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Directors' report

5. Economic

5.1 Financial performance

Income statement
The business performance for the period was as follows:


	Target	Actual	Actual
	2006	2006	2005
	(12 months)	(12 months)	(15 months)
	Rm	Rm	Rm
Profit before fair value gain/(loss) on embedded derivatives and taxation	n/a¹	5 453	7 690
Eskom Holdings Limited	4 721	5 741	6 458
Eskom Enterprises (Pty) Limited	215	389	296
Escap Limited	166	154	227
Gallium Insurance Company Limited	221	341	144
Intergroup eliminations	–	(1 172)	565
Fair value gain/(loss) on embedded derivatives	n/a¹	1 322	(4)
Eskom Holdings Limited	(580)	1 418	72
Eskom Enterprises (Pty) Limited	–	(96)	(76)
Profit before tax	4 779	6 775	7 686
Less: Taxation	n/a¹	(2 154)	(2 313)
Eskom Holdings Limited	(1 504)	(2 095)	(2 033)
Eskom Enterprises (Pty) Limited	(61)	(91)	(118)
Escap Limited	(48)	(38)	(64)
Gallium Insurance Company Limited	–	–	–
Intergroup eliminations	–	70	(98)
Profit from continuing operations	n/a¹	4 621	5 373
Eskom Holdings Limited	2 637	5 064	4 497
Eskom Enterprises (Pty) Limited	154	202	102
Escap Limited	118	116	163
Gallium Insurance Company Limited	221	341	144
Intergroup eliminations	–	(1 102)	467
Profit from discontinued operations: Eskom Finance Company	25	14	38
Profit for the period	n/a¹	4 635	5 411

^1. Group targets are not calculated.

Key numbers for the group include:
	Target	Actual	Actual
	2006	2006	2005
	(12 months)	(12 months)	(15 months)
Sales
Eskom electricity sales – external, GWh	212 472	207 921	256 453
Eskom electricity sales growth – external, GWh %	3,0¹	(18,9)²	30,5²
Eskom electricity sales growth – external Rm %	4,6¹	(13,9)⁴	30,3
Revenue	n/a⁵	36 607	43 207
Electricity revenue – external, Rm	35 580	35 425	41 127
Electricity revenue – internal, Rm	74	88	96
Other revenue – external, Rm	107	45	164
Subsidiaries – external, Rm	1 167	1 103	1 587
Subsidiaries – internal, Rm	3 200	3 589	4 087
Intergroup eliminations	–	(3 643)	(3 854)
Other gains
Interest income	n/a⁵	2 951	3 936
Eskom Holdings Limited	n/a⁶	2 939	4 091
Subsidiaries	n/a⁷	267	247
Intergroup eliminations	–	(255)	(402)
Fair value gains/(loss) on financial instruments	n/a⁵	1 134	(99)
Eskom Holdings Limited	(681)	1 211	(26)
Subsidiaries	–	(77)	(73)
Interest expense	n/a⁵	(4 656)	(5 447)
Eskom Holdings Limited	n/a⁶	(4 841)	(5 761)
Subsidiaries	n/a⁷	(80)	(84)
Intergroup eliminations	–	265	398
Impairment (expense)/reversal	–	96	(258)
Eskom Holdings Limited	–	898	(116)
Eskom Enterprises (Pty) Limited	–	27	(307)
Intergroup eliminations	–	(829)	165
Earnings before interest, taxation, depreciation and amortisation (EBITDA)	n/a⁵	12 249	14 828
Eskom Holdings Limited	11 086	12 476	13 487
Subsidiaries	666	932	822
Intergroup eliminations	–	(1 159)	519
Key ratios
Interest cover (EBITDA), %
Eskom Holdings Limited	≥ 3,51	3,54	3,62
^1.Target sales growth for the review period compared to the 12 months from 1 April 2004 to 31 March 2005. ^2. Actual sales growth was 0,8% when comparing to the 12 months 1 April 2004 to 31 March 2005. ^3. Actual sales growth was 5,1% for the 12 months from 1 January 2004 to 31 December 2004 and negative 1,2% for the three months from 1 January 2005 to 31 March 2005. 4. Actual sales growth was 4,4% when comparing to the 12 months 1 April 2004 to 31 March 2005. ^5.Group targets are not calculated. ^6. Net interest income and expenditure target R1 809 million. ^7. Net interest income and expenditure target R37 million.

Eskom Holdings Limited
When reading this commentary on the financial performance of the company, it should be borne in mind that, due to the change in the financial year end at 31 March 2005, a 12-month period is being compared with a 15-month period.

The operating financial performance for the company was most encouraging given the low sales growth, and the technical problems experienced during the period. Operating costs were well contained, and savings more than compensated for the increase in primary energy costs. Embedded derivatives impacted the results by R1,4 billion, highlighting the volatility associated with accounting for embedded derivatives.

The actuarial valuation of the post-retirement medical aid provision reflected a reduction in the required liability of R594 million at 31 March 2006 and this amount has been written back in the income statement.

A review of the impairment provision for the investment in Eskom Enterprises raised in the last two years indicated that R828 million could be released this year, which is also reflected in the income statement. Refer to note 10.

Eskom is now in a tax paying position and the current tax charge to the income statement was R1 317 million and R855 million was paid to the South African Revenue Service during the review period.

Subsidiaries

Eskom Enterprises (Pty) Limