Eskom Special Appropriation Bill [B16-2015] & Eskom Subordinated Loan Special Appropriation Amendment Bill [B17-2015]: Parliamentary Budget Office & Financial and Fiscal Commission inputs

Meeting report

Briefing by Parliamentary Budget Office (PBO)
Dr Sean Muller, Economic Analyst, PBO, said that the PBO had recently completed an overview of the financing of state-owned enterprises (SOEs) for the Standing Committee on Finance, and he would incorporate aspects of that presentation. That presentation had been organised around four areas of interest: (i) the role of SOEs in a developmental state, (ii) the separation of commercial and non-commercial mandates of SOEs, (iii) different approaches to the funding of SOEs, and (iv) the sale of non-core assets to provide cash injections. The present submission would also divide into four parts: (i) a background to SOE financing, noting (ii) issues of particular relevance to Eskom and the appropriations Bills under discussion, (iii) a detailed analysis of the Bills themselves, and (iv) a summary of the key issues.

Dr Muller gave three reasons why the government should fund SOEs, given that they had the ability to raise their own revenue and borrow on their own balance sheets. Firstly, it would provide them with initial capital, either for the purpose of establishing or expanding their operations. Secondly, SOEs might have non-commercial mandates. Eskom, for instance, was obliged by government to provide electricity to some consumers free of charge. Thirdly, it would improve the financial standing of the SOE with the aim of protecting its own financial interests. The factors affecting the financial status of an SOE were detailed, distinguishing those that affect all commercial enterprises and those particularly affecting SOEs. The fungibility -- the ability of an organisation to shift its funding between areas of its operation -- of SOE funding made it difficult for government to exercise oversight over SOEs. Even attaching conditions to funding was not always effective.

Dr Muller provided an overview of the broader policy space in which the two Bills under consideration were placed. In this connection, he drew attention to two reports. The first, by the Presidential Review Committee on SOEs in 2012, had stated that the government should be funding SOEs and addressing the issue of SOEs that were not financially viable. In the second, the 2014 Medium-Term Budget Policy Statement, the National Treasury had stated that the capitalisation of SOEs would be achieved only through the sale of non-strategic state assets, and not be drawn from tax revenue or added to the government's debt. Government's policy remained that SOEs should operate on the strength of their balance sheets. It was of interest to the Committee that Eskom holds R350 billion in government guarantees, of which it had used R145 billion. National Treasury had estimated a 0.5% to 1% reduction in Gross Domestic Product (GDP) growth due to load-shedding, and tariff increases also had a significant effect on GDP.

Dr Muller noted that the PBO had not had the opportunity of doing a detailed analysis of Eskom’s finances, and asked the Committee to request one of they deemed it necessary.

The main reasons for Eskom’s current financial difficulties were (i) its capital expenditure programme, for which it was not well prepared, (ii) the delays in completing infrastructure projects, which had had the double effect of increasing their cost and delaying the return on investment, (iii) historically low tariffs, (iv) loss of revenue through load-shedding and running expensive gas turbines (a result of a maintenance backlog), (v) supply chain costs and (vi) municipal non-payment.

Dr Muller discussed the role of the National Energy Regulator of South Africa (NERSA) in determining electricity tariffs. The regulator was important for SOEs like Eskom, which effectively hold a monopoly in their market but operate “at arm's length” from government. It emulates the disciplining effect of market competition. Nevertheless, there was a widespread view that NERSA had not allowed Eskom the tariff increases it needed to stay financially viable. The formula NERSA uses to calculate electricity tariffs was discussed. The allowable revenue is given by an estimate of Eskom’s asset base, multiplied by the return on these assets, added to operational costs. The most obvious source of potential savings in this formula was in operational costs, he said. There was also the important question of whether cost overruns from infrastructure programmes should be included in the calculation as part of the asset base. On the one hand, Eskom would face the consequences of those costs, but on the other, government did not want to reward Eskom for inefficiency.

