By Sarah Logan
Last week, Standard & Poor (S&P) downgraded the long-term credit rating of Eskom, South Africa’s electricity utility, from BBB- to the junk status of BB+. The downgrade came after Eskom suspended four of its most senior officials pending an inquiry into the struggling utility’s operations, leading S&P to have less confidence in Eskom’s corporate governance arrangements. Coming after the South African government’s sovereign credit rating was downgraded in November 2014, Eskom’s downgrade raises important questions concerning the ratings’ impact on the utility’s operations, as well as South African companies and public at large.
Eskom’s recent faltering performance appears to be largely due to the rising costs of operations. South Africa’s electricity generation capacity margin has grown extremely tight after extensive delays in bringing the Medupi and Kusile coal power stations into operation. Further, the collapse of a 10,000-ton coal storage silo at Mujuba power station in early November 2014 added to the woes the utility already faced over diesel shortages and maintenance difficulties. Given Eskom’s significant financial and operational challenges, and the utility’s inability to avoid widespread loadshedding (or rolling blackouts), economists have warned that further downgrades to Eskom’s credit rating may be likely.
Eskom generates approximately 95 percent of South Africa’s electricity, making it the largest electricity utility in Africa and rendering it highly probable that the South African government will be forced to bail out the cash-strapped utility. Indeed, the government has already committed to keep Eskom afloat financially, pledging to give Eskom $190 million in the next financial year. As far as electricity generation, transmission, and distribution in South Africa are concerned, Eskom is simply too big to let fail.
The South African government’s sovereign credit rating has also taken a hit recently with Moody’s downgrading the country’s sovereign credit rating in November 2014 to Baa2, just two notches above junk status. A Baa2 rating is associated with moderate risk that the South African government will default on its financial obligations.
The South African government’s downgrade was based on the country’s poor medium-term economic growth prospects, which have been hampered by the electricity shortages, as well as rising interest rates, and prolonged industrial action—notably recent labor strikes in the platinum sector. An unemployment rate of about 25 percent, relatively high current account deficits, and government debt also contributed to the downgrade—the country’s first sovereign credit rating downgrade since post-Apartheid economic reform was instituted in 1994.
The immediate implication of a diminished credit rating is a raised cost of borrowing in international bond markets for governments and public utilities, as interest rates are increased in line with heightened risk of repayment default. This will make it more expensive for Eskom to borrow the funds that it requires to expand its electricity generation capacity and to improve its maintenance—changes that are vital if the utility is to reduce loadshedding across South Africa. A credit rating downgrade also raises the cost for the South African government to borrow money for bailing Eskom out of its financial difficulties.
Public utilities, municipalities, local and provincial governments, and local companies generally cannot have better credit ratings than their host government. Therefore, a downgrade in the credit rating of the South African government directly impacts the interest rates applicable to all these entities when they borrow on international markets. Worse yet, South African companies are experiencing raised interest rates that increase their cost of doing business at a time when they are already facing difficulties operating in a struggling economic environment.
Resolving the current electricity shortage has now become a battle against time for Eskom as winter in South Africa is fast approaching, bringing with it anticipated increases in electricity demand for heating purposes. South Africa’s dry winters also mean that electricity generation from hydropower dips significantly during the winter months, thereby placing greater reliance on fossil fuel-fired power stations.
Eskom urgently needs to increase its generation capacity in the immediate future, either through expanding the capacity of existing power stations or bringing new ones online. It is also necessary for Eskom to improve its maintenance of generation facilities to ensure that power units are not in danger of operational failure. Such expansion and maintenance activities will require immediate funding. The promised R23 billion from the South African government will be essential in this regard but will also likely place the government under budgetary strain.
However, maintenance requires the shutdown of generation facilities, temporarily reducing generation capacity. Eskom will therefore need to carefully balance maintenance and generation obligations in the coming weeks—favoring the former before the cold weather sets in and the latter thereafter. Unsurprisingly, Eskom has warned of almost daily loadshedding until the end of April, and it is hoped that such efforts will prevent a complete collapse of the country’s generation facilities.
Meanwhile, Eskom and President Jacob Zuma have urged South Africans to reduce their electricity usage, especially during peak demand times, and to use gas for cooking and heating as much as possible. As Eskom rushes to stabilize operations before winter, South Africans will increasingly be turning to gas and generators for their basic energy needs, all the while bracing themselves for a dark and brutally cold winter.
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Sarah Logan is a Zimbabwean lawyer and development practitioner.
[Photo courtesy of cocoparisienne and ddouk]