Restructuring Report: Eskom ‘Fundamentally Insolvent, Permanently Impaired’

Eskom, South Africa’s state-owned utility that produces nearly 90% of the African powerhouse’s electricity, is saddled with liabilities, unavoidable expenses, and stranded costs that exceed $113 billion, and for various reasons, it is “fundamentally insolvent, permanently impaired, and will never be a true going concern enterprise under its current legal, operational, and governance structure,” concludes a report recently issued by an independent chief restructuring officer (ICRO).

The bombshell two-volume report issued on Oct. 17 by Abu Dhabi–based consulting firm CRO Advisers—a firm that specializes in restructuring and recapitalization of sovereign government assets—was authored by the firm’s chairman, K.W. Miller, whom Eskom stakeholders appointed as ICRO advisor. As part of its independent restructuring analysis, CRO Advisers sought to assess the financial and operational health of South Africa’s Treasury as it relates to Eskom, as well as Eskom’s own governance, credit risk, and quantification. As Miller told POWER on Oct. 22, another key objective was to determine a “realistic path to restructure Eskom, the South Africa electricity sector, deployment of future resources, and achievement of true economic growth.”

But the report’s conclusions are damning. Scrutinizing every detail about Eskom’s finances, operability, and governance, they put the 1923-established vertically integrated utility’s current operations and financial situation under a harsh light, drawing a direly pessimistic picture of the utility’s scramble to avert financial disaster.

POWER contacted Eskom for its view on future restructuring, but an immediate response was not received.

‘Hard Facts’ that Eskom Stakeholders Need to Face

As POWER has reported, the utility resumed power cuts last week after a seven-month lull, and it continues to flail financially, owing largely to the construction of two massive defect-ridden coal plants—the 4.8-GW Medupi and Kusile projects—and a significant decline in liquidity that is exacerbated by lower than required price increases awarded by the National Energy Regulator of South Africa (NERSA). On Oct. 11, Eskom took the desperate step of challenging NERSA’s latest tariff decision in court, even while it underscored that its operations are critically hobbled by a stunning debt burden of 450 billion rand ($30 billion).

South Africa’s government, meanwhile, acknowledges the utility is “too big and important” for the government “to let it fail,” which is why it moved in August to inject $8 billion into the beleaguered utility over a three-year period. However, the government bailout rests on the condition that the company establish a “restructuring office” that would deal with debt and “interrogate various proposals to resolve Eskom financial challenges.” It has suggested one avenue would be to split the company into three entities, starting with the creation of a transmission entity—a recommendation that is in line with government ambitions dating as far back as 1998. President Cyril Ramaphosa in October, however, nixed full-out privatization, claiming Eskom’s power plants are “Crown Jewels,” and that “South Africa is not inherently in the business of selling power stations.”

But according to the ICRO’s findings, the “hard facts that must be faced by all stakeholders” are that “while Eskom is a vertically integrated utility on paper, it has devolved into an operationally dysfunctional, financially insolvent, unreliable and corrupt entity.” At this time, faced with “severe financial and operational challenges and malfeasance,” Eskom is “not ready” to be broken up into separate operating companies, the report concludes.

Soaring Debt and Future Liabilities

Perhaps most critically, Eskom’s current management accounts, internal costing, and qualified financial statements are “not reliable,” it notes. “The ICRO finds that material financial, operating liabilities and unavoidable costs are not properly accounted for, nor are they captured in the Company consolidated financial statements,” the report says. It also alleges “there is no reliable cash management and control structure at Eskom,” and it urges the government to appoint new independent external auditors to examine Eskom’s books and records.

The ICRO’s as-is case study suggests that the utility’s aggregate debt and future liabilities are “at least 2.3 times the total book assets of the company before adjustments”—and currently, that stands at a “simply staggering” 1.7 trillion rand ($115 billion). Compared to a “full restructuring strategy,” which the ICRO proposed, a “do-nothing” strategy by Eskom and its stakeholders would burden the utility with a deficit of 591 billion rand ($40 billion)—and that is certain to yield “staggering liabilities and insolvency.”

The utility is “nearing the endgame,” warned Miller. Underscoring the urgency for stakeholders to act now, he noted Eskom lacks “true independence from political pressure,” but the South African government “has not seized the initiative, primarily due to continued protracted political disputes, archaic ministerial oversight, and core lack of risk management oversight and expertise.”

Government Issues New IRP

Meanwhile, Eskom’s own attempts to fix its crippling issues have collapsed. Over the past 15 years, the company has hired more than 10 South African CEOs and replaced numerous board of director members, but “corporate governance and management have completely failed,” Miller said.

Its future plans are also problematic. To cover short power supplies—which have been exacerbated by faulty maintenance—the company is relying on costly, diesel-fired open-cycle gas turbines and leaning on independent power producers (IPPs).

On Oct. 18, the government issued its long-awaited 2019 integrated resource plan (IRP), which will serve as an energy blueprint through 2030. The plan calls for 1.5 GW of new coal-fired capacity, 2.5 GW from hydro, 6 GW from solar PV, 14.4 GW from wind, 2 GW from pumped hydro storage, and 3 GW from gas. The 2019 IRP also suggests extending the design lifetime of South Africa’s sole nuclear plant, as well as adding new nuclear capacity in the future. Minister of Mineral Resources and Energy Gwede Mantashe last week told reporters that while coal will continue to play a “significant role in electricity generation” for the coal-rich country, renewable energy combined with storage also presents good prospects to build out distributed power closer to demand.

But according to the ICRO’s report, it is already evident that Eskom is “paying excessive amounts for power” purchased from renewable IPPs as well as those operating gas and diesel turbines. As Miller noted: “Renewables are not the solutions to Eskom and South Africa’s energy and economic problems at this stage. They are still significantly more expensive than traditional resources, on an all-inclusive system wide basis factoring in the balancing and intermittency costs.”

For now, Eskom’s most important recourse would be to appoint a non-South African senior energy and infrastructure chief restructuring officer (CRO) who could independently control the utility’s assets and finances, with market-based governance and risk-management controls in place, the report recommends. It suggests the new CRO report to an independent board of directors and the Minister of Finance.

South Africa’s Economy on the Brink, and Eskom Is the Anchor Around its Neck

Miller said CRO Advisers, which specializes in complex restructuring and recapitalization of distressed sovereign government assets, state-owned enterprises, and infrastructure companies globally, is “prepared to provide” independent outside support and expertise. However, the process will require a “clear and transparent directive from President Ramaphosa.”

But here, too, he sounded a pessimistic note. In a separate brief issued on Oct. 20, CRO Advisors warned that the government would “most likely let South Africa go into complete economic collapse” before giving up control and agreeing to “stiff financial controls” required by current creditors, new investors, the International Monetary Fund (IMF), and other institutions, which could bail out the country if its economy spirals out of control.

The country currently faces “mounting global market pressure” as debt rises but gross domestic product (GDP) declines, it explains. “South Africa won’t be able to pay its bills for much longer,” the report says. “Government borrowing capacity is going down.”

Among factors that are crushing the economy are fuel taxes and internal power prices. “More than 50% of the South African fuel prices are made up by taxes, margins, levies, and other costs,” it notes. And without reliable and efficient power generation, the rate of deterioration of the industrial and mining sectors has escalated, it claims. “Sales and delivery of electricity to these combined sectors has declined over 25% since 2011. Mining has declined from 21% of the GDP in 1970 to less than 8% in 2019.”

“South Africa has essentially become [t]oxic. Corruption remains rampant, the energy sector has collapsed (Eskom) and will take [10] years or more to rebuild,” Miller said. “South Africa has run almost every major industrial company off or scared them from coming into [South Africa] with any real projects and capital. Those mining and industrial companies currently operating in South Africa are on the ‘margin’ operationally and financially,” he added.

And for now, the government of South Africa’s equity interest in its biggest burden—Eskom—appears to have been essentially “wiped out,” he warned. “Full restructuring of Eskom is the only viable and available option and should be non-negotiable for all Eskom stakeholders.”

Sonal Patel is a POWER senior associate editor (@sonalcpatel, @POWERmagazine)