Q3 2021 - (released November 2021)
SA's quarterly Private Equity & Venture Capital magazine
ITSMO of the same – as Eskom expects to miss DPE Roadmap date for transmission unbundling
by Michael Avery
Technically insolvent state power utility, Eskom, revealed in its 2021 integrated annual report that it is projecting to miss the target date for the proposed unbundling of its transmission division as part of the Department of Public Enterprises (DPE) Roadmap, which promised to oversee the unbundling of Eskom into three separate stand-alone businesses.
Tucked away on page 48 of the Report it states that“[r]egrettably, a number of delays are being encountered in preparation for the legal separation of Transmission. A number of dependencies are lagging behind, and this puts the finalisation of the separation by 31 December 2021 at significant risk. Guidance is awaited from DMRE regarding licensing and internal market operations of the Transmission entity. At the moment, our projection is that separation will not be achieved by the target date. Our intention remains to comply with the timelines set out in the DPE Roadmap, despite the obstacles encountered.”
DPE's Roadmap sets out timelines for the restructuring of Eskom from a vertically integrated utility into an unbundled state, with three wholly owned separate legal entities in the form of Transmission, Generation and Distribution, as follows:
Divisionalisation by March 2020
Functional separation by March 2021
Legal separation of the Transmission entity by December 2021
Legal separation of the Generation and Distribution entities by December 2022
Eskom’s debt remains unsustainable, attracting a net finance cost of R31,5 bn, turning an operating profit of R5,8 bn into a loss of R18,9 bn after tax. It reduced its gross debt by R81,9 bn – a 16,9% reduction – to an outstanding debt of R401,8 bn.
The utility’s finances have been a binding constraint on economic growth since load shedding first started in 2008.
As part of the country’s economic reconstruction and recovery in the wake of the pandemic, Busi Mavuso, CEO of Business Leadership SA, revealed that finance minister Enoch Godongwana told the Business Unity SA annual general meeting that the state was working to strengthen the security of supply, including the unbundling of Eskom into three separate units, while implementing a just energy transition towards a low-carbon economy. “These developments pose serious policy questions about the future of the electricity supply industry,” he said. “This will effectively introduce competition in the sector.”
The delay poses serious questions about the urgency with which government is trying to tackle the problem.
Anton Eberhard, a University of Cape Town (UCT) professor who heads its Power Futures Lab, called it “a very disappointing statement”.
“I don’t see any impediments around NERSA transferring the licence to a Transmission subsidiary,” said Eberhard. “Of course, there are a number of issues around the internal market, for example, the novation of IPP contracts, setting up contracts with Eskom generators, etcetera, but one would have expected more progress on this by now.”
It is a requirement, and key dependency, that bondholders and financial instrument holders approve any unbundling of Eskom.
While Eskom’s Annual Report states that, “[b]ased on engagements with investors, they question the ability of the business separation to bring about financial sustainability for the company”, Eskom bondholder, Futuregrowth says that it has not had any discussions with Eskom about the unbundling yet.
Olga Constantatos, Head of Credit at Futuregrowth, says it’s not clear to her what is meant by “engagements with investors”.
“Certainly, to our knowledge, Eskom’s unbundling has only been discussed in results presentations and other general market updates. There has not, to our knowledge, been a specific engagement with investors to discuss any plans or proposals for the unbundling and the resolution of the debt problem, nor to discuss any concerns we may or may not have on these issues.”
“The issue of negotiations with lenders is, of course, tricky,” says Eberhard, “but not impossible. 106 countries around the world have unbundled transmission.”
“Lenders, in general, look forward to a separate transmission company. It’s a well understood, stable and easily regulated business with a predictable, steady income. What lenders are worried about is generation, which carries most of Eskom’s debt. Again, we need more leadership and urgency in resolving these issues.”
“We welcome the idea of Eskom’s unbundling as a move to a decentralised, competitive and efficient energy ecosystem for South Africa,” says Constantatos, “but recognise that the detail of how this is done, and the allocation of assets, cashflows and debt to the generation, transmission and distribution subsidiaries is important to understand. The unbundling on its own is not going to restore Eskom to financial and operational sustainability – Eskom’s debt problem needs to be urgently resolved, as well as its high cost base addressed, and these are key determinants of Eskom’s return to financial sustainability. As regards the ITSMO unbundling – from an investor’s perspective, we would need to have a degree of certainty that this entity is indeed “independent” of Eskom – and that it will buy electricity on a least cost basis from any electricity generation provider, regardless of who the electricity generator may be – be it Eskom, an IPP or some other generation entity. We cannot have a situation where the ITSMO is favouring Eskom’s generation capability as a means to ‘cross subsidise’ a sister subsidiary.”
Eberhard points out that transmission accounts for roughly 10% of Eskom’s total assets.
“It's really not a big deal, taking an Independent Transmission System and Market Operator (ITSMO) out of Eskom. Lenders will agree and welcome new opportunities for funding much needed new transmission assets,” says Eberhard.
Constantatos says there are two concerns though.
“The first is that any material transaction, and we would argue that fundamentally changing Eskom’s operating model and group structure is material, that effectively strips assets and cashflows out of the entity we as investors have lent money to, has the consequence of degrading our investment and increasing our credit risk. There needs to be protection for our clients’ money (the nations’ savings) against this.”
“The second concern is in the ITSMO’s ability (or not) to buy electricity at the cheapest cost, regardless of the identity of the generator of that electricity. In a decentralised energy world, the generation of electricity would be done by any one of a number of entities (Eskom, the IPPs, big industrial companies that set up self-generation and sell back excess electricity to the grid etc) and the role of the ITSMO is to procure that electricity “blindly”, as it were – on a least cost basis and with no preference to anyone. We cannot have a situation where Eskom’s generation subsidiary is being subsidised by some sort of preferred arrangement with the transmission entity – that would be a conflict of interests; is inefficient. It goes against the very idea of decentralising the energy eco-system and providing electricity as cheaply as possible to the nation.”
What does the Eskom bondholder make of this revelation of yet further delays around this critical unbundling process?
“To be frank, it is to be expected,” says Constantatos in an almost nonplussed fashion. “We’re used to plans and dates being published to much fanfare, and then experiencing significant slippage on the actual execution of the plans. This is a general problem and not isolated to Eskom. Furthermore, this is a complex matter requiring a cohesive and dedicated response, and likely requiring significant corporate finance, tax and legal advice. The unbundling is but one of the problems that needs to be solved – it goes hand-in-hand with resolving the debt problem which has not yet (to our knowledge) been meaningfully addressed with investors.”
But, more generally, at a ‘status-of-the-system’ briefing in late October 2021, Eskom COO, Jan Oberhlozer, provided a worrying overview of the utility’s poorly performing generation business. He acknowledged that Eskom’s weak performance had already resulted in 32 days of load-shedding so far in the current financial year, a concerning trend compared with 47 days for the entire previous financial year. Eskom again emphasized that to eliminate load-shedding and stimulate the economy, there is an urgent need for additional capacity. But where are we going with all these promises and with Eskom’s poor performance taking longer and longer to fix? It’s a question that sits uncomfortably with an administration trying to sell South Africa to investors on a reform ticket.