Economic Overview for Business Owners
Let’s hope Eskom can score at least 77 per cent
I have commented on numerous occasions in recent years on the material bounce in earnings of small and medium enterprises in the aftermath of the past recession as businesses focused on reducing operating costs and enhancing efficiency.
However, the earnings momentum of small capitalisation shares listed on the Johannesburg Stock Exchange, has been waning against a backdrop of subdued domestic final demand growth.
JSE small capitalisation sector earnings and returns
Source: I Net
The operating environment for small business is not getting any easier. There is, of course, some good news, notably the collapse in oil prices. In essence, the fall in fuel costs represents an improvement in South Africa’s purchasing power. One ounce of gold can currently buy twenty-five barrels of oil compared with just twelve barrels six months ago.
South African households spent an estimated R108 billion on petroleum products in 2014. Given the current level of the Rand and the oil price, the implied saving for households is R27 billion in 2015 relative to 2014 (or around 1 per cent of personal disposable income).
The concomitant 27.8 per cent fall in petrol prices between August 2014 and February 2015 reduces consumer price inflation, which is expected to average just 4 per cent in 2015, before increasing on base effects in 2016. Along with the expected improvement in South Africa’s current account balance, due to the lower oil import bill, this implies the South African Reserve Bank can pause, perhaps for a lengthy period this year, in its quest to “normalise” its policy interest rate.
However, the positive impact from lower oil prices on the economy is likely to be negated, to a significant extent, by lower coal and base metal export commodity prices and electricity supply shortages.
NERSA indicated in January 2015 that Eskom’s total capacity (including imports) was expected to reach 46 252 MW in 2015, while peak demand is expected at 39 536 MW. The addition of the first unit of Medupi, with a capacity of 794 MW, is expected in June 2015. And, even though additional capacity from the Ingula pumped storage plant will only be available in 2016 (postponed from 2015) Eskom’s total capacity is expected to exceed electricity demand. However, the problem is that in recent years an ever larger portion of Eskom’s capacity has been unavailable to due maintenance. Especially worrying is the spike in unplanned maintenance. Overall, only 77 per cent of Eskom’s capacity (known as its energy availability factor or EAF) was available on average in 2014 (including a decline to below 70 per cent at one point in December 2014).)
The problem is, since the largest portion of current maintenance is unplanned it is exceedingly difficult to predict the likely availability of capacity through the remainder of this year. Eskom does a large amount of planned maintenance at the height of summer and it is reasonable to expect a significant amount of capacity to come back on line in the months ahead. But, even if the EAF increases to around 77 per cent, it is likely to be a close run thing as to whether available capacity can meet demand. Failure to reach an EAF of 77 per cent would be a most worrying development.
The bottom line is frequent electricity outages are likely. But, it is not merely the supply constraint of insufficient capacity which businesses must deal with. Sharp electricity price increases also appear likely. One problem Eskom faces, for example, is the cost of running its open-cycle gas turbines (OCGT) in an effort to meet demand. Initially, the intention was to use the OCGTs for around 3 hours per day in order to deal with peak demand. However, in recent months the power utility has been running its OCGTs for up to 12 – 16 hours per day on occasion. The largest of these, namely Ankerlig and Gourikwa, operate fourteen turbines between them. Each turbine uses around 47 000 litres of diesel per hour. Assuming the turbines run at 30 per cent (7 hours per day) they would use 7 million barrels of oil per annum at a cost of R500m per month. Since, the OCGTs are run at a sizeable loss to Eskom the costs will need to be recouped, most likely through tariff hikes.
Further, Eskom has also turned to the National Treasury for assistance at a time when the fiscal authorities have no room in which to manoeuvre. Indeed, the National Treasury indicated in its Medium Term Budget Policy Statement (October 2014) that additional revenue raising measures would be needed in the coming fiscal years. At the time of writing the outcome of the National Budget for the coming fiscal year, to be read by Minister Nene on 25th February 2015, is unknown. At least, perusal of the Davis Tax Committee recommendations suggests the Committee is in favour of a tax system that is supportive of small and medium enterprises. The Committee also recognises the need to reduce the burden of compliance on small and medium business enterprises. Needless to say, any tax relief or reduction in the compliance burden would be a very welcome development for small and medium enterprises.
Written by Arthur Kamp, Investment Economist, Sanlam Investment Management
