More First Strut pain – impact of fraud on Medupi cost insurers R1bn
The ongoing drama surrounding the construction of the Medupi dry-cooled coal-fired power plant in Limpopo province has captured news headlines for months. Fraud, mismanagement, labour disputes, tender irregularities, liquidations, even a murder – the Medupi story has it all, and taxpayers seem to be footing the bill. However, as this fascinating interview PCBS's Brian Africa reveals, some of the biggest losers in the Medupi debacle have been the insurance companies that covered the project. PCBS issues performance guarantees for the construction industry – they basically promise that contractors will do their jobs, and pay out if the contractor doesn't perform. Obviously, on the Medupi site, there were some pretty serious non-performance issues. In fact, First Strut, one of the major contractors, turned out to be a giant fraud balloon. Africa estimates that the collapse of First Strut and Cosira, and their consequential non-performance on the Medupi project, has cost the South African insurance industry a cool R1bn. So spare a thought for the poor guys in grey suits when your lambasting the government's mismanagement of the project. – FD
ALEC HOGG: Medupi's first generating unit was expected to come online in December last year. Well, when is it going to happen? Here to give us an update is Brian Africa of Marketing and Business Development Executive at Performance Customs and Bonds Services. You need a shorter name.
GUGULETHU MFUPHI: What a name.
BRIAN AFRICA: Use the acronym – PCBS.
ALEC HOGG: PCBS and you guys do – what?
BRIAN AFRICA: We issue performance guarantees for the construction industry as well as customs and excise bonds for the trade.
ALEC HOGG: Meaning?
BRIAN AFRICA: Performance guarantees are used within the construction industry to guarantee the performance or non-performance contractor.
ALEC HOGG: So what about First Strut, the guys who went bust and were very involved in Medupi? Did they have performance guarantees?
BRIAN AFRICA: Yes, they did. They had performance guarantees as well as credit insurance products, which basically insures your debtor's book.
ALEC HOGG: Somebody's taken a big hit on that.
BRIAN AFRICA: That's correct – both credit insurance and the guarantee markets have taken a very big knock as a result of the demise of Cosira specifically as well as the First Strut group. Once again, we can't just lay the blame completely with Eskom. There are also a number of other factors, which have influenced the demise of the construction company.
ALEC HOGG: It was all fraud, wasn't it, with First Strut. That's clear, what's coming out there; something happens fraudulently, these fellows don't deliver, and then you end up paying. Is that what happened?
BRIAN AFRICA: Yes, that is what happened. The delays on the construction of the Medupi power station have obviously had a knock-on effect, so if you have a delay at the top with one of the main contractors, it filters down all the way to your smaller subcontractors. That played out and that has had a major impact on the performance…on the actual contract itself because obviously, there has been late payment on those payments as well, which has basically facilitated/rendered the construction company's performance impossible. Cash flow is very important within any organisation – within in any business.
ALEC HOGG: Brian thanks for getting the memo. I like the way we're doing this today. Has there been a knock-on effect? There's therefore a problem up here and there's a knock-on effect all the way down, and you guys end up as the insurers – having to pay for it.
BRIAN AFRICA: That's correct.
ALEC HOGG: So whom do you sue?
BRIAN AFRICA: We would naturally have to recover from the actual contractor itself, so like all of the other creditors of this First Strut Group and Cosira as well; we would then obviously have to recover our losses in the event of…during the liquidation process we would have to recover our losses from them.
ALEC HOGG: This is really interesting. Gugu, I was never aware. I know there are many bondholders who lost over a billion rand. We know Investec Group lost a lot of money. RNB have lost money – these various bankers. In fact, insurers are the guys who are standing. How much is it altogether that the whole First Strut story is going to cost?
BRIAN AFRICA: In total…if we look from just a credit insurance perspective, we're looking at close to 900 million, just on debt that Cosira could not…
ALEC HOGG: Who pays for that at the end of the day?
BRIAN AFRICA: Actually, the reinsurers would have to fork out a bulk portion of the actual cost or the damages that the employer has suffered, but with performance guarantees, it is not an insurance product. It's basically standing surety for someone, so in the event that the company goes into liquidation, we wouldn't actually have to recover whatever we can from the asset base of the company.
GUGULETHU MFUPHI: So there's no guarantee of getting 100 percent of the debt.
BRIAN AFRICA: That's correct. As in any liquidation, you won't necessarily get your full amount back.
ALEC HOGG: Excuse me, are you going to get any amount back? If you get once cent on the rand out of these crooks – Cosira – you'll be lucky.
BRIAN AFRICA: That's correct. If we look at the number of investors and institutions that obviously backed the First Strut group, as well as Cosira, we're looking at an amount that exceeds both First Strut and Cosira's asset base. If we do recover anything, we would be very lucky – if we do.
ALEC HOGG: More importantly, Brian: as far as the country is concerned where do we stand with Medupi now? Given all these problems that have occurred – and we should have had the first coming on in December – when is it likely that it will?
BRIAN AFRICA: Where we stand at the moment, is that Eskom needs to employ damage control. We are obviously running out of time and we're also running out of capacity, but the way we need to look at this is instead of looking at reducing consumption, we should actually look at public/private partnerships where our mining companies can actually contribute to the available power capacity of the electricity grid.
GUGULETHU MFUPHI: Has that conversation begun and, if so, with which mining companies?
BRIAN AFRICA: The conversation hasn't begun as yet, but from a credit risk perspective, the risk profile for us looks a whole lot better if we have both the private and public sectors involved. I think we need to look at a shift in policy from Eskom's perspective to actually look at facilitating independent power producers, because where we stand at the moment; the capacity is constrained and we're looking at renewable energy in the form of solar power etcetera. We therefore need to scale up on that because there is a delay. That's the fact of the situation, so it is damage control that Eskom is looking for at the moment.
ALEC HOGG: That's a conversation, which I think everybody is having, but getting back specifically to Medupi: it was supposed to come on stream in December. When is it now likely to start kicking in?
BRIAN AFRICA: There has obviously been a change in terms of the project with the contractors, because Siemens has been called to actually participate in the contract and to help speed up the process. Where we stand at the moment is, we don't expect it to be within the revised completion date. We do expect further delays because now we brought in a new contractor, which obviously needs to get used to the actual project itself. This is obviously going to take a few months for them to be integrated completely into the bigger project itself, so we can expect delays. However, we are all hopeful that the units will come into use as soon as possible.
GUGULETHU MFUPHI: How much have these delays cost so far?
BRIAN AFRICA: The delays have, from a short-term insurance perspective – and that's where I can actually comment, as that's where I actually have the facts. If we look at the delays, it has cost close to one billion just for the short-term insurance industry as it stands, which covers surety and credit insurance. Just the delays on that have obviously caused quite substantial losses, which is the way our reinsurers are looking at it. They question the sustainability of the construction industry within South Africa and also, the way they look at the risk profile of mega projects, because delays are inherent risks of these mega projects. Obviously, the delays also cost additional funds because with every delay…obviously, the price of construction materials change, which obviously has a larger impact on the total cost of the project.
ALEC HOGG: So this Medupi mess actually has knock-on effects that we haven't even considered yet. The unintended consequences are enormous. Clearly, the one thing – if I read you correctly – is that the insurance premiums on the kind of business that you do, are going to go up significantly.
BRIAN AFRICA: The cost of credit insurance as well as guarantees will definitely increase – obviously, based on the loss ratios we've suffered over the last two or three years. We've seen a number of big companies – including Sanyati, which is a listed company – also going into liquidation, so our foreign investors and our re-insurers are obviously looking at how sustainable the construction industry is. They're also looking at these mega projects that, when they actually invest in these projects they're not getting any return. Therefore, the longer there's a delay in the actual project itself, the more it will cost them.
GUGULETHU MFUPHI: How does this impact on the future outlook of the construction projects in South Africa, given the fact that there are so many in the pipeline?
BRIAN AFRICA: One aspect that we've actually noticed is that the infrastructure projects are fragmented, so we find that we're working on one project. Like for argument's sake the Medupi power station. Clearly we should be looking at trail infrastructure. We should also be looking at improving the availability of resources to actually facilitate the growth in the economy itself. Where we stand at the moment, the knock-on effect… socioeconomic that this has had, has obviously resulted in a number of people being unemployed as result of the liquidation of First Strut and the liquidation of Cosira.