Dr Muller then handed over to Mr Brandon Ellse (also an Economic Analyst at the PBO) to discuss the detail of the two Bills and point out some particular issues that the Committee should consider.

Mr Ellse focussed on the financial implications of the Bills. The Eskom Special Appropriation Bill [B16-2015] was intended to address a shortfall in the 2015/16 financial year -- in other words, it had a short-term impact. The R23 billion that Eskom was to receive in accordance with the Bill were to be raised from the sale of non-strategic state assets and would be issued in three instalments. Mr Ellse said that he would consider the implications of the Bill for Eskom and for government separately, but pointed out that government was the sole shareholder and therefore in the end wholly responsible financially for ESKOM. The R23 billion would improve Eskom’s balance sheet at the expense of the government's. The government would also forgo any money earned by the assets sold, which was estimated at R1.36 billion per year.

The Eskom Subordinated Loan Special Appropriation Amendment Bill [B17-2015] was an amendment to the 2008 Eskom Subordinated Loan Special Appropriation Act, which was intended to strengthen Eskom’s balance sheet by converting the remainder of the R60 billion loan, granted according to the Act, to equity. Mr Ellse explained that a subordinated loan was basically a low-priority loan. Eskom had not been expected to pay interest on the loan for the first ten years, and thereafter only if their finances allowed. In addition, R30.5 billion of the loan was actually considered equity, and thus not subject to interest or repayment. It was clear, therefore, that the conversion of the remaining R29.5 billion to equity was in Eskom’s interests, freeing them from the obligation to repay it, and at government's expense, effectively lowering their priority of repayment even further to the level of a shareholder. This would not be too serious if Eskom was expecting to pay dividends, but they were not.

In closing, Mr Ellse said that it was in necessary and desirable for Government to support Eskom financially, because they were their sole shareholder. The causes of Eskom’s current problems were important for effective oversight of their spending, but the issue of fungibility posed a challenge and suggested that a focus on outcomes, rather than expenditure, might be most effective. He reminded the Committee that the sale of state assets would have an impact on their revenue.

Discussion
Mr A McLoughlin (DA) asked why Eskom was seeking funding, given that they still had excess government guarantees.

Dr Muller said that this question was probably best addressed to National Treasury. He speculated that the reason was that their borrowing costs would have been too high.

Regarding the second Bill [B17-2015], Mr McLoughlin said that the Act called for the loan to be repaid at a market-related interest rate. It did not seem that the loan agreement complied with the Act, at a very high cost to the taxpayer. It was also deceptive, he said.

Dr Muller said that the actual loan agreement was not in the public domain. The Committee was in a position to request it, but this was effectively now a matter of historical detail and his assumption would be that the agreement did comply with the Act.

Regarding the first Bill [B17-2015], Mr McLoughlin said that no time frame had been given for the sale of the assets needed to fund the R23 billion cash injection. He felt that the Bill needed to be reworded to insist that the assets be sold before the cash was paid out to ESKOM. He admitted that the National Treasury had said that significant sales had been made, but the Committee had not been given details.

Dr Muller suggested that Legal Services could advise on the question of the wording of the Bill. Regarding the assets that had been sold, he said the PBO had tried to get an assets database from Treasury, but had not been able to. This was not unusual worldwide, however. He suspected that the reason Treasury was with-holding information about assets in the process of being sold was that they might be affected by information about their sale.

Dr C Madlopha (ANC) asked about the money lost from the sale of state assets. What was the PBO's recommendation? She said that this information would have been useful before Treasury had committed to the sale of the assets.

Dr Muller explained that the PBO did not make recommendations or take positions. Its job was simply to advise the Committee on the effects of a certain decision.

Dr Madlopha asked for the PBO's view on the challenges faced by NERSA and the problem of regulators of SOEs in general. Would it be better if the government controlled tariffs directly?

Dr Muller reiterated that the institution of “arm's length” SOEs with economic regulators had always been problematic to a certain extent, but it was not within the PBO's mandate to make recommendations.

