The Growing Crisis at Eskom Holdings Drags Down the South African Economy

Eskom Holdings is South Africa’s only power utility, supplying 95% of the nation’s electricity. In November 2018 the utility started instituting daily rolling blackouts (load-shedding) to prevent a collapse of the power grid across the country. These rolling blackouts are a measure of last resort to protect the power system from a total collapse or blackout. But plunging the entire country into total darkness has essentially brought economic activity to a halt.

Consumers in South Africa were previously hit with extreme outages in 2008 and 2015 because of maintenance issues at power plants, coal transportation problems, and general internal mismanagement at Eskom. The utility has had 10 different CEO’s in the last 10 years, highlighting its ongoing instability and leadership failure. Eskom’s current CEO, Phakamani Hadebe, announced in May 2019 that he will step down at the end of July 2019, citing health reasons.

Given Eskom's size and its vertically integrated structure, any challenge experienced in one part of the business threatens the entire company and places the country's electricity supply at risk, which in turn adversely impacts the overall economy.

Economic Optimism in the Face of Ongoing Challenges

In May 2019, South Africa held its sixth democratic election. The re-installation of President Cyril Ramaphosa was met with optimism for an economic renaissance, but the country still faces serious challenges. After contracting in the first two quarters of 2018, GDP rebounded in the second half of the year. However, the expansion was short-lived. GDP slumped an annualized 3.2% in Q1 2019 as Eskom’s power cuts crippled the manufacturing, mining, and agricultural sectors.

At the same time, unemployment is on the rise. The unemployment rate stood at 27.6% in Q1 2019 and is expected to increase to 29.6% in 2019 and 30.5% in 2020 according to FactSet Economic Estimates.

Eskom’s Debt Soars

While Eskom’s problems have significantly worsened in the last year, the company has been in trouble for the past decade. Eskom’s revenue has increased nearly four-fold over the last 10 years, yet its profits decreased by more than 50% over the same period. In the last 12 months, Eskom's total debt has surged from just under ZAR 400 billion ($26.8 billion) to roughly ZAR 444 billion ($29.8 billion), according to data compiled by FactSet, including short-term debt, revolving credit, term loans, notes/bonds, and other debt instruments. Eskom's debt continues to spiral, with experts saying it could reach half a trillion rand by the end of the year. Loans account for 55.9% of Eskom’s total debt, as the company continues to borrow to keep itself solvent.

South Africa’s state pension manager, the Public Investment Corporation (PIC), oversees the pension funds of the Public Servants Association, the trade union for South Africa’s public servants. The PIC holds large stakes in several South African companies, including ZAR 54.8 billion of Eskom bonds, or 16.8% of the company’s total debt outstanding. The labor union is demanding that PIC stop investing in the debt of Eskom, potentially increasing funding pressure on the heavily indebted utility.

Eskom Calls on the Government to Share the Burden

Eskom’s debt is mostly guaranteed by the South African government, which is also facing a tough battle ahead. Eskom still depends on state guarantees and bailouts to survive, but it may need even more assistance. Earlier this year, Eskom proposed that the South African treasury take on ZAR 100 billion of the utility’s debt. Having the government absorb part of Eskom’s debt would improve the company’s balance sheet, but would in turn diminish the South African government’s standing with credit rating agencies who decide whether the government is rated at “junk” status, any rating below investment grade. Currently, only Moody’s still assesses South Africa’s local currency denominated debt at investment grade; both Fitch and S&P have assigned junk ratings.

In his most recent budget speech, Finance Minister Tito Mboweni announced that the national treasury would commit to providing financial support to Eskom of ZAR 23 billion per year for three years. The combined ZAR 69 billion package is intended to assist in splitting the power utility into three entities: generation, transmission and distribution. President Ramaphosa proposed this restructuring plan back in February as part of a strategy to cut costs and turn Eskom around. The restructuring would also allow for greater participation by private industry in the electricity industry, although there are no plans to privatize Eskom. The proposed cost-cutting measures would mean a significant reduction in Eskom’s employment numbers; thus, the changes are opposed by labor unions.

Conclusion

After growing just 0.8% in 2018, the International Monetary Fund (IMF) predicts that growth in South Africa will marginally improve to 1.2% in 2019 and 1.5% in 2020. Analysts surveyed by FactSet are somewhat less optimistic on 2019, predicting annual GDP growth of 0.9% for 2019 and 1.8% for 2020. The projected recovery reflects modestly reduced but continued policy uncertainty for the South African economy following the May 2019 elections. These growth rates are well below the 5-7% target rates that Ramaphosa presented in January as part of his vision for South Africa.

Eskom’s ongoing difficulties remain a challenge for the economy. According to the IMF, Eskom is a “major downside risk” to South African economic growth. Until the government can engineer a solution to this systemic problem, the country’s economic future remains uncertain.

Sara B. Potter, CFA also contributed to this article