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An Analysis of the Macroeconomic
and Sectoral Impact
of the Capital Expenditure Programmes of
Eskom and Transnet
over the Period 2005 to 2010

Gerhard Kuhn
Jorge Maia
Lumkile Mondi
Charles Morolo
Xoliswa Mose
Neo Ramakoae

13 December 2005

INTRODUCTION

1.

The expansion of a country’s economic and socio-economic infrastructure is a prerequisite
for sustainable growth and development. It is in this regard that government and public
corporations play an invaluable role by facilitating and propelling the investment process by
creating a conducive and investor friendly environment, including the provision of the
necessary economic infrastructure, which will lead to the crowding-in of increased private
sector fixed investment to enhance the country’s productive capacity.

Over the past two and a half decades, fixed investment by public corporations declined on
an ongoing basis, with their share of overall investment declining from 25% in 1980 to 10%
by 2004. This adverse trend not only impacted negatively on the efficiency of service
delivery by state owned enterprises (SOEs), but also contributed to the downscaling or even
the demise of industrial activity in specific sectors of the domestic economy that supplied
capital equipment, components and materials consumed by SOEs in their investment
programmes.

The trend in SOE investment expenditure is set to be reversed in coming years, particularly
through the massive R134 billion capital expenditure programmes of Eskom and Transnet
planned for the next five to seven years in South Africa’s energy and transport infrastructure,
respectively. This will be the largest infrastructure development programme in many years
and will provide a major stimulus for industrial development in the country. The importance
of this capital expenditure (capex) becomes even more significant considering that total fixed
investment in the country amounted to R226 billion in 2004, with public corporations
contributing just over R24 billion to this amount in the same year.

Eskom’s infrastructure investment is aimed at increasing the utility’s generation capacity by
5 300 megawatts to 41 500 megawatts. The objective is to re-commission mothballed power
stations such as Camden, Komati and Grootvlei, whilst also creating new generation
capacity and increased transmission capacity in many areas of the country, including
Johannesburg, Bloemfontein, Richards Bay and the Cape Peninsula, as well as supply lines
to Coega (Budget Review 2005).

Transnet’s capital expenditure programme is aimed at improving the quality and efficiency of
the country’s rail network, major ports and harbours. A substantial portion of this investment
will be directed towards locomotives, wagons, signalling equipment and various types of
cargo handling equipment (cranes, straddle carriers, etc.).

The investment plans of Eskom and Transnet are intended to address existing backlogs and
capacity constraints, whilst creating a solid foundation for increased private sector fixed
investment to expand its productive capacity and thus enabling the South African economy
to achieve a substantially higher and sustainable pace of economic growth over the medium
to long term.

2.

Fixed investment, or gross fixed capital formation (GFCF), is a crucial contributor to
economic growth and development, as demonstrated by several newly industrialised
countries where investment activity largely underpinned many of their well documented
successes. Such investment includes capital spending on the expansion and maintenance of
economic infrastructure such as roads, rail networks, port and harbour facilities, electricity
supply, as well as telecommunication services. A rapid increase in fixed investment
broadens a country’s economic base and provides a robust base for future economic
activity, increased levels of production capacity as well as the associated wealth creation.

FIXED INVESTMENT TRENDS IN SOUTH AFRICA

2

It is in this regard that government can play a catalytic role, with the benefits of expanding a
country’s economic infrastructure manifesting themselves in the long term and being a pre-
condition for an accelerated growth trajectory.

In recent years, the relationship between public and private sector investment activity in
South Africa has generally been characterised by insufficient spending on infrastructure
development and/or
the
transportation network, particularly rail, as well as bottlenecks at the country’s main ports
and harbours. Such inefficiencies consequently translated into increased operational costs
for the private sector, whilst the resultant delays also reduced the credibility and ability of
local business enterprises to compete in an increasingly competitive international trading
environment.