Ms S Nkomo (IFP) stressed the seriousness of load-shedding as a source of revenue loss. She also said that the public needed to understand the reasons for the cash injection.

Ms S Shope-Sithole (ANC) drew attention to the urgency of Eskom’s needs, but said that in future they needed to “follow the money” very closely. Several other Committee members agreed that Eskom’s spending would need to be monitored on an ongoing basis.

Dr Muller suggested that the Minister of Finance had a role to play in providing financial oversight of ESKOM

Ms Shope-Sithole also pointed out that, with respect to their non-commercial mandates, Eskom had been founded to provide electricity to a very small proportion of South Africans, but it now had an enormous responsibility and needed the government's support.

Ms Nkomo said that it would be a good idea to ask the PBO to do a detailed analysis of Eskom’s finances.

Mr M Figg (DA) asked for clarity regarding the difference between a state-owned entity and a state-owned company. Could a state-owned entity issue equity if it was not a company? If it was a company, had anyone seen the memorandum of incorporation?

Dr Muller said that state-owned companies were a subtype of state-owned enterprises (a subtype of state-owned entities with a commercial function) that were governed by the Companies Act. In Eskom’s case, the terms state-owned company and state-owned enterprise were equally appropriate. His understanding was that Eskom would need approval from the government (as shareholder).

Mr Ellse added that the memorandum of incorporation was in the process of being finalised, according the Eskom’s website.

Mr Figg observed that the conditions of the subordinated loan meant that it was effectively a bailout. He also asked whether the first R10 billion of the R23 billion cash injection, due to be paid at the end of June, would be paid if not enough assets had been sold. He hoped that government would not suffer too much from the sale of assets because, being non-strategic, they would not be income-generating.

Dr Muller said that although Treasury did not have a specific definition, a strategic asset was not any asset that generated revenue, but only one that provided them with important leverage over the economy or social outcomes.

Mr Figg asked how Treasury could be sure that it would be able to raise R23 billion if it did not have a detailed database of its assets.

Dr Muller said that there was no detailed information about the value of government assets, but he estimated that they were several orders of magnitude greater than R23 billion. The issue arose in deciding which assets to prioritise for sale.

Mr McLoughlin questioned whether it was appropriate to continue talking of Eskom operating “at arm's length” from government, given what Mr Ellse had said about government's ultimate responsibility for Eskom’s debts. He said the degree to which the loans were being manipulated seemed like insider trading.

Dr Muller said that they had used the term “arm's length” in a colloquial sense. He suggested that Eskom was perhaps “too big to fail.” It was so important for South Africa that, even if it were a private company, it was unlikely that government would simply let the market take its course. He compared the situation to the bank bail-outs in the United States of America in 2008.

Mr Shope-Sithole reiterated her call for ongoing monitoring, extending it to all SOEs.

Financial and Fiscal Commission (FFC) Presentation
The FFC explained why the two Bills under consideration were important. They were critical to ensure Eskom’s sustainability, and energy was critical to fulfilling the National Development Plan (NDP).

Dr Ramos Mabugu, Research Director, FFC, went though the technical details of the FFC's submission.
He showed a graph indicating that electricity production and consumption were closely correlated over many years, with both falling in 2015. Electricity and real GDP growth were also closely correlated, and statistical analysis indicated that it was in fact economic growth that drove electricity consumption. If Eskom received no government financial assistance, there would be a loss in GDP of about 1.4%. The relevant question therefore was: Did the losses from the sale of assets (as discussed in the PBO presentation) exceed 1.4%? According to Treasury data, the answer was 'no.'

Looking at the two Bills in more detail, Dr Mabugu pointed out that the Special Appropriation Bill incorporated oversight provisions in the form of the Public Finance Management Act. This allowed National Treasury to impose conditions to ensure transparency and accountability. According to Clause 1(3), the Minister of Finance could withhold funds if he was not satisfied that funds were being properly spent. There was a need for Eskom to communicate more effectively with the public regarding the reasons behind the various forms of financial support it was receiving from government which were, after all, partly intended to lessen the increases in electricity tariffs. There was at present a problem in Eskom’s interface with its consumers, such as non-paying municipalities and resistance to prepaid meters.

