Dames job at Eskom has become difficult

Brian Dames’ job has become even more difficult if not unbearable. Following speculation that knives are out for Dames, the National Energy Regulator of South Africa (Nersa) may have added more burden on Dames’ shoulders by clipping Eskom’s application for electricity tariff increase by half to 8%.

Eskom had asked for 16% average annual increase over the next five years citing its R340bn new capacity building programme. A widespread outcry that a 16% increase would cripple the economy won the day.

The Eskom situation is not very far to the South African National Roads Agency Limited (SANRAL) which forced the CEO Nazir Ali to resign, even though he was called back and accepted.

In its reaction to Nersa’s decision Eskom seems to have chosen to avoid confrontation. It issued a terse statement yesterday but the electricity utility did signal that it has been set on a difficult path.

Eskom said “We will have to study the decision in detail to understand its consequences and assess its impact”.

Eskom however added that the 8% average annual increase approved by Nersa allows for total revenue of R906.6bn over the next five years.

On its 16% tariff increase application the power utility had budgeted for R1.1trillion revenue over the next five years. This means the utility is set to be under budget by about R1.5bn. There will be fears that this could have negative implication for its massive infrastructure development programme.

Eskom said its application was based on the current regulatory rules and policy and its mandate to keep the lights on. The policy, said Eskom, “provides for the prudent recovery of input costs such as coal, maintenance and human resources, as well as the cost of servicing the debt raised to finance Eskom’s investment in South Africa’s energy infrastructure”.

If the utility’s previous statements are anything to go by, Eskom has to go back to the drawing table and rework its funding model. The utility had maintained right up to the last moment that it needed a minimum of 16% tariff increase to cope with its capacity expansion programme.

The R340bn development programme has to be funded by a combination of internally generated funds, revenue, and debt. The revenue portion is critical as a leveraging foundation. Funders will look at the revenue base to assess the commercial sustainability of the operation.

Eskom has said that it has already secure about 80% of the funding required for its capex. At this stage it is not clear what numbers metrics was used to secure this funding. The question to ask is: What number, in terms of tariff increase of the next five years, did Eskom use when approaching the debt market for funds? Did it use 16% to project its future cash flows as tied to its ability to repay its debt? This is an area which will worry credit rating agencies and will inform Eskom’s ability to raise debt going forward.

Eskom seems to have coped well thus far with the 25% increase which expires in March. Last year’s figures were impressive. Net profit for the 12 months ended March 2012 came in at R13.2 billion from R8.4 billion in 2011. In the 2012 financial report Eskom CEO Brain Dames stressed that the surplus will be re-invested to fund capital expansion over the next six years and to reduce debt.

In that report Dames noted that an appropriate tariff structure that allows for cost recovery, including return on assets is necessary to encourage investment in the electricity industry over the long term. He said this will ensure that South Africa has the energy infrastructure that it needs – and that the country can afford it. “Tariffs need to be set at levels that are sustainable, by allowing an appropriate migration to cost-reflective tariffs while taking into account the impact on the economy with provision made to ensure that low-income households are able to obtain electricity in a sustainable manner”.

It would seem that Dames has to go back and redo his numbers and he might need finance minister Pravin Gordhan to help him with these numbers. Will he?


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