When a private company grossly mismanages a project designed to add revenues and profits or mismanages the project such that its capital costs grossly exceed budget, the management takes the blame. They may lose their jobs as well as their reputations, and the shareholders who appointed them have to bear the burden of a lower return on the extra plant and equipment created. In extreme cases the overruns and the waste of capital incurred may bring the company down, causing shareholders to lose all and debt holders to salvage what they can out of the loss making wreck.
In the case of a government-owned and regulated monopoly the outcomes for the management and the company may not be so severe. Unlike the private company, the regulator may be persuaded to allow the company to charge more to maintain a regulated return on the extra capital employed. Unlike the private company facing competition and market determined prices, largely beyond its control, the public monopoly may be able to cover its cost overruns with higher prices. With little alternative, the consumer will have to pay up and hope to economise on the more expensive essential service. The consumers, not the company, then have to bear the consequences of what might well be very poor project management. And the international competitiveness of all those who use the now more expensive service suffers accordingly. Factories and mines will then become less profitable, especially in export markets, because they will not be able to pass on higher costs, so discouraging further investment in their enterprises. And households will see their real disposable incomes taxed further, discouraging consumption of other goods and services.
Making customers rather than owners carry the proverbial can for poor project management is not only unfair – it covers up for poor management so encouraging managers to become less responsible and efficient.
Price and return on capital-regulated state owned enterprises play a critical role in supplying the SA economy with essential infrastructure, such as new power stations (Medupi) and new pipelines (Transnet’s new pipeline from Durban to Gauteng). The problem is that the managers of these state owned enterprises are not making a very good fist of project management. These important projects are well behind time and well over original budget.
Fortunately for the consumers of electricity or pipelines, the regulator is adopting a more critical approach to the costs, both capital and operating, claimed by Eskom and Transnet to justify higher prices. A report (Businessday/BDlive, Razina Munshi, 2 August 2013) commented:
“The National Energy Regulator of South Africa (Nersa) is investigating the near doubling of the costs of Transnet’s new multiproduct fuel pipeline from Durban to Gauteng, in a move that could herald closer scrutiny of big cost overruns on state infrastructure projects. The outcome of the probe could also have implications for petroleum pipeline tariff hike requests in the future……. Transnet originally budgeted R12.7bn for the project, but this soon rose to R15.4bn, and it quickly became clear that even that was conservative. The final price tag of R23.4bn includes the cost of pump stations in Durban and Heidelberg, still under construction….”
Commenting on Eskom’s claim for higher prices, Business Report (12 July 2013 ) said: “The failure to push through big-enough price increases has created a 225 billion-rand cash-flow shortfall as the company struggles to meet the continent’s biggest economy’s electricity demands.”
This cash flow shortfall – the difference for Eskom revenues between a 16% per annum price increase over five years and the 8% per annum increase granted by Nersa – helps reinforce the important point. If the consumers cannot be forced to pay up for management failure, then the owners have to.
The owner of Eskom and Transnet is of course the Republic of South Africa, ie the citizens whom the government represents. To overcome the huge cost overruns they, the people, have to come up with the extra cash, that is the extra capital required to keep Eskom and Transnet going. They have to borrow the money and pay the extra interest on the additional debt, and/or impose additional taxes on themselves to cover up for poor project management. Even if some of the people believe that others, not themselves, will be stumping up it is clear that the funds so raised and the taxes paid could be put to better alternative uses, for example building homes, schools or hospitals.
It is not at all clear why the people of SA would wish to take on these risks of poor project management that they need not have to do. The assets and activities of Eskom and Transnet could be privatised, as they are in many economies, with the current plant and equipment sold off at market determined prices. The pipeline would fetch a pretty penny at current regulated prices. In this way not only would the debt levels and interest expense of the Republic be reduced significantly, the exposure of the SA citizen to huge cost overruns would be eliminated. Shareholders in privately owned utilities with highly predictable revenue streams would willingly bear those risks, especially if the regulator offers them a fair risk-adjusted return on capital. And the Republic would also collect its normal share (28%) of the profits earned by a privately owned utility and the dividends paid out.
Little sympathy should be accorded to Eskom having to raise the extra debt to cover their cost overruns. A recent positive response by a private company, Exxaro/GDF Suez Energy to a Department of Energy call for participation in electricity generation (13 June 2013);if accepted, will allow this private company to build a new coal fired power station producing a respectable 680MW of electricity, to be delivered to the grid at presumably current wholesale prices set by the regulator for Eskom – plus inflation.
This indicates that the price of electricity in SA is now more than high enough to encourage private owners to risk their capital to supply additional electricity. No doubt the company has built in high enough returns on the capital it intends to employ to make the project viable. Should it succeed SARS will be looking to its normal share of profits. And should it fail to produce a profit, or even go out of business, the shareholders will have to stand up and bear the loss. Some other group of owners would then take over the plant at what will be a distressed price and hope to manage it better.
SA citizens would surely find this a better prospect than having to bear the risks of owning assets over which they have very little control and their managers do not appear to do a very good job of managing.