The Special Appropriation Bill was essentially a substitution of assets, controlled by state preferences. It was intended to provide a once-off, short-term improvement in Eskom’s cash flow. The Subordinated Loan Amendment Bill, on the other hand, was intended to improve its gearing (total debt as a percentage of equity), allowing it to borrow money on more favourable terms. Dr Mabugu pointed out that government guarantees, which had come up in the discussion of the PBO presentation, placed a large burden of risk on government, and were not usually subjected to the same level of rigour that ordinary spending was. Therefore, they should be used only as a last resort.

The FFC supported government's call for cost-reflective tariffs. It also recommended that the issues about consumers' willingness and ability to pay needed to be addressed vigorously. In its assessment, resistance to prepaid meters was partly a result of a lack of communication leading to a lack of trust. Dr Mabugu compared the situation with the payment of taxes, which was to a large extent adhered to because communication was clear. Municipal debt stood at about R9 billion, and it would be important for this debt to be called in.

It was normal business practice to optimise one's mix of debt instruments, and the proposals of the Bills under consideration were essentially a means of managing Eskom’s debt. The two Bills also stayed below the ceiling set by the 2015 Budget Review, which was an indication of prudence.

In closing, Dr Mabugu suggested that to mitigate the risk of Eskom’s liquidity position weakening in the future, there were four measures which the government needed to take:

Speed up policy clarification and the implementation of alternative energy supply options;

• Within policy parameters -- that is, without renegotiating the state ownership of Eskom, but looking at public-private partnerships -- look at bringing in private equity and expertise;
• Use guarantees only as a last resort (this applied to all SOEs); and
• The Department of Energy and Eskom must communicate better with customers.

Discussion
Ms Nkomo said that the projection on possible GDP growth losses needed to be publicised. Regarding the second of the FFC's recommendations, she asked why there was an imbalance of skills between the public and private sectors. Was it the pay, or perhaps the culture of work?

The FFC said it was unable to comment on the level of publicity of financial projections.

Ms Nkomo asked for clarity on the use of government guarantees.

The FFC said that government guarantees placed a high level of risk on government and that, by their nature, they introduced bad incentives to SOEs.

Mr McLoughlin expressed concern about Eskom’s level of borrowing. Did the amount of R280 billion over the next five years, indicated in the FFC's document, include the amounts contemplated in the two Bills under consideration? If not, there seemed to be very little gearing left.

The FFC responded that the amounts contemplated in the Bills were in addition to the R280 billion.

Mr Figg asked whether the improvements to Eskom’s ability to borrow would be matched by a corresponding deterioration in government's ability to borrow. Government itself also had a debt problem -- the budget deficit for this year was R173 billion.

Dr Mabugu said that the fact that the R23 billion was funded by the sale of assets meant that government's borrowing capacity would not be affected. He also pointed out that even if government's borrowing capacity were affected, the effect on GDP growth of leaving Eskom to its own devices would also lead to an even greater credit downgrade.

Mr Figg questioned whether the conversion to equity should really be called equity, if dividends were not going to be paid.

Mr N Gcwabaza (ANC) offered a summary of the morning's submissions: that the Committee should approve the Bills, but then vigorously “follow the money” to make sure it was well spent. Ms Shope-Sithole agreed.

Mr McLaughlin wondered whether Eskom had factored in the cost in lost revenue from tariffs, of customers leaving the grid in the face of ever-rising tariffs and finding their own electricity supply solutions. Was there a plan to attract those customers back to the grid when prices became more attractive?

Dr Mabugu said that there was no clear policy on this matter. One of the FFC's recommendations was that the Department of Energy should clarify the legislation around independent power producers. He added that people leaving the grid also reduced the demand on the grid.

The Chairperson thanked the FFC for their submission.

The meeting was adjourned.