Eskom fights for right to impose penalties

2013-07-14 14:01

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Hitachi’s interdict sets bad precedent for errant contractors

Eskom is heading to the Supreme Court of Appeal (SCA) next month to undo the damage caused by Hitachi Power Africa’s successful evasion of performance penalties.

As things stand, Eskom might be unable to decisively enforce its performance guarantees against any of the contractors on its multibillion- rand build programme.

Eskom tried and failed to demand payment of performance guarantees from Hitachi in February this year after repeated delays and evidence of faulty welding, but instead got a bloody nose in court.

Hitachi managed to get an interdict from the South Gauteng High Court on February 13, which not only spared Hitachi penalties potentially worth billions, but also, in effect, undermines Eskom’s other contracts at Medupi and Kusile.

According to Eskom, “the same or similar clauses” to those affected by the Hitachi interdict are to be found in the Medupi contracts and in those for Kusile.

“In the circumstances, the judgment has potentially far wider implications for Eskom than simply the relationship between it and Hitachi,” Eskom says in its heads of argument submitted to the SCA.

But the high court made a finding that “went beyond even the case that had been made out by Hitachi”, says Eskom.

“Hitachi will not oppose the appeal but the matter is not a formality. The SCA will need to provide its judgment on the matter,” Eskom said on Friday in response to questions.

According to Eskom, Hitachi’s urgent application on February 13 was heard at 8pm that evening, when Judge NF Kgomo granted Hitachi an interdict that stopped Eskom from claiming guarantees until at least the end of that month.

“More importantly, however, Eskom was directed forthwith to revoke the demand that had already been made. This is an order that is unlimited by time and becomes final once effect is given to it,” said Eskom.

As a result of the judgment, Eskom might now be obliged to treat all its contractors with kid gloves, giving them a month’s notice before claiming any guarantees.

“More troubling, the finding not only has retrospective effect, but also applies prospectively to future circumstances in which Eskom may seek to make demand upon the guarantees that are currently held by it.

“Eskom would, on the strength of the judgment, be required to give notice if, in the future, it sought to call up any such guarantee.”

The Hitachi contract is worth roughly R38.5 billion and required Hitachi to provide performance guarantees, “which were provided in the form of six performance guarantees drawn on the bank”, says Eskom.

The bank in question is the Japanese Mizuho Corporate Bank.

Eskom has claimed performance guarantees from Alstom, the French contractor responsible for the latest delay, for its failings but mystery has surrounded its failure to do the same with Hitachi.

“There has been no settlement with Hitachi,” Eskom’s CEO Brian Dames said on Wednesday when Eskom’s annual results were announced.

On Friday, Eskom reiterated that simply making the December deadline would not be enough to secure the guarantees. At the same event, Public Enterprises Minister Malusi Gigaba said that Hitachi has committed to finishing the Medupi work by the end of the year.

“If they reach that deadline there is no reason to express displeasure,” he said.

His earlier assurances that “heads will roll” about Medupi’s delay were correct at the time, he argued.

He went on to announce that an independent consultant has been appointed to assess Eskom’s ability to manage its megaprojects.

The consultant, Acorn Consulting, will also “ascertain the full extent of any risks to the build programme”, and research risks of further delays and cost escalations at Medupi and other projects.

The study will “inform remedial actions”, he said.

That does not preclude Eskom from pursuing its contractual remedies, he added.

“The relevant contract is a modified version of an internationally accepted and widely used standard form of construction contract, which includes several potential remedies for Eskom,” the power utility said in reply to questions on Friday.

The original switch-on date for Medupi was the end of 2012, which was then extended to May this year. It was again extended to December this year, mostly because of Hitachi.

This week, it was officially delayed to the second half of next year, although the main culprit this time is the French contractor Alstom, which is installing the Medupi control systems.

Medupi was originally scheduled for completion in 2015 and Kusile in 2017. Now Medupi might only be finished late in 2017 and Kusile in 2018.

“Eskom considers that the issues related to the Hitachi bond are specific to the Hitachi contract.

Having said this, however, there is a broader significance related to the legal precedent that should be addressed to avoid any future adverse ramifications.

“The appeal therefore has practical significance,” argues Eskom.

Eskom earnings

Eskom spent R60.7 billion on coal and diesel in its last financial year, a massive 36% increase with two main causes: the poor performance of Eskom’s “tied” coal mines which forces it to buy more coal at market prices, and its monumental use of diesel to keep its emergency peak generators burning around the clock.

It costs Eskom, on average, R0.542 to generate a kWh of electricity. Its revenue was, on average, R0.585/kWh. It also spent R2.9 billion buying electricity from independent producers at R0.83/kWh.

“This gives an idea of the real cost of power,” said Paul O’Flaherty, Eskom’s outgoing financial director.

Net profit fell from R13.2 billion to R5.2 billion, modest for a company with revenue of almost R130 billion.

Eskom had long warned its gross debt will balloon to R400 billion by the end of the programme, and that could now very likely become R450 billion, according to O’Flaherty. The major problem is that the interest on this debt might become unaffordable.

The net interest payments in the year were R7.2 billion with gross debt at R203 billion.

Debt levels are five times higher than “investment grade”, meaning Eskom will need more and more government guarantees. “If all else fails”, Eskom will have to go back to the National Energy Regulator of SA and plead for higher tariffs in the next round, said Dames.

How it happened

Hitachi Power Africa won the largest single contract on Medupi as well as its sister power station Kusile – erecting the boilers – in October 2007.

The deal was almost immediately mired in controversy when it emerged that Hiatchi’s minority shareholder in South Africa is Chancellor House, an ANC investment firm.

The guarantees are generally estimated to equal 10% of the value of the contract, which would make those tied to Medupi worth roughly R2 billion.

“In the course of Hitachi’s undertaking the works under the construction contract, various disputes have arisen between the parties with regard to the performance by Hitachi of its obligations,” says Eskom.

“Eskom alleges that Hitachi is guilty of material and ongoing breaches of the construction contract, which, inter alia, are causing delays in the commissioning of the first operating unit at Medupi.”

According to Eskom’s court papers, it has been threatening Hitachi with calling up the guarantees for some time in order to get it to improve its performance and “discussions had been ongoing since at least September 2012 with a view to averting the calling up”.

Eskom set January 31 as the deadline to “remedy mal-performance” after which Eskom would call up the guarantees.

This deadline passed and on February 1, Eskom wrote to Hitachi “recording” that they had failed, but also offering them a further grace period to the end of February.

Hitachi wrote back a week later, on February 8, allegedly rejecting Eskom’s damning appraisal of the work at Medupi and purporting to “set the record straight”, says Eskom.

Hitachi then set its own condition before Eskom can claim the guarantees – essentially demanding that its failings be independently verified.

According to Eskom, that was “an outright refutation of Eskom’s proposal”.

“Far from accepting the offer made by Eskom, Hitachi bluntly, if not indeed high-handedly, rejected the offer,” it says in court papers.

As far as Eskom was concerned, that was the end of the grace period for Hitachi and it then went on to claim the guarantees from the bank – at which point Hitachi got the interdict.

According to Eskom, the offer of a new deadline in no way meant that Hitachi’s performance guarantees were safe, but Hitachi?convinced the court to interpret it exactly that way.

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