its maintenance,

inefficiencies

increased

resulting

in

in

Inward
Inward
industrialisation
industrialisation

Isolation &
Isolation &
sanctions
sanctions

New political
New political
dispensation &
dispensation &
economic
economic
reforms and
reforms and
restructuring
restructuring

illustrated

in
graph,

the
As
accompanying
fixed
investment spending expanded
at a rapid rate during the 1960s
and 1970s, mainly due to high
levels of investment activity by
public corporations. It was in
this period that a number of
investments were
strategic
announced,
the
SASOL II expansion and new
investments by various of its
subsidiaries
the
petrochemical industry. Very
the
large
country’s electricity generation
capacity also took place during
these two decades.

expansions

including

involved

in

in

Moreover, the government of the time adopted a policy of inward industrialisation in an
attempt to establish a strong domestic manufacturing industry in South Africa as it strived for
self-sufficiency. This strong inward focus culminated in large domestic investments in
support of the country’s mining sector, as well as strategic investments in the petrochemical
sector and in the basic iron and steel sector. Underpinned by numerous expansion projects
undertaken by Eskom, Sasol and Iscor, the share of total fixed investment contributed by
public corporations increased substantially over this period (refer to the table below), from a
mere 6% of gross fixed capital formation in 1960 to around 25% by 1980.

3

Despite a rapid increase in private sector fixed investment during the same period,
considering an average annual growth rate of just over 6% in real terms, its share declined
from 58% in 1960 to 50% by 1980.

During the first half of the 1980s, the contribution of fixed investment began to decline as
South Africa became increasingly isolated from the global economy. This situation was
aggravated when trade and financial sanctions were imposed upon the country in 1985, with
detrimental implications for overall economic performance. The ratio of gross fixed capital
formation to gross domestic product (GDP) declined from 27.5% in 1982 to 20% by the end
of that decade, whilst average annual GDP growth measured a mere 1.2% p.a. over this
period.

South Africa’s remarkable transition to democracy in 1994 established a new platform for
growth, with its re-entry into the global economy presenting a multitude of business
opportunities through renewed market access. After years of stagnation and neglect due to
international isolation and sanctions, the demand for investment goods (machinery and
equipment) was revived from 1994 onwards, growing at an average annual rate of 8% until
1998.

Despite the strong growth in gross fixed capital formation (GFCF) over the past decade, its
contribution to GDP has remained at unsatisfactory levels. However, as illustrated in the
previous graph, this trend was reversed in the last two years with a marginal improvement in
the fixed investment-to-GDP ratio from 15.1% in 2002 to 16.5% by 2004. In order to achieve
a substantially higher GDP growth of 6% per annum or more, significantly higher levels of
fixed investment are required and the fixed investment-to-GDP ratio should be raised to a
level of at least 25%.

is encouraging, but remains
The
unsatisfactory. Nonetheless, the prevailing lower interest rate environment (South Africa is
experiencing the lowest interest rates in more than two decades) is conducive to higher
investment activity in the country, whilst the strong Rand is also supportive of investment
decisions from a cost perspective, as imported capital goods have become increasingly
affordable. Local business enterprises should thus be taking advantage of this favourable
set of circumstances to upgrade and/or replace existing equipment.

3.

FIXED INVESTMENT AS A CONTRIBUTOR TO A SUSTAINED 6% GROWTH
TRAJECTORY

turnaround witnessed over

two years

the past

Domestic demand, fuelled by a sharp increase in gross fixed capital formation and robust
consumer spending, has been the key driver of the relatively strong growth performance
experienced by the South African economy over the past two years. Supported by both the
private and public sectors, fixed investment increased at a rapid pace of more than 9% p.a.
in 2003 and 2004.

The medium-term outlook remains extremely positive, with average annual GDP growth
forecast at roughly 4% p.a. over the next five years. A rapid increase in fixed investment
and brisk growth in consumer spending should underpin the expected higher growth
trajectory. The positive investment outlook is strongly supported by the R134 billion capex
programmes of Eskom and Transnet, by the Expanded Public Works Programme (EPWP)
and government spending on social infrastructure, as well as by the Gautrain project and the
build-up to the 2010 Soccer World Cup, among others. Robust private consumption
expenditure is also expected to propel expansions in productive capacity.

