An open letter to Pravin: A six-pronged approach to fixing Eskom

It’s been deemed too big to fail, but then surely all eyes should be on an Eskom fix? The only thing being thrown at it seems to be billions of rands, given Tito Mboweni’s latest bailout talk. And yes, while President Cyril Ramaphosa has spoken of a three-pillar attack with a potential restructuring of the energy utility, the kick back seems to have muted that. And while the CEO of African Source Markets, Bevan Robert Jones agrees with the concept of deregulation, he’s also added five other options to try and fix the flailing operation in an open letter to the minister of Public Enterprises Pravin Gordhan, who today announced executive chair Jabu Mabuza will assume the role of acting CEO for three months. This while the search for a suitable replacement for Phakamani Hadebe continues. The one missing option is leadership, something any turnaround needs more than anything else, especially if it involves keeping the lights on. – Stuart Lowman

Open letter – Six ways to fix Eskom, starting today

By Bevan Robert Jones*

1. Improve finances

No company or nation has ever escaped their debt burden. From the Fall of Rome to the Weimar Republic and the emerging titanic that is the global pensions crisis and the US debt balloon, overwhelming debt eventually leads to collapse. The only solution is to pay it off asap or default. As the latter option is simply not palatable, we need to find a way to pay it down, fast. What about bringing forward payments for future power, but also giving purchasers of that forward power some incentive to pay for it now? For example, consumers could purchase forward power certificates e.g. Soweto Municipality or Hillside Aluminium Smelter could purchase 10MW of Winter 2024 Baseload at today’s fixed price. However, in order to
receive today’s price, and not whatever inflated price prevails in 2024, they must pay for it all upfront now and then hand in their certificate when receiving their 10MW per month during the Winter of 2024.

In a properly deregulated power market, they would typically purchase a forward strip at whatever prevailing price it was trading at on the forward curve. However, as we are not there (yet), this forward power certificate option could immediately help Eskom pay down some expensive debt, whilst also ensuring that customers pay in advance of receiving their power. Eskom should not be in the business of collecting outstanding debts from errant customers for power long ago delivered. In fact, all of Eskom’s power sales, even if only for Month Ahead, should be paid for in advance.

However, astute traders might realise that this arrangement is akin to Eskom selling an option on their power revenues. This would only work financially where the cost of debt is higher than the underlying volatility or expected increase in future power prices will be. But of course, this dynamic once properly understood, can be managed by Eskom’s Treasury.

Eskom could alternatively charge an option premium for these forward sales, allowing consumers to lock in future prices and pay later as usual. However, whilst the premiums collected would be extra revenue, the quantum would be less than outright collection of forward power revenues. Either way, what prudent financial director at any company or responsible municipality would not want to create budget certainty and lock in their future power price exposure?

2. Coal

It is madness that Eskom pays vastly different prices for the same grade of coal, depending on whether that coal came from an underground (more expensive) mine, or a cheaper open-cast mine. I’m sorry but that price risk belongs squarely with the mining company, and not the utility. At least that’s how most of the rest of the world views it. We also need to standardise our lower quality domestic grades of coal and increase transparency in the domestic coal sector, thus also reducing excessive trucking, reprocessing and washing inefficiencies, whilst eliminating rent-seeking middlemen who add zero value and only inflate costs. African Source Markets can and will clearly assist in this regard.

Furthermore, Eskom needs to understand and embrace their powerful position as the buyer of last resort for most lower grade coal in this country. Global demand for coal will likely continue to fall and global coal prices are more likely to continue coming down than going back up. It would be a travesty for Eskom to end up paying higher inflation adjusted cost-plus prices for their lower grades of coal, than what better quality export coal is pricing at in Mpumalanga. Again, with an efficient and robust physical spot and forward coal market, this will not happen. Transparent commodity markets also incentivise investment in both mining and beneficiation as investors can lock in their returns.

3. Eskom & Transnet to help each other

Has anyone noticed that Transnet makes money from transporting export coal, whilst Eskom spends money in burning lower grade domestic coal? Also notice how these financial risks are exactly opposite to each other. Now consider what would happen if both Eskom and Transnet had a coal index to hedge these financial risks against. They would simply agree to offset cash-flows with each other by fixing the coal index price between them. One would need to mathematically adjust for coal quality differentials or use two different coal quality indices. Either way, the price movements would be highly correlated at well over 90%.

As both state-owned entities are under your ostensible financial control this is a zero-sum game for the state. Furthermore, the mining industry would get both an added benefit and a risk, which it could easily manage. Those miners railing their coal would get some margin protection, in that their rail costs would decrease as coal prices decreased and vice-versa. Of course, when coal prices decrease all miners selling coal to Eskom would
feel some pain, but would also benefit as domestic prices rise, as opposed to selling at a forward fixed price. Eskom should not however be overly concerned at coal prices rising as they would be hedged with Transnet, to the extent of Transnet’s annual coal railings of circa 75 million tonnes. However, clearly this solution is a little more complex than the others so let’s call this a Stage 2 solution.

4. Deregulated market

There is no doubt that Eskom needs to be split into Generation, Transmission and Distribution. Generation makes its money from the “Clean Dark or Spark Spread” i.e. the profit margin between paying for coal, diesel, gas etc. and buying in external IPP power etc. versus the revenues it receives from the sale of such power, minus the cost of the carbon tax to nominally clean that coal, gas, diesel etc.

Transmission will make its money by operating the power pool and charging brokerage on all transactions, ensuring that buyers and sellers into the Day Ahead, Month Ahead etc. markets are properly matched. Their fees would also include line usage and transmission fees. Distribution (typically municipalities) make their money on the difference between their wholesale purchase cost of power, and their retail sale price. Those municipalities
that charge too much for power would find businesses and residents moving elsewhere.

It would be pointless to split Eskom into the three separate units if one also does not deregulate the market in such manner. NERSA for its part should get increased and specific powers to oversee and properly regulate all three entities, although it would largely lose its ability to set pricing, something all consumers should largely appreciate whilst the power of a free market works for them instead. As the complexity of regulation is increased, whilst also becoming more transparent, there will be greater opportunities for more highly skilled jobs across the board, whilst still protecting lower-paying industrial jobs. Unions should be pushing for this approach with gusto.

5. Act before fossil fuel assets are stranded

Eskom has valuable power generating assets in several of its older coal-fired stations, which could still operate at healthy Clean Dark Spreads for some time to come. One doesn’t want to split Generation into Good Generating Assets and Bad Generating Assets. However, the healthier coal assets could be ring-fenced and sold-off for a premium, with the revenues being used to settle outstanding debt on the Bad Generating Assets. Of course, this should not excuse Eskom from trying to recover all the outstanding monies fraudulently lost to prior corruption.

Ultimately Eskom should not be in the fossil fuels generating business. Rather try to extract as much value for these coal assets now, before we are forced as a country to dispose of them as stranded assets, due to external environmental pressures. Imagine the doomsday scenario when no investor can buy Eskom corporate paper anymore because it owns dirty fossil fuel assets. Instead, Eskom Generation should be in the business of renewable energy generation and storage. We have incredible solar energy and there are amazing emerging technologies for the storage of power from concentrated solar.

We also have plenty of unused mine shafts where we can use our tried and tested pump-storage technology. However, instead of pumping water upwards at night, we could pump up during the day and over weekends when we have excess solar capacity feeding into the grid, and then use the gravity-fed hydro power during peak loads. We are a truly blessed country with vast solar reserves and we only need a little imagination to succeed in turning this into viable baseload power. This is what Eskom Generation should be pre-occupying itself with. Imagine all the new jobs that could be created.

6. Rehabilitation & biomass

Whilst on the subject of the environment, open cast strip mines create perfect permaculture terraces and swales. Miners should take a leaf out of the wonderful restoration work done by the Banks Group in the United Kingdom, turning hundreds of hectares of surface coal mines into pristine wildlife reserves, whilst developing and selling offvaluable new Lakeland housing developments. Strip mines can also become income producing pine and indigenous forests, where the trees can help restore damaged soils, whilst harvesting and pelletising the pine into renewable biomass for co-firing with coal, thus reducing Eskom’s overall fuel cost. Project Drawdown ranks afforestation as 15th out of the top 100 global solutions for drawing down atmospheric CO2.

The acidic soils of previously mined coal seams are also well suited for mycelium growth, which when combined with certain plants, enjoys a symbiotic relationship by increasing phosphorous uptake and drawing down further CO2 into the soil web. What’s more, several relatively cheap pyrolysis techniques can re-process coal slimes and fines into higher carbon content biochar, which can then be further activated with steam to produce activated carbon, an essential ingredient in water purification. Note that we currently import almost all our activated carbon at great cost. Inoculated biochar containing beneficial efficient micro-organisms is a wonderful soil ameliorant, which many farmers suffering under increasingly severe drought conditions are turning to as a lifesaver.

All of these techniques will reduce environmental liabilities for mines and associated power plants, whilst improving our environment, lowering the cost of fuel and improving food security. Together, these several solutions could help restore Eskom to the mighty powerhouse it once was and serve
once more as an example to the rest of the world of a leading and environmentally responsible power generation company.

  • Bevan Robert Jones, CEO, African Source Markets.