Eskom driving South Africa out of business

Ten years ago the cost of energy was 50% the cost of maintaining a hospital. This year, for the first time, the cost of electricity is equivalent to the cost of maintaining a hospital, according to hospital group Mediclinic. Similarly, a decade ago electricity accounted for 0.8% of sales at Shoprite. It now accounts for 2% and the retailer expects this to rise to 4% of sales.

At African Rainbow Minerals, an 18% increase in sales generated a 2% rise in headline earnings, because electricity and wage increases swallowed the profits. And Astral Chickens has suspended wage negotiations during its most difficult period in 30 years. Rising electricity costs means the company has little wriggle room in the face of other industry related challenges.

The food industry is set to impose a 10% price increase as profit margins are eroded by rising input costs like fuel and electricity.

These are the stories of big, listed companies with resources to lessen the impact of cost increases. The difficulties faced by the small entrepreneurial businesses are untold. But all the stories, it would appear, are falling on deaf ears.

“South African business is at a tipping point,” says Mike Rossouw, chairman of the Energy Intensive User Group (EIUG). “Energy pricing is pricing capacity out of business. There is no doubt in my mind that further price hikes will push companies out of business.”

His comments come as the window for written comment on Eskom’s multi-year price determination application – for tariff hikes over the next five years – closes. Public hearings on the MYPD3 will take place in January and final decision will be tabled in parliament by the middle of March 2013.

Tuesday also saw Eskom release its results for the six months to end September 2012. Revenue increased to R73.4bn, up from R63bn last year. This was largely thanks to the tariff increase which the National Energy Regulator (Nersa) granted Eskom earlier this year. Net profit fell marginally to R12.6bn. Eskom ascribes this to the 2.9% drop in electricity consumption.

The profits are reinvested in full in Eskom’s business to service debt and support the funding of its capacity expansion programme.

Eskom’s growing financial stability does not ease business’s pain. “The mining sector accounts for about 22% of the gross domestic product and 55% of direct foreign investment. We should protect that investment at all costs,” says Rossouw. “Instead our miners and energy-intensive manufacturers are being approached by the likes of the US, Canada and China.”

Eskom electricity prices
Eskom electricity prices (Courtesy of Professor Anton Eberhard and Chris Logan)

The EIUG consists of 38 of the largest energy consumers, covering 40% of South Africa’s electricity use. Rossouw notes that more and more companies are approaching for support, saying they cannot sustain their businesses.

They are not just mining companies. “There seems to be an immense insensitivity and lack of concern that the effect of input costs, especially electricity, has on South African manufacturers,” founder and chief executive of Pan-African Capital Holdings, Dr Iraj Abedian, said at the Manufacturing Circle 2012 third quarter bulletin and survey results last week.

The survey reflects the views of South African export manufacturers across various industries, including ArcelorMittal, Saab Grintek, Altron and others.

“In my little circle I know in excess of R20bn of investment that is on hold for one simple reason: lack of energy. Not lack of energy today, but the lack of a credible energy policy,” Abedian said. “Remember, somebody who wants to invest is investing for the next 20 to 30… 50 years.”

What international competitiveness South Africa has retained is being eroded by the rapid rate at which the domestic electricity price is rising

Eskom and the department of Energy have sold the story that the price increases are necessary to build and pay for new infrastructure the country needs so desperately.

But there are alternatives and Tuesday’s interim results presentation from Eskom was revealing.

“Eskom is determined to stick to a cost reflective model,” says investment analyst Chris Logan. “This is despite the increasing evidence which suggests its price path should emphasise productivity and efficiency. Cost reflective tariffs take away any incentive to cut costs.”

Eskom’s operating costs, measured per kilowatt hour increased by 23% over the last year. These were driven up by extraordinary costs such as running its two highly expensive open cycle gas turbines and electricity buy-backs from the ferrochrome producers. “It is questionable whether Eskom needed to do these buy-backs considering they sold less electricity than budgeted for.”

Logan notes that the number of employees increased by 7.5% in the last year and average remuneration per head jumped. “If Eskom is producing the same amount as it was seven years again, why have employee numbers risen by 37% – it violates any notion of productivity.”

Also worrying is the fact that Eskom aims to earn 7% to 8% return on assets within the next three or four years. “For a company like Eskom which is government guaranteed and a monopoly, that is far too high,” Logan adds.

Mike Rossouw
Mike Rossouw

While the regulator may have reduced Eskom’s previously approved tariff increase of 25.9% to 16% for 2012/13, this does not address the problem. The time to avoid and postpone difficult decision making has gone. “Government needs to take a very serious look at all the aspects in MYPD3,” Rossouw says. “Nersa does not have capacity to scrutinise that application to the extent it needs to be scrutinised.”

One of the objectives of the supply of efficient and reasonably priced electricity is to drive economic growth, which in turn lifts living standards. But according to Rossouw government has mixed its objectives. It is also using electricity sales as a source of funding for social development objectives. According to Rossouw, roughly 14% of an industrial tariff is for non electrical charges – including free basic electricity and other items. A similar amount is levied to municipal customers.

Until the cost of electricity is addressed in a substantive manner, it won’t only be heavy electricity users who will find it increasingly difficult do business in South Africa, he says. Rising electricity costs make it difficult for businesses from small ice cream makers to industrial manufacturers to overcome their many challenges.

Source: Moneyweb

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Eskom driving South Africa out of business