Eskom must raise debt to spread cost of expansion fairly
October 20, 2009
By Brian Kantor
Eskom's understandably inadequate balance sheet, given the scale of its capital expenditure programme, should not be allowed to influence electricity prices.
If such debt management considerations were to influence the electricity tariff, this would mean far higher prices for electricity than would make any economic sense. It would seriously undermine the ability of the economy to compete in the global markets of which it is so much a part.
Eskom is no ordinary firm. It is a wholly owned subsidiary of the government with a monopoly over the supply of electricity. It should not be allowed to abuse this by charging excessive prices to avoid raising the appropriate amounts of debt finance.
The balance sheet of relevance is therefore not that of the subsidiary company, Eskom, but that of its only shareholder, the South African state. This national balance sheet is supported by the capacity of its government to raise taxes to pay interest and repay capital on the loans it chooses to raise. The borrowing capacity of South Africa is surely more than enough to finance an economically sensible expansion of electricity production here.
Unfortunately, there is every indication that such an approach to the financing requirements of Eskom will not be followed. It appears that a vast capital expenditure programme by a government agency to produce electricity over the next 30 years is to be funded to a large and unnecessary degree from current consumers.
In other words, Eskom's expansion is to be funded by what is the taxation of electricity consumers as the alternative to South Africa directly or indirectly raising debt finance to fulfil the purpose.
That Eskom is not an ordinary firm is revealed by its pricing intentions. All firms would much prefer to finance their growth, particularly truly transforming growth, by raising prices. Such natural preferences for higher prices are usually constrained by the prices their rivals charge in the markets they compete for. Eskom has no such competition to influence its pricing options, at least over the next five years, which is why its prices are regulated.
Funding alternatives
Provided the Eskom investment programme makes economic sense, it should be financed largely by raising fresh capital on the most advantageous terms possible.
These capital funds could be raised directly by extra issue of South African debt and transferred in the form of subscription to Eskom's equity capital by the Treasury. Alternatively, South Africa could explicitly guarantee the debts Eskom incurs on its behalf.
The economic effects would be exactly equivalent for the taxpayer and would be quite apparent were the income statements and the balance sheets of South Africa and Eskom consolidated, as economic logic indicates they should be and as the markets and debt rating agencies do anyway.
Eskom, if financed by infusions of equity capital provided by its shareholder, would earn higher accounting profits and so pay higher dividends or taxes.
These dividends and taxes would hopefully completely cover the interest costs incurred by the Treasury on its extra debt. Or if the borrowing was by Eskom itself under government guarantees, it would pay out more interest. This would lower dividends and taxes to South Africa while the government incurred lower explicit interest expenses. The debt rating of South Africa would be unaffected by such financing decisions.
Applying such principles of finance and economics would ensure enough extra electricity is supplied to consumers to meet the increased demands for electricity at prices that cover the costs of electricity and coal supply, as well as its costs of capital. The relevant cost of capital for a low-risk electricity utility with a monopoly, we suggest, is but 1 percentage point above the cost of issuing long-term South African debt.
The tariffs consistent with such expected returns would have to be estimated over the long economic life of the extra plant and equipment, which is at least 20 years, and regularly updated on the same principle. Sensibly estimating the tariffs and the tariff increases consistent with such prospective long-term returns should not be beyond the competence of Eskom's management and its regulator.
The prices necessary to convert the direct costs of its operations, plus the financing of the additional plant and equipment, would then be recovered over the lives of the capital equipment installed and should be sufficient to amortise the debt and to provide 1 percent a year risk premium.
Such price rises would not prove a shock to the economy. They would also not discourage unhelpful longer-term substitution away from efficiently supplied electricity towards alternative energy sources.
It would mean that current and future consumers of electricity would help pay for the large justifiable investments to be made in additional capacity, as is usually the case where competition prevails. Hopefully these economic realities can still prevail, calling upon debt finance to avoid grossly overcharging current consumers.
Brian Kantor is an economist and strategist at Investec Private Client Securities
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