Eskom Crisis: Challenges, Insights, and Solutions

1. BRIEFING ON ESKOM Presentation to Nedlac 05 March 2019

2. Eskom Power Stations and Mines CONFIDENTIAL

3. South Africa has installed Capacity of 48 039 MWas at March 2018

4. Context: Eskom is in severe difficulty • Eskom faces both financial and operational challenges. • Company unable to meet its obligations • Over reliance on borrowing to service debt • Deterioration plant performance

5. Context: Eskom is in severe difficulty • Proposed solution: Comprehensive Turnaround/Transformation Plan CONFIDENTIAL

6. How did Eskom get here? • Insights: • Capacity grew slightly over the period • Coal Purchases – volumes flat over the 10 year period • Coal costs grew significantly for same volume • Employee costs increased driven by employee benefits CONFIDENTIAL

7. Key Issues from President’s SONA • Security of energy supply is an absolute imperative. • Eskom is in financial crisis and the risks it poses to South Africa are great. • It could severely damage our economic and social development ambitions. • Eskom need to “minimise any adverse economic cost to the consumer and taxpayer.” • The nine-point Generation turnaround plan which we support and want to see implemented. • Eskom will need to take urgent steps to significantly reduce its costs. • It will need more revenue through an affordable tariff increase. • We need to take steps to reduce municipal non-payment and confront the culture of non-payment that exists in some communities. • Eskom will need to develop a new business model. • Three separate entities will be established – Generation, Transmission and Distribution – under Eskom Holdings. These will remain the property of the State. • As we address the challenges that face Eskom we will ensure that there is meaningful consultation and dialogue with all key stakeholders. • We will lead a process with labour, Eskom and other stakeholders to work out the details of a just transition, and proper, credible and sustainable plans that will address the needs of all those who may be affected.

8. 2019 SONA Commitments

9. 2019 SONA Commitments CONFIDENTIAL

10. Key Interventions • Operational - to urgently address the operational problems at Eskom, of which generation is paramount, the Eskom Chairman and I have decided on the following— • Experienced engineers who have left Eskom during the period of corruption and state capture have indicated they want to return to help – Thuma Mina • The board has been directed to do a full operations audit of all power stations to give us an independent view of where the most serious problems are • These experts will also train, mentor and transfer skills to a younger generation of Eskom engineers so that we build a capable team to run our electricity system into the future. • The board must institute an urgent review to establish when – realistically - Medupi and Kusile will be completed. • Also to determine the extent of design- and other operational faults, what steps can be implemented to minimize escalating costs and what can be done to increase output. • The board will appoint a panel of experts to compile an in-depth, independent audit to ensure that every technical problem is understood.

11. Financial

12. How did Eskom get here? • Insights: • Capacity grew slightly over the period • Coal Purchases – volumes flat over the 10 year period • Coal costs grew significantly for same volume • Employee costs increased driven by employee benefits CONFIDENTIAL

13. How does ESKOM spend money? Since 2007, revenue grew more than 4 times mainly driven by massive tariff increases However, expenses (primary energy and employees cost) increased faster than revenue growth EBITDA (proxy for free cash cash-flow) insufficient to cover interest costs and capex (investment) Resulting in a shortfall which is covered through borrowing CONFIDENTIAL

14. Eskom is Facing Liquidity Challenges • The engine is broken: Eskom’s costs are greater than its revenues. • Forecast debt service cover ratio FY19: 0.46 • Eskom is generating less than half of the cash it needs to service its debt (interest and principal (capital) repayments) • Debt trap: Borrowing to repay its debt! 3,08 2,52 2,50 2,11 2,00 1,65 Mar’14 Mar’15 Mar’16 Mar’17 Mar’18 NOV LE Debt Equity Gearing CONFIDENTIAL

15. Municipal Revenue Collection is Rapidly Deteriorating Municipal debt increased by R5.06bn in the last 9 months. This excludes Soweto which now amounts to R17bn with collections stuck at 5%. Value split is for Total municipal debt and not the overdue amount as reflected in the trend growth above

16. Age Analysis of the Top 10 Defaulting–September 18 CONFIDENTIAL

17. Proposed Financial Interventions Government • Eskom request a tariff increase of 15% for the financial years 2019/20 to 2021/22. • NERSA will be making a determination on the tariff application by 1 March 2019. • Government to renegotiate round 1 & 2 of renewables with regard to contractual rights • Recover municipal and Soweto debt (R28 billion). • Embark on a process for the legal separation of Eskom. • Develop a just transition plan to deal with socio-economic impact.

18. Financial To support the Turnaround Plan, Government has allocated R23 billion each for the next three years. The fiscal support is conditional on an independent Chief Reorganisation Officer (CRO) being jointly appointed by the Ministers of Finance and Public Enterprises.

19. Employee Numbers per Business Unit CONFIDENTIAL

20. Operations

21. Eskom Generation Fleet are Aging • More than half of Eskom’s generation is more that 37 years old. • Major midlife refurbishment is required and have not been implemented due to financial constraints and requisite space. CONFIDENTIAL

22. Capacity Outlook based on Planned and Unplanned Outages Total installed nominal Capacity ~ 45000MW ~17000 MW unavailable Breakdowns (UCLF) Breakdowns (UCLF) Planned Maintenance (PCLF) Diesel Electricity demand CONFIDENTIAL

23. Eskom ran OCGTs to manage the system during low levels of energy availability to avoid or minimise load shedding. • Eskom produced 429GWh by December 2018 with the cost of R1 373 billion . Projecting that by Fy year end, the figure will be R2 665 bn • OCGT load factor has gone beyond the 1% approved by NERSA OCGT usage has increased significantly due Poor Plant Performance CONFIDENTIAL

24. New Build Programme Statistics CONFIDENTIAL

25. Eskom’s 9 point plan for Generation turnaround

26. Structural Interventions

27. Business Case for establishing separate entities entities • Despite Eskom being regulated and licensed as three (3) separate businesses i.e. Generation, Transmission and Distribution. • Eskom reports in an aggregated basis leading to lack of transparency, accountability, consequence management ; and no clear P&L allocation • Inefficiencies inherent in monopolistic industries • Global trends with alternative energy sources Advantages of three separate entities: • Increase transparency in costs, transfer prices and corporate structure helps protect public interest; • Better control of the different elements of the value chain via regulatory benchmarking; • Easier to introduce competitive pressures in the supply chain; • More agile exploitation of market opportunities by suppliers; and • Easier for non-traditional providers to enter the market • Leveling the playing field for non-Eskom generators • Agility in responding to new models and technologies

28. Business Case for establishing separate entities • Mitigate the risk arising from an Eskom that is “too big to fail” and limit financial contagion from the underperforming parts of Eskom’s generation business, where most of the problems originate; • Position the electricity sector to embrace clean technology, distributed generation and respond to other changes taking place in the electricity sector; • Provide open access to the grid and remove conflicts of interest to the procurement of power, both conventional and renewable, from independent generators; • Diversify the generation of electricity across a multitude of power producers, thereby reducing the country’s reliance on a single supplier; • Generate competition in the electricity market that is expected to drive improvements in efficiency and put downward pressure on prices; . • Enable greater management attention to be focused on turning around the different parts of the business, whilst enhancing accountability; • Reduce the opportunities for fraud, corruption and rent-seeking; Crowd in private investment into the electricity sector; • Allow lenders to separately fund the different components of the business, allowing debt to be priced more tightly, as it more accurately reflects the unique risks of each individual business;

29. New Transmission Entity Establishment of a new wholly-owned subsidiary of Eskom – Transmission entity which will be tasked to: • Own and operate the transmission assets; • Perform the functions of the single buyer office, purchasing power from Eskom and independent power producers; • Operate the transmission system; • Sell electricity to municipalities, industrial users and other customers; • Have a board of directors which is independent of Eskom

30. New Transmission Entity Establishment of a new wholly-owned subsidiary of Eskom – Transmission entity which will be tasked to: • Own and operate the transmission assets; • Perform the functions of the single buyer office, purchasing power from Eskom and independent power producers; • Operate the transmission system; • Sell electricity to municipalities, industrial users and other customers; • Have a board of directors which is independent of Eskom

31. Possible Road Map to the Creation of Transmission Entity

32. New Transmission Entity Establishment of a new wholly-owned subsidiary of Eskom – Transmission entity which will be tasked to: • Own and operate the transmission assets; • Perform the functions of the single buyer office, purchasing power from Eskom and independent power producers; • Operate the transmission system; • Sell electricity to municipalities, industrial users and other customers; • Have a board of directors which is independent of Eskom

33. Reforms required to Support Sustainability Eskom Today Functional Separation DPE DPE Eskom Eskom Gx Dx Rx SB Tx Gx SB1 Tx Dx Rx2 Eskom What is the legal entity? Eskom Eskom, Gx, Tx, Dx, Rx Where does the P&L reside? Eskom Who employs the FTEs? Eskom Eskom Eskom Where does the debt reside? Eskom N/A 12-18 months How long to implement from today? First Step • Single Buyer 2. Retail & beyond the meter services 3. Any combination HoldCo/Subsidiary possible. One option shown • Based on Board Decision having considered the BCG and Lazard input 33

34. Stakeholder consultations & other LRA processes • Government has already started the process of consulting with key stakeholders - Labour (NUM, NUMSA & Solidarity) - Alliance Secretariat - Political Alliance Council - The Presidency - Mineral Council of South Africa - Engineering Council of South Africa - Cabinet • Eskom has commenced with Sec 189 process - Executives reduced from 21 to 9

35. Conclusion • Eskom has a serious financial crisis • National Treasury has set R23 billion/year/10 year, but more has to be done • In the interest of the economy and the country – immediate measures must be taken - Financial - Operational - Structural - People skills 4. Government will ensure constructive consultations with all stake holders- particularly labour 5. A more comprehensive business case and structural transformation is being developed and brought to NEDLAC