Special Appropriation Bill [B10-2019]: National Treasury briefing

Meeting report

Briefing by National Treasury on the Special Appropriation Bill

Mr Dondo Mogajane, Director General, National Treasury, explained that Eskom is vital to the economy in many ways. If Eskom is not fixed; then the system will clog. If Eskom fails to keep the lights on, it may be detrimental to South Africa and Africa, as a whole. The government must ensure that Eskom is strong and sustainable in a way that supports economic development. Eskom has high levels of debt, unsustainable debt, and some liquidity challenges. It is for that reason that the President in his State of the Nation address mentioned the importance of Eskom’s business model and capital structure changing. The President went on to say that a totally different business model is needed and that Eskom should be broken up into three. All of this is in the mix of trying to see where Eskom is currently, where Eskom should be, and what it takes to take Eskom to where it should be.

Eskom’s financial challenges

Eskom was in a debt reliant liquidity situation that has resulted from the following:

• Decline in sales volumes year-to-date,
• Low tariffs determinations from the National Energy Regulator of South Africa (NERSA),
• Primary energy and employees benefit costs increasing, and
• The continuing cost escalations of the new build programme due to its persistent delays.

All of these challenges have put Eskom into a very tight and difficult situation. Eskom has survived until now by borrowing increasing amounts, not only to service its debts but also to keep its operations alive. This is unsustainable.

Eskom was also experiencing challenges in raising its required funding due to lenders’ concerns about the following:

• Eskom’s future sustainability;
• Uncertainty of Government’s restructuring plan; and
• Lack of clarity on the policy direction of the energy sector as a whole

Government was dealing with these challenges at various levels of the state. Failure to manage the short-term liquidity will result in Eskom defaulting on its debt repayments and this will result in the possible call for a Government guaranteed debt. Eskom currently has R420 billion worth of debt and almost R250 billion plus of that is guaranteed debt. It is important that its liquidity position improves so that it is able to secure all identified funding initiatives. Eskom had a funding plan that it had agreed upon at the beginning. A funding plan simply means how much it is going to get from tariffs, how much it is going to get through raising bonds, and how much it is going to get through the lending that it needs. All of that informs the funding plan. When one of the legs of the funding plan is not met then it is a challenge. Government intervenes when the funding plan is not effectively implemented. There was a clear need for the shareholder, in this case Government, to pump in resources like in any other business. 

Given the lower tariff determination by NERSA and slower implementation of cost-saving measures, projected Eskom revenues will not be adequate to cover its interest payment, debt repayments and capital expenditure requirement. If interest payment, debt repayments and capital expenditures are not met because of revenue streams then there is a problem. This is the current situation Eskom is in. Other than that, the expenditure side also needs to be considered. Expenditure will mean cost containment measures should be put in place. Eskom should be forced to meet certain obligations around retaining costs. Primary costs, overheads, recurring costs, staff costs, all of these things need to be looked at as one.

Government decided in the meantime while addressing Eskom’s challenges, whether that is debt or liquidity or capital programme, to provide it with financial support to assist with its financial challenges.

Government Intervention

In February, the Minister of Finance announced in his 2019 budget speech that the government has allocated R23 billion a year, over the medium term to support Eskom during its reconfiguration.

The allocated amounts were intended to enable Eskom to service its debts and meet redemption requirements, while making resources available for urgent operational improvements.

It had been anticipated at the time that shortfalls in the capital structure of Eskom could be dealt with through the normal Appropriation process and that funds would be disbursed in October 2019.

This approach was partly premised on the assumption that Eskom will continue to raise the required funding between February and October in 2019.

Hence, National Treasury did not submit a Special Appropriation Bill for consideration by Parliament before the end of its term as there was no indication at the time that Eskom will experience difficulty in raising the required borrowing.

On 2 April 2019, the Minister of Finance invoked Section 16 of the Public Finance Management Act (PFMA) and the maximum allowable amount in terms of section 16(2) of the PFMA that could be transferred amounted to R17.652 billion.

The section 16 approval accelerated part of the R23 billion allocation announced in the February 2019 budget.

To date, Government has transferred R13.5 billion to Eskom from the R17.652 billion that was approved using the section 16 of the PFMA.

The disbursement of the remaining R4.1 billion of the R17.652 billion was anticipated to be disbursed in accordance with Eskom’s cash flow requirements.

