At the end of June, the coldest part of the southern hemisphere in winter, in South Africa the electricity went out. For eight hours a day until early July, traffic lights went out, factories and offices closed, and food had to be served cold.

These were not the first power outages, but the worst so far. Periodic supply cuts over the past 14 years have already undermined business confidence and limited private investment in South Africa. In 2017, when he was leading Goldman Sachs Group’s sub-Saharan Africa business, Colin Coleman cited the difficulties of state-owned energy company Eskom as the biggest threat to South Africa’s economy.

This winter’s blackouts have finally prompted the government to take action. The National Treasury has pledged to cover part of the company’s 413 billion rupiah debt. President Cyril Ramaphosa changed the rules to allow private companies to generate more electricity – a plan that, while welcomed by business, will take years to have an effect.

Fixing South Africa’s broken utilities system and its shaky energy system is a critical test for the ANC ahead of the 2024 elections. ANC chairman Gwede Montashe has described Eskom as the party’s “biggest opposition”.

Eskom is “a litmus test of ANC’s ability to deliver basic services,” says Sridaran Pillay, Eurasia Group’s Africa director. “You can’t grow an economy without electricity and without the ability to spend on infrastructure.”

It was not always like that.

Founded in 1923, Eskom quickly built hydroelectric and coal-fired power stations, driven by the needs of the world’s largest gold mining industry. In the 1970s, the company began building a fleet of coal-fired power plants that are still in operation today. The apartheid state invested in infrastructure and industrial capacity as a bulwark against international sanctions. Eskom even built Africa’s only nuclear power plant.

The best energy company in the world

In the early 1980s, the company ran into financial problems after committing to building unnecessary factories. The government has appointed a commission to reorganize the management of Eskom. After the fall of the apartheid regime in the country in 1994, the company quickly connected electricity to millions of black South Africans. In 2001, the Financial Times recognized Eskom as the best energy company in the world.

But over the next two decades, Eskom’s fortunes suffered from erratic government decision-making and political interference. Around 2001, then President Thabo Mbeki decided that the power stations would be built by private investors and stopped Eskom’s expansion plans. A few years later, he reversed this decision, but by then the company had lost many of its skilled technicians.

A shortage of generating capacity led to regular blackouts beginning in 2008. In January of that year, the near-collapse of the national grid shut down gold and platinum mines for five days, and in July the government appointed Bobby Godsell, the former CEO of the gold mining company, as chairman to help stabilize Eskom.

“When I left the company in November 2009, the debt was much lower,” recalls Godsell. “For a long time, Eskom bonds have achieved lower risk [premium] than sovereign bonds.’

But the financial situation of the company deteriorated sharply. Today, these bonds have a risk premium of about four percentage points higher than government bonds.

After Godsell’s departure, Eskom accelerated the construction of Kusile and Medupi, two of the world’s largest coal-fired power stations. They were originally supposed to be completed in 2014. Instead, both projects are behind schedule, with a combined cost estimated at 464 billion rand, nearly triple the original budget.

To help fund the construction program, South Africa increased Eskom’s total debt to 350 billion rand in October 2010 from 176 billion rand a year earlier. Ten years before Eskom’s financial year ends in March 2022, the utility has increased the amount of borrowed money it has been guaranteed by the government by 324% to 328 billion rand.

The projects were accused of corruption, which in some cases increased costs. Hitachi paid $19 million to settle allegations by the U.S. Securities and Exchange Commission that it made $6 million in “improper payments” to Chancellor House, an investment arm of ANC with which Hitachi partnered to win contracts to install boilers at plants. In a separate settlement with South African investigative authorities, ABB agreed to return 1.56 billion rand paid for monitoring and measurement work at the plants. The ABB contracts were among a number of contracts Eskom entered into with international and local companies, the terms of which have changed many times. In some cases, the new terms cost Eskom several times the original amount. Neither Hitachi nor ABB have admitted wrongdoing.

The government’s policy of increasing the participation of black South Africans in the economy, aimed at eliminating apartheid inequality, resulted in Eskom favoring contractors and suppliers who were less experienced and often less efficient.

Local companies were hired to service Eskom’s plants instead of the equipment manufacturers who helped build them. Coal contracts once held by mining giants such as Anglo American and Glencore, which often moved coal to power plants on giant conveyor belts from nearby pits, have been awarded to smaller companies that sourced it more expensively from smaller mines.

These mining companies often received a higher price for their coal, says Lumkile Mondi, a senior lecturer in economics at the University of the Witwatersrand who has written extensively about Eskom.

Local companies “were given access and were treated differently in the Eskom process under political pressure,” Mondi says. “You have the start of Eskom’s balance sheet eroding.”

Some of these arrangements led to alleged corruption.

Under pressure

In 2015, Eskom and then Mineral Resources Minister Mosebenzi Zwane allegedly pressured Glencore to sell mines that supplied the utility to a company owned by the Gupta family, which was a friend of former president Jacob Zuma. Zuma’s son Duduzane had a stake in the company. Two of the three Gupta brothers were arrested in Dubai this year and are awaiting extradition on separate corruption charges. The Ramaphosa administration said at least 500 billion rand had been looted during Zuma’s nine-year rule. Zuma and the Guptas have denied wrongdoing.

Meanwhile, municipalities were 49 billion rand behind in paying their electricity bills as of the end of July. The national government did little to encourage them to pay even after Eskom threatened to cut off Pretoria in August.

The energy company, when asked about the crisis it faced, blamed the national regulator. The company claims it is prohibited from setting adequate electricity prices to cover its costs and finance the construction of the new plant, forcing it to take on debt. The regulator claims that Eskom’s revenues have grown by 320% in a decade, even as electricity sales have fallen. Pravin Gordhan, who oversees Eskom as public enterprises minister, blames the crisis on corruption and management instability. Eskom, whose CEOs are appointed by the utility’s board in consultation with the government, has had 14 CEOs since 2007.

As Goldman Sachs’ Coleman warned, Eskom’s woes are damaging the country’s economy.

“South Africa’s original industrial model was based on cheap labor and cheap electricity,” says Peter Worthington, senior economist at Absa. “We are no longer a country with very cheap electricity.”

Energy Minister Gwede Montashe. Image: GCIS

Eskom’s desire to raise prices does not have much support. “Transferring these inefficiencies to the wider economy through ever-higher tariffs as the only lever is wrong,” says Olga Konstantatos, head of credit at Cape Town-based Futuregrowth Asset Management, the 193 billion rand money manager that holds Eskom bonds.

ANC chairperson Montashe, who is also South Africa’s energy minister, was particularly critical of the company’s explanation. “Let Eskom blame anyone and everyone,” Mantashi says. “Let them hide behind everyone.” He proposed setting up a second state-owned energy company to compete with Eskom.

Ramaphosa has promised to fix Eskom in every state in the country, which he has given since coming to power in 2018. A few plans have been published, but little has happened.

Public Investment Corp, which manages pensions for South Africa’s public workers, has offered to convert about 90 billion rand worth of its Eskom bonds into a stake in the company. The government considered listing Eskom on the stock exchange or moving some of its debt into a special vehicle. Deputy Finance Minister David Masondo suggested some of the debt could be forgiven, while Finance Minister Enoch Godongwana advocated selling the company’s coal-fired power plants.

All these proposals, which could lead to some Eskom creditors being treated worse than others, raised concerns among credit rating companies. According to people familiar with the situation, who are not authorized to speak to the media, the companies have told the government that if the plans go ahead, Eskom could be classified as in default. Moody’s Investors Service rates the company’s long-term debt at Caa1, just above default. In contrast, South Africa’s sovereign debt is rated Ba2, two notches below investment grade, and the outlook was changed from negative to stable in April.

A series of proposals “was madness that was allowed to run rampant. It would also lead to a default,” says Peter Attard Montalto, head of capital markets research at Intellidex in Johannesburg. “It’s a mess. There’s no easy answer.”

But inaction had consequences.

Only one option

“This has clearly had an impact on South Africa’s credit rating,” says Razia Khan, chief economist for Africa and the Middle East at Standard Chartered Bank. “There has been a huge cost to the South African economy, lost investment, jobs that could have been created.”

In July, Duncan Peters, head of asset and liability management at the National Treasury, said “broad strokes” of government debt transfers would be announced in the updated October budget.

In the end, there is only one option: for the government to absorb the debt that its decisions have created.

“Fixing unsustainable debt has been talked about for several years with very little momentum and action,” Constantatos says. “As much as some decisions can be difficult and have consequences, not making a decision also has consequences.” — Anthony Sguazin, Prinesha Naidu and Paul Burkhardt, (c) 2022 Bloomberg LP

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