Stop funding failure: Why SA’s utilities need a radical economic reset

Our state-owned enterprises (SOEs) are in the news daily. We are constantly reminded what they need and how they must be financially sustainable, regardless of how well they manage their businesses or their accounts, or how much economic damage their subsidised survival causes for the rest of South Africa’s economic participants – all of us. 

We celebrate when they declare a profit, without ever understanding the fundamentals of why they make a profit, or what their profit may have cost their customers. If they make huge losses, then the focus turns to the extent of their borrowing capacity or the bailout they may require.

We accept all of this because we have no choice. Our utilities are monopolies and they can’t be allowed to fail, so the bailout happens and the money has to come from somewhere, from somebody – that would be us, the taxpayers, the few who are left.

Because all the money goes into and comes out of the same pot – National Treasury – the extent of cross-subsidy is invisible, never mind open to analysis or criticism. Blanket guarantees wash over all of this, so there is no need for specific entity performance or bankability.

We have become used to borrowing from our future, if not our past. That, if nothing else, is certainly not sustainable, despite its general acceptance as the go-to crutch of our various utilities’ flawed economic models.

If we’re going to stay stuck with this central funding apparatus then, for goodness’ sake, let’s rethink, nationally and holistically, what to do with it.  If Treasury had as its primary decision driver the financial wellbeing of SA Inc and all of its peoples then our utilities would serve us, not dictate terms to us in their selfish best interest. The logic of what has to be done applies to any and all utilities, pick your favourite.

Eskom, for instance, cannot be allowed to increase electricity tariffs by 8.8% while inflation is at 4.3%, population growth at 1.1%, GDP growth at less than 1% and unemployment at 33.6%. It just doesn’t add up. There must be another way.

What if Eskom decided to purposely enable growth in the economy rather than retard it through unaffordable input costs? If you take this SA Inc first approach then a very different strategy emerges (driven by a virtuous capital circle), which goes something like this: 

Eskom approaches its major industrial users to engage with them on a partnership-driven understanding of and sharing in their economic models. A smelter that produces exported products makes a good case study.

A huge amount of energy is required to fire up (and maintain) the furnaces to temperatures that can melt ore, sand, metal, whatever goes into the production process. Although various sources of energy come into the mix (like gas, the supply of which is increasingly uncertain and the price significantly influenced by geopolitical forces beyond our control, or other alternative energy sources), one of the biggest components is still electricity, which is a big enough proportion of input costs to determine whether or not the entity is profitable – as binary as that.

A break-even input cost of electricity can be objectively determined in consultation with the smelter. From that starting point various levels of input cost-correlated profitability can be determined and three things could start happening: 

1. Profits are taxable and taxes revert to the state (via National Treasury) which is Eskom’s sole shareholder;

2. Foreign exchange is earned for SA Inc; and

3. Foreign direct investment becomes a commercial reality, lowering the necessity for state (the sole shareholder) funding or Treasury guarantees (the state’s burden), and significantly influencing SA Inc’s cost of capital.

Scenarios can easily be modelled to determine optimal funding mix alternatives. 

That would be a great start, but with a now profitable, managed and predictable set of locally based export industries we could go much further. 

The primary source of capital for any enterprise (public or private) is profit. Borrowing to fill cash flow shortfalls in the absence of current or future profitability is a fundamentally flawed strategy which ultimately results in creditors replacing shareholders as the controllers of the entity, and in the case of our government entities, our destiny. By contrast, the predictability of forward-positive cash flows attracts capital at a lower cost.

These and similarly aligned financial structures resulting in predictable cash flows make a clear case for long-term off-take agreements which can be part of the economic equation in which the state shares – justified as it is only through lower input cost agreements that the forward-supply price of our products becomes internationally competitive.

This is not privatisation. This is financial common sense which benefits all the participants. This is team sport for efficient capital allocation.

At all levels of government – municipal, provincial and national – we need to move away from central pots of money controlled, wasted and handed out (to be kind) among a very small group of politicians, and instead towards very focused economic modelling and prudent capital allocations. 

As things stand, we’re borrowing ourselves into bankruptcy. Let’s rather earn the money together as Team SA and then spend it wisely to address poverty, inequality and unemployment. DM