim, Acting CFO: Eskom, referred to the revenue increase in the 2015/16 financial year, and said that the average increase awarded to Eskom by the regulator had been 9.4%. In the same financial year, Eskom had grown profit at the bottom level to R888m, and at a company level it was R870m. Currently it had no intention of asking for funds from the Treasury through the Committee or the DPE. The current plan was that they would fund some of their operations, cut costs and keep costs at inflation levels. When the balance sheet improved, they were hoping to release some of the guarantees back to National Treasury.

The meeting was adjourned.