If you’ve got coal, you’ve got problems ~ Buffett: Solving SA’s power conundrum in an age of clean emissions and climate change

Warren Buffett, often introduced as the Oracle of Omaha, illustrated why he deserved this title by painting coal investments with a tar brush some four years ago. On 6 May 2017 he told a gathering of Berkshire Hathaway shareholders that coal was unlikely to make a comeback in the United States. “If you are tied to coal, you’ve got problems; I do not think there is any question [over whether] coal is going to go down as a percentage of revenue,” he said. A telling statistic is that America’s coal industry, which employed 862 000 workers in 1923, accounted for just 81 000 jobs by 2017.

An ongoing struggle to ‘light up’ South Africa

This almost four-year-old prediction, coupled with the global trend shift towards impact investing, is sobering news for South Africa’s state-owned power utility, Eskom SOC Limited. Eskom, which has achieved global notoriety for its ongoing struggle to keep the country’s lights burning, is heavily dependent on old-tech coal-fired power stations to generate its base load. The group’s 2020 Integrated Annual Report reveals that 95% of its total base-load capacity is produced from ‘dirty’ coal. And by Eskom’s admission: “Our environmental performance continues to be deeply disappointing, with both emissions and water usage performance far exceeding targets”. 

Eskom CEO, André de Ruyter, is painfully aware of the base load conundrum. He told the audience at a 24 November 2020 “Think Big” webinar, hosted by local asset manager, PSG, that it was becoming increasingly difficult to build new coal-fired projects in South Africa. “Any proposal to add new coal is [problematic] because you could go and borrow the money … which might take you the better part of a decade … and then still have to comply with strict environmental conditions,” he said. Eskom faces a major challenge to increase its total base load from renewables, while at the same time replacing the load lost due to its forced decommissioning of dozens of end-of-life ‘dirty’ coal-fired plants. It needs capital for new builds; but faces two hurdles in raising funds. 

The first is a consequence of its weak balance sheet. the utility is more than R500 billion in debt and struggling to meet its interest payments, let alone find cash for new projects. This means that it will be increasingly difficult for Eskom to find the cash to buy additional base load. “There are some opportunities for us to participate in new generation by means of repurposing old coal-fired power stations, which we can convert to natural gas or integrate with wind or solar projects,” said De Ruyter. He said they may consider contributing its existing infrastructure in some kind of public / private partnership. This signals a shift from Eskom being “the only game in town for generation” and paves the way for the much-publicised restructure into distribution, generation and transmission business units. 

Investment focus turns to sustainable investing

The second is the trend shift among allocators of capital to integrate environmental, social and governance (ESG) concerns in their investment decisions. ESG and impact investing filled an entire day at the 2020 Alternative Investments Summit, held 27-29 October. And the 2020 Morningstar SA Investment Conference revealed that ESG-focused funds are mushrooming globally, with more than 3400 fund choices and assets under management topping US$1 trillion. The conclusion from these and other asset management conferences is that both institutional and retail investors are keen to generate sustainable returns from their investment portfolios. There is a growing realisation that ‘investment return’ and ‘sustainable investing’ are not mutually exclusive and that ESG investing is akin adding ‘conscience’ to the profit debate. 

Eskom has no chance of topping a list of 2020 ESG or impact investing opportunities until it addresses the dirty legacy that its coal focus has left. The group boasted that its “relative particulate matter emissions would reduce by 51% by 2030; SO2 by 22% and NOx by 27%, compared to a 2020 baseline”; but made no attempt to compare these achievements against tough international targets. Eskom’s 2019 atmospheric emission reduction plan was estimated at R67 billion in nominal costs over the next 10 years; but there are plans afoot to reduce this number by petitioning the Department of Environment, Forestry and Fisheries to lower emission targets. This move is unlikely to score points among the gathering crowd advocating for clean energy.

De Ruyter has his work cut out to turnaround a utility hamstrung by regulated income, soaring bad debts and unionised workers. “It is critical for us to operate with cost-reflective tariffs,” he said, explaining the utility’s recent decision to challenge the national energy regulator’s price determination. He reminded consumers that high electricity prices were not entirely Eskom’s fault: “Our municipalities use electricity as a significant money spinner for their own revenue collection … and the margins that they add to the electricity bill is sometimes as high as 80 per cent”. 

No appetite for S189 retrenchments

Eskom’s management encountered strong resistance to reducing staff head count via a section 189 retrenchment process. “Our appropriate staffing level is somewhere between 36 000 and 38 000,” said De Ruyter. “At end-2019 we had 46 000 employees and are currently at 44 000, with a clear glide path to 38 000 by end-2023”. These job cuts would be cut using a combination of natural attrition, recruitment freezes and voluntary settlements. And that leaves the challenge of collecting the growing debt that Eskom’s customers simply refuse to pay. Eskom has begun the long term ‘cat and mouse’ game with its municipal clients to get them to settle outstanding accounts that run into billions of rand. 

What does the future hold? De Ruyter believes that Eskom has the necessary foundation to put in the right systems. “What happened at Eskom was more of a leadership failure than a failure of people,” he said. He deflected suggestions of political interference, saying: “Everyone from Cabinet Ministers to members of Parliament to dissatisfied customers [believe] that their agendas are the most important for Eskom”. It is a difficult balancing act that is best addressed by being honest and transparent about the challenges the power utility faces. He also reminded the audience that social media was being weaponised by groups with narrow interests, as evidenced by recent conspiracies. One example was an anti-De Ruyter campaign on Twitter that was traced back to just five individuals. Will De Ruyter succeed where countless others have failed? 

Slightly better than ‘heads or tails’ odds

We would offer slightly better than even odds that De Ruyter rescues the behemoth from its decades-long wallowing in a sea of corruption, mismanagement, poor maintenance and under investment. The question becomes whether the struggling utility can manage its balance sheet and raise enough capital to remain relevant in a world that places higher emphasis on sustainable investing.