The disbursement of the remainder of the R23 billion is envisaged to happen during the course of 2019/2020 as the Appropriation Act was assented to by the President and subsequently gazetted in early August 2019.

National Treasury and the Department of Public Enterprises continues to work closely with Eskom Treasury to monitor the company’s daily cash flow requirements and its financial positon. If Treasury did not do that there is a chance of being surprised once more when Eskom is not able to fulfil the obligations and the management of their finances.

Special Appropriation Bill

In the June 2019 State of the Nation Address (SONA), the President announced that a Special Appropriation Bill will be tabled by the Minister to allocate a significant portion of the R230 billion that Government provided over the next 10 years in the early years according to Eskom’s requirements.

On 19 June 2019, Cabinet approved the additional funding allocation to Eskom for the 2019/20 and 2020/21 financial years to assist the company with its financial challenges.

On the 23rd of July the Minister of Finance tabled a Special Appropriation Bill in Parliament of enactment to make formal the extra allocation.

The Special Appropriation Bill requests approval for additional financial support for Eskom as follows:

• Additional R26 billion in 2019/20 financial year; and
• R33 billion in 2020/21 financial year

National Treasury is currently finalising the conditions, which will be imposed on Eskom, to be included in the Special Appropriation Bill.

This financial support also addresses the growing concern status which has enabled the external auditors to sign off Eskom’s 2018/19 annual financial statements on a going concern.

Two years ago, when Eskom got a qualification, agencies like the French Development Agency, the Development Bank South African and some lenders were almost on the verge of exercising their right as per the loan agreements that if Eskom gets a qualification then they should get their money because they did not believe or trust that their money was safe.

Eskom will be required, under the conditions, to reduce unnecessary costs and overheads. Eskom will be required to get rid of the Eskom finance company. The loan books should be sold off. Eskom should not be in the business of banks nor making out loans.

This financial support is based on Eskom’s ability to execute its funding plan of R46 billion for 2019/20, of which 58% has already been secured.

Failure to execute the funding plan may result in Eskom experiencing liquidity shortfalls at 31 March 2020 and require additional funding in addition to the funding provided through the Special Appropriation Bill.

Eskom cannot expect handouts of money from Government. Money cannot just be pumped in from the revenue side. There has to be obligations imposed on Eskom on the cost side, to meet certain targets, so that there is a reduction in costs. Cost reduction, like in any state entity, can come in many forms. The labour costs leaves much to be desired in Eskom and this needs to be addressed. The operational costs must be faced head on. Creative ways need to be used to approach Eskom.

The Director-General pointed out that he had recently said in public that maybe government employees cost too much and should take a 10% wage cut. That had created a public discussion. Whether it was appropriate was up for debate but the reality was that the same thing could be applied to Eskom. If the same number of employees at Eskom want to be kept then they need to be paid less. These are the tough conversations that are needed as Eskom is continuing to be funded from the purse of the State. If an executive at Eskom earns R2 million today, can that same executive earn R1.8 million tomorrow? He was not only talking about low level employees but also referring to higher level employees where salary cuts are possible. It is a discussion that needs to take place, especially when Treasury did not have resources at its disposal, when the economy is not doing well and when tax revenues are not coming through. The pay levels of Eskom and other State Owned Companies (SOC) need to be categorised as junior, middle, senior, executive, board member and the areas where salary cuts are possible need to be found. There needs to be a ‘grand social bargain’ from all the role players in South Africa. Business also need to play a role. Business need to make some sacrifices. Those businesses that sell the coal to Eskom should think about selling it for cheaper. Businesses should help keep Eskom alive. Everyone needs to help ensure that Eskom is sustainable in the future. He called for some businesses to make smaller profits in the need to rebuild Eskom. Government was playing its part in allocation of various funds and maybe business could do more. Civil society, labour and everyday South Africans all have a role to play.

Eskom reconfiguration

Government recently announced the appointment of Mr Freeman Nomvalo as the Head of the Chief Restructuring Office (CRO).

The CRO will be responsible for developing the financial turnaround of Eskom and this will be vital in the development of a sustainable turnaround strategy for Eskom.

Government is working on a Special Paper to be released in September 2019 on Eskom to outline a roadmap for the reform of the company. This Special Paper is still being drafted. It is a work in progress.