4

Gross fixed capital formation is forecast to expand at a fast pace of close to 9% p.a. over the
next five years, compared to an average growth of 6% p.a. during the preceding five-year
period. As illustrated in the
accompanying graph,
the
investment-to-GDP
fixed
ratio is expected to increase
from
level
recorded in 2004 to 21% of
GDP by 2010. Although a
significant improvement, this
ratio will still fall short of the
generally accepted 25%
ratio
investment-to-GDP
required to sustain a 6%
annual growth path over the
long term, and to make a
substantial dent on the high
unemployment levels facing
South Africa.

16.5%

the

ESKOM’S CAPITAL EXPENDITURE PROGRAMME

It is against this background that the massive spending on economic infrastructure planned
by Eskom and Transnet over the next five to seven years is analysed herein, so as to
determine the potential impact on the South African economy, both from a boader macro-
economic perspective as well as sectorally. This analysis focuses on the contribution of the
projected SOE capital expenditure on GDP and employment creation in particular, whilst
also establishing the potential balance of payments implications and the possible
contribution to government revenue via indirect, personal and company taxes.

4.

South Africa is regarded as one of the cheapest electricity producers in the world, with
Eskom, the state owned electricity utility, currently dominating electricity generation,
transmission and distribution.

With a generating capacity of 39 810 MW (out of a total nominal generating capacity of
42 011 MW), Eskom is ranked 11th in world terms, whilst its 206 TWh in generated sales
afford the state owned utility 7th position in global rankings (Eskom Annual Report 2005).
Around 90% of the electricity produced is derived from coal resources, which are abundant
in South Africa. Anticipated strong demand for electricity in the 1940s and 1950s led to large
investments in regions where there were substantial supplies of coal, including parts of what
is today Mpumalanga. These massive investments continued until the 1980s, resulting in
excess generating capacity which made it possible for Eskom to continue providing
electricity at a relatively low cost, without having to invest in new capacity in over twenty
years.

Structural changes in the South African economy, coupled with a transformed political and
social landscape have had a strong effect on electricity demand patterns and levels. As a
result, demand for peak capacity has increased considerably while most excess is in base-
load capacity. In order to meet this growing energy need, Eskom has embarked on an
expansion programme that is intended to meet future capacity requirements. Indications are
that Eskom would need new peaking capacity from 2006, based on moderate growth in
electricity demand and base-load capacity by 2010.

5

Responding partially to these needs, as well as government’s goals of an investment-led
growth in the medium term, Eskom’s five-year capital expenditure plan of R110 billion was
announced in late 2004 by the Minister of Public Enterprises (this figure was subsequently
reduced to R92.9 billion). According to Eskom, this will include the design, building and
refurbishment of assets to meet South Africa’s electricity generation, transmission and
distribution requirements, the ‘return to service’ of the Simunye power stations (Camden,
Grootvlei and Komati), as well as new capital expansion and network strengthening. Eskom
has already initiated the process of bringing back the Simunye power stations that had been
mothballed in the 1980s and early 1990s due to excess capacity at the time. The following
table outlines Eskom’s capital expenditure plans over the next five years. Eskom is
expected to provide about 70% of the new capacity requirements, while the rest will be
provided by the private sector through the introduction of independent power producers
(IPPs).

Eskom Holdings Capex
R million
Generation
Transmission
Distribution
Corporate
New Business
Total
Source: Eskom

4.1

The following charts illustrates the divisional allocation of Eskom’s combined capital
expenditure programme over the period 2005 to 2009:

2009
15 999
1 541
2 851
366
2 192
22 949

2005
6 789
1 494
2 857
270
1 760
13 170

2006
10 275
2 451
2 790
334
960
16 810

2008
14 478
2 325
2 465
360
560
20 188

2007
14 391
2 203
2 646
312
280
19 832

Total
61 932
10 014
13 609
1 642
5 752
92 949

Capital Expenditure per Eskom Division

4.1.1. Generation Division

The bulk of new energy capacity expenditure will be spent on generation, and this division
accounts for about two-thirds of the total capital expenditure programme. Preliminary data
indicates that over 14% of total generation will be spent on the return to service of the
Simunye power plants. The upgrade and refurbishment of an existing coal plant will cost
about 17.8% of the total, while combined cycle gas turbine plants at Saldanha and Coega,
as well as an open cycle gas turbine and the building of a hydroelectric pumped storage
scheme at Braamhoek, are expected to take about 29% of the spend. The rest of the new
capacity expenditure is estimated at around 39%.