Conclusion

Energy security needs to be ensured at all costs as it is crucial for economic growth and South Africa maintaining its sovereign investment grade rating. Restructuring, management of its finances and reduction on its reliance for fiscal support should be the hallmarks of a new Eskom.

The failure to urgently strengthen Eskom’s balance sheet while Government is working on long term sustainable solutions may likely have a negative systemic impact. Eskom is the largest non-bank corporate debt issuer in South Africa and any default will result in a crisis for Government and to some South African banks given that Eskom was the largest exposure to some banks and Government.

The Director General remarked that everyone needs to make sure that the capital structure changes. Capital structure means should debt and loans exceed certain ratios then that will have to be looked at. Business models look at whether this is optimal in its current form. Is there a way of reconfiguring Eskom to help it fulfil its mandate? Eskom is asking for an additional R26 billion but there is a plan in place. A paper is going to be circulated in September with regards to restructuring of Eskom. In the meantime. Eskom needs to be hard on itself, on a cost-containment point of view and from a cost structure point of view. A ‘grand social bargain’ was needed from all of role players: labour, business, civil society and Government. This entity is vitally important to the South African economy. He requested that the Committee considers approving this Special Appropriation Bill so that can be taken through the processes in parliament.

Discussion

Mr A Sarupen (DA) asked what conditions were being considered by National Treasury? Where was the funding actually coming from? Would there be an adjustment budget that will cut cost elsewhere in Government services? Will Treasury be issuing bonds? Will Treasury go to the debt market? Where will Treasury find the funds needed in order to give Eskom additional money?

Mr Sarupen raised a point on Eskom’s listed financial challenges. It was problematic to say that there were low tariff determinations from NERSA) Between 2007 to 2017, NERSA had approved effectively 350% in tariff increases for Eskom. Electricity prices went up 13.8%. This is far above inflation. NERSA has, over the past decade, been trying to balance the needs of the people versus the needs of Eskom. Eskom needs to be honest if meaningful conditions are to be developed. The President himself said that the challenges at Eskom are massive cost overruns, the effect of state capture, as well as the collapse of governance structures. Will the conditions include fixing governance structures and cleaning up the process of procurement?

Ms M Dikgale (ANC) also wanted clarity on where the money is coming from that will assist Eskom? In his view, Eskom’s financial challenge was due the unpaid debts, which lead to its unsustainable condition. He requested that the allocation of funds focus primarily on paying the outstanding debt that Eskom has first before the funds are used for anything else.

Ms R Komane (EFF) asked what was the plan to sustain Eskom so that it does not have to come in year in and year out for a bailout. What were the conditions attached to the bailout? She was worried that the conditions will come after the bailout. If they need further assistance Government needs to first check and see if they had met and satisfied the conditions of the allocation.

She further raised a point about certain Government Departments not paying Eskom. Eskom needs to be assisted by the relevant body. There are municipalities and departments who owe money to Eskom. How can Eskom be assisted in getting the money they are owed, particularly by Government departments?

Ms E Peters (ANC) stated that the bailout needs to come with stringent conditions. The Committee was considering allocating this large amount of money without a clear indication of a plan. Eskom and the Department of Public Enterprises (DPE) need to present their plan to the Committee before the Special Appropriation Bill is finalised. There needs to be a clear indication of a plan.

Ms Peters asked how much money do municipalities owe Eskom. The various companies that owe Eskom money also need to be found. Government should blacklist companies that do not pay State Owned Entities (SOE). SOEs are public entities and are part of the state so companies should not short-change them. When Eskom and the DPE come to Parliament they should give an indication as to how much time the CRO will be given to develop the work plan. There has been an indication in the presentation that in September a “roadmap” will be released. She wanted further clarity on whether the roadmap and the turnaround strategy are connected and what the role of the CRO is.

Ms Peters made a point about executive salaries. The executives need to be held responsible for the challenges Eskom is facing. They are being remunerated for the value that they add to the entity.

Ms Peters pointed out that about 90% of Coal contracts are given to two companies and 10% of the contracts are shared by 60 companies. The South African private sector is not patriot enough. A supplier of a major energy provider cannot be ‘milking this emaciated cow so much that it does not even produce milk anymore’. The 90% of the coal contracts being given to two companies is a source of concern. There is a problem with the procurement processes being done by Eskom. The primary energy issue needs to be included in the conditions that is given to Eskom. Another matter was about the minerals leaving the country. The best coal should not be taken out of the country.

Mr X Qayiso (ANC) stated that before proceeding any further with the Bill, Eskom needs to answer the Committee’s questions and talk about these issues. Secondly, on the announcement of cutting worker’s salaries, he did not think it was a strategic announcement at a public level. There are some CEOs who earn huge bonuses and give themselves bonuses. In the future these bonuses could be redirected to target the challenges facing Eskom. Finally, he asked the Director General if he could elaborate on the comments made about the uncertainty of Government’s restructuring plan and the lack of policy direction of the energy sector?

Mr D Joseph (DA) commented that at some stage Eskom had deviated from its mandate. Where did National Treasury stand on this point? What was National Treasury’s report saying to Eskom at the time? He would like to know from National Treasury when Eskom had started to deviate from its mandate. How much money was going to go to maintenance and Infrastructure? Or were the approved funds going to support the performance bonuses within Eskom? The structure of performance bonuses within SOEs needed to be reviewed. The bonuses may have been possible during the good times but now, during the bad times, they are not appropriate. He noted some of the conditions that Eskom needs to meet, but the Committee needs to hear about more concrete conditions that will have to be fulfilled. Lastly, what was the projected income of Eskom while National Treasury is giving it billions of rands? What is Eskom’s own projected income and what is its own recovery plan? He was not sure if Eskom had the capacity to deal with the theft of electricity and how it was solving that issue. People need to pay for electricity. Eskom needs to be managed out of its current crisis.

Mr Z Mlenzana (ANC) remarked that eventually a day will come when ‘we will say we are tired of being held for ransom by Eskom’. Eskom was emotionally blackmailing South Africans. What was the percentage rate of escalation of the debt? Were there no non-core functions within Eskom that Treasury can order to put on hold for now? Did Eskom have in its cash flow projections a clear and reliable income or funding projection? What was the percentage ratio in terms of government-Eskom shareholding?

Mr O Mathafa (ANC) supported the view that the Committee needs to have a meeting with Eskom and DPE so that it is able to ask certain questions. Treasury will not be able to respond to some of the questions the Committee might have. On page three of the presentation, it is stated that Eskom is requesting this special appropriation to service the debt. On the very same slide, it highlights that one of the utility’s main challenge is the delay in the build programme which leads to cost escalations. Is Eskom in a position to introduce interim measures to contain such costs while a turnaround strategy is still being finalised? How were these costs likely to impact on the future means of Eskom because the more the costs escalate the more money Eskom is going to need? He supported the view that Eskom will have to have a discussion with the Committee. He was further concerned about the rate at which SOEs are losing CEOs. Eskom had lost more than 12 in the past ten years. A CRO had been appointed. The role and responsibilities of the CRO will border along the lines of the role and responsibilities of the CEO, who in the main will be developing long and short term strategies. What are the reasons that lead to the resignations of the former CEOs?

The Chairperson stated that Eskom had a loss of about R20 billion this year. That is about 85% deterioration with regards to profitability. What had happened in one year that could result in Eskom deteriorating by a rate of about 85% between 2018 and 2019? Secondly, what were the financial impacts of the Independent Power Producers (IPP)?

The Chairperson then raised the matter of SOEs asking for debt guarantees. One of them was the SABC. What criteria is used to determine which SOE can be saved? What is the governing structure at Eskom? How are the governing and leadership structures of Eskom going to relate to one another?

The Chairperson noted that in the presentation many of the things stated are futuristic as if the problems of Eskom have been formed yesterday. What has Eskom done so far to try and deal with this problem? While the Committee is waiting for the grand plan it would like to know what has happened to create this problem. Government and Eskom is putting so much reliance on the CRO. It is assumed that all the problems there will suddenly be solved by the CRO. The CRO will be overburdened. There is no one person that will be able to deal with the problems like the magnitude of Eskom’s or as complex as Eskom. There is so much reliance on the CRO and that might create the danger in which the CEO at Eskom might feel like the CRO is dealing with all the problems and that their work will not be necessary. The CEOs might not support the CRO. What is the relation between the CRO and the CEO within Eskom? Is there too much of a burden on the CRO to identify the issues and understand the organisation and come up with solutions for Eskom? DPE and Eskom will be meeting with the Committee on 10 September at 10 am to brief it on the progress made.

Some of the SOEs had the attitude that ‘government will never let us fail’ and that they can always ask the Treasury to bail them out. From the side of the shareholder, how are we dealing with that kind of attitude?

Ms Peters had raised the matter of coal supply. There needs to be a ‘social contract’ between Eskom and the companies that supply coal because if things do not go right at Eskom it means that their profitability is going to decrease. What are those companies bringing to the table? Those contracts need to be reviewed and how could they help resolve this problem?

Where will Eskom have sufficient gains when the restructuring comes? What are the features of the reconfiguration plans that have been spoken about?

The Committee also need to know about the IPPs and their financial viability on Eskom.

The Director-General supported the point that the Committee is making and agreed that the DPE and Eskom needed to come in and engage on all these issues raised. The Committee should avail itself for the 10 September meeting so that full explanations and information may be received.

Rate of debt escalation

The Director-General noted that it is worrying that the percentage rate of escalation of Eskom’s debt is 10%. At the end of last year, the debt was at R400 billion and now the projection is around R446 billion. This debt is as a result of low tariffs.

The impact of IPPs

When the agreement with the IPPs was signed some time ago there was an impact with regards to how much Eskom was paying per kilo.

Criteria for awarding SOCs funding

The criteria was simple. The Minister of Finance had certain authorities and powers. The Minister can issue guarantees. National Treasury has a sub committee that assists the Minister of Finance to make decisions. Recommendations are made by the sub-committee to the Director-General, Deputy Minister and Minister to determine whether to give guaranteed aid to a Government entity or not. A guarantee by definition means – if entity X cannot pay then government will come in and assist it. Government gives a guarantee because it believes that because of their business operation this entity should be able to generate money in order to repay. The criteria takes into account the impact and the need. So there are no ‘blue-eyed boys or girls’ in the way Treasury treats entities. It is essentially a team of financial analysts who are non-political, who are just looking at the finances. Is this entity able to repay or not? Then there’s also the option of giving a bailout if Government cannot give a guarantee. The Minister of Finance has said that contingent liability needs to be brought down and this is a sign of a well-functioning state. If contingent liabilities are small it’s a good thing.

The governance structure at Eskom

The Director-General wanted to believe that there is a governance structure at Eskom that functions like any other business. There was also a relationship with the shareholder which in this case is government represented by the Department of Public Enterprise. One expected that that relationship should work. When that relationship breaks down there is potential for that system to fall apart. The board must maintain responsibility and management of the entity.

In response to the Chairperson, the Director-General stated that the plans are futuristic but that was because the current Eskom was unsustainable. What kind of Eskom will be seen tomorrow? He envisaged an Eskom that is debt free, or that can manage its debt. He envisaged an Eskom that will be self-sustainable. He envisaged an Eskom that is able to generate electricity at much cheaper costs and therefore contribute to the functioning of the economy. The profitability and its current business model is problematic.

Role of the Chief Restructuring Officer

It was not necessarily that all the reliance will be put on the CRO. The CRO should be viewed as an office. Eskom was too complex and too big for a single person. A whole lot of people are needed to make the business work. On 10 September, the Committee should ask Eskom to present the turnaround strategy.

The turnaround strategy

The turnaround strategy has many components. One of which is an injection of funds by the government. The second is modelled around cost containment. There are a few other broad components to the turnaround strategy that will be teased out on 10 September.

Budget Cuts

Debt restructuring is a complicated matter. Specialists are needed to understand the implication for bond holders, Eskom’s ratings, and sovereign rating. The reality is that debt to GDP is 60.8%. Government cannot cut budgets because the budgets were set up in February already. It will be irresponsible to announce in the middle of October that Treasury will be cutting the budget by 40% to take care of Eskom’s new debt. It will destabilize the system.  Treasury will not be reckless and just start cutting.

Let us wait for Eskom and DPE to present, on 10 September, to present the various components and plans they have to move Eskom forward.

Resignations of the CEOs

The Director-General said that he did not know the reasons for the resignations of the CEOs. Rating agencies and lenders worry if there are governance issues. There should be governance certainty and continuity within SOEs. He did not want to speculate as to what the reasons were for CEOs resigning. It is important that the issues of governance are noted.

Departments and Municipalities owing Eskom money

Municipal debt was a very sensitive matter. Some municipalities are very small, and their revenue generating capacities are almost zero. The rely on the equitable share and additional grants for survival. This needs to be approached carefully. With regards to departments in government owning Eskom, he has written to them and instructed them to pay up. Accounting officers in those departments need to be held accountable to pay those accounts. If they do not pay those accounts, they should be fired because they are not managing those finances properly. There is no excuse for government departments to not pay Eskom.

Conditions

Where are these draft conditions? Additional funding should be used to pay off financial obligations and to pay off debt and interest first. Additional funds should not be used to pay bonuses. It is a condition that as money is given, only debt and interest is paid. If Eskom requires further funding for other operations, it would have to seek Treasury’s approval first. Eskom has to submit a board approved annual schedule of redemptions and interest payments. Eskom’s bonds overtime are coming to an end. Treasury needs to know that schedule and who they must be paying off and by when, including interest payments. Treasury wants daily reporting on their liquidity position with national treasury and public enterprise. Eskom must report daily on all their operations.

Treasury wants Eskom to close and sell the Eskom Finance Company (EFC). (EFC) is sitting with a R10 billion loan book. They are not in the business of giving loans and can recoup that R10 billion and put it back into operations.

Treasury wants Eskom to publish the turnaround strategy as soon as it is approved so that all can see, understand and engage with it.

Treasury wants Eskom to submit monthly management reports that are signed off. In a big entity like Eskom, management reports become critical and necessary.

Treasury wants proof that the company is tax-compliant. It wants to make sure that at any point in time Eskom is tax compliant and that they are paying their due.

A steering committee needs to be set up to report on the reorganisation of Eskom on an on-going basis, quarterly basis.

South Africa needs to understand that it is in trouble. “We need to impose some harshness on ourselves”. If it means earning a little bit less so that the future will be better, then that will need to be done. He is ‘of the school of thought that says don’t budget on the basis of stolen money or corruption’. Law enforcement will take care of that. ‘The treasure box is empty’. The numbers show we are in trouble. We have to continuously to bailout SOEs. Restructuring must be accelerated. DPE must come to the party. Eskom must come to the party. As South Africans we must be hard on ourselves. Government, business and labour must play a role. Senior members and DGs need to take a bigger cut from their salary anyway. South Africa is in trouble and alternative ways to cut costs and save money need to be found. 

Lack of policy direction.

The Director-General said he is putting pressure on the DPE to provide a policy direction. There is now a date when DPE will present to Treasury.

Coal contracts

The Director-General said it is up to Eskom and DPE to make sure that: firstly, there are more players in the sector. Secondly, that good quality of coal is obtained. The private sector needs to play a role to help and assist rebuilding Eskom. Business has to come and make sacrifices too, it cannot only be Government. He concluded by saying that ‘If Eskom fails then we all fail’. 

Ms Dikgale remarked that maybe there should be a switch to solar energy so that the burden felt by Eskom is lessened.

Ms Peters raised questions around the 49M programme launched by Eskom. It had serious financial injections. There were various programmes launched to encourage civilians and companies to reduce their energy consumption and for everyone to play a role. What happened to all of those initiatives? It was a way of inculcating responsibility onto corporates and the general public.

The Chairperson replied that the Department of Minerals and Energy need to be brought into the discussions on this matter. The quality of coal and stock of coal is both a Department of Public Enterprises and the Department of Minerals and Energy matter.

The Director General responded that the 49M and energy saving devices programme was not really abandoned because it was partially successful. Sufficient awareness was created at the time around those various energy saving issues. However, the solar water heater programme was a failure. Billions remained unspent within the solar heater programme. The new Eskom will have to go back to the fundamentals. How is solar and other energy resources maximised? What is the future with regards to green energy resources? The Committee will have to ask Eskom and the DPE about these various programmes and why they did not succeed? Eskom had a schedule of the current fleet and when their lifespan ended. New energy sources must be discussed. The sustainability of Eskom is a challenge that will need to be discussed further involving all relevant parties.

The Chairperson thanked the Director General for his contributions. Whenever the recapitalisation of SOEs arise the discussions are always emotive and complex and therefore need to be handled with care.

The meeting was adjourned.