6

As pressure is anticipated to be on peaking capacity, priority projects will focus on meeting
this demand, with Eskom planning to commission two open-cycle gas turbine (OCGT) plants
by 2007, which will have a combined capacity of 1 000 MW. Five companies have qualified
to bid for two oil-fired, open-cycle gas turbine power stations, with a combined capacity of
about 1 000 MW. These will operate as peaking plants at sites in the Eastern Cape and
KwaZulu-Natal, and are expected to come on stream in 2008 (Department of Minerals and
Energy, 2005).

4.1.2 Transmission Division

According to Eskom, the distant location of most generating plants has called for the
strengthening of the transmission corridor, particularly in the Cape, which has experienced
phenomenal economic growth over time. The Cape strengthening will take the bigger
portion – about 28% – of the estimated R10 billion transmission capital expenditure.

The Northern Corridor, which serves the platinum base, will also be reinforced, while
transmission capacity in Richards Bay, Bloemfontein and Johannesburg, as well as supply
lines to Coega (over 14% of total) and at decommissioned power stations, will be
strengthened further.

4.1.3 Distribution Division

Over 80% of the capital expenditure on distribution will be spent on lines and cables,
substations, reticulation, refurbishment and control systems.

4.1.4 Corporate and New Business Divisions

These two divisions account for around 8% of the capital expenditure programme. The new
business expenditure is mainly on projects outside South Africa, specifically in the
Democratic Republic of Congo. Capital spending on the Inga Hydropower and Inga Wescor
Power line is estimated at around 53% of new business capital expenditure plan, while
around 17% is for the Coega smelter.

4.2

Preliminary figures provided by Eskom indicate that the combined capital expenditure
programme will have an import leakage estimated at 42.8%. This compares with a total
import leakage of around 11% for the South African economy in 2004. While the imported
component differs across the various Eskom divisions, on balance, it remains high due to the
nature of the equipment required.

Sectoral Distribution of Eskom Capex

7

Domestic spending is expected to be on the following sectors:

• Construction, particularly civil engineering: Approximately R14.6 billion will be spent

on services provided by this sector of economic activity;

• Metal products, excluding machinery: An estimated R9.4 billion will be spent on these
items, which include structural metal products, steel power and poles, as well as
conductors;

• Electrical machinery: R8 billion is likely to be spent on transformers, cables and
conductors, circuit breakers, isolators, metering panels, as well as protection panels
and other related equipment;

• Non-electrical machinery: Expenditure in this sector is expected to total R6.3 billion;
• Coal mining: Over R6 billion will be spent on refurbishing the coal plants;
• Financial and business services: An estimated R1.9 billion will be spent on services

• Motor vehicles, parts and accessories: Approximately R1 billion will be required for

provided by this sector; and

the purchase of fleet and accessories.

investment

levels and

TRANSNET’S CAPITAL EXPENDITURE PROGRAMME

5.

The Transnet Group strategy comprises elements associated with four core businesses,
namely Spoornet, South African Port Operations (SAPO), National Ports Authority (NPA)
and Petronet. A divestment strategy is in place for non-core businesses such as South
African Airways (SAA), whose ownership is anticipated to be transferred to government.
Transnet is set on radically improving its infrastructure and service delivery to its clients.
The planned investment can be divided into maintenance that operates the system at
reasonable efficiency
that would expand port and railway
infrastructure. The combined Transnet capex programme for the period 2004/5 to 2008/9 is
valued at R40.8 billion, to be funded primarily from operational cash flows and borrowings.
The consolidated capex expenditure, together with the portions pertaining to each of the five
main business areas (including SAA), is reflected in the following illustration:

Transnet’s capex programme places most of the emphasis on the core business, that is, rail,
ports and pipeline. The following table reflects Transnet’s capex expenditure amounting to
R34,1 billion, excluding SAA and Transwerk, for the period 2004/2005 – 2008/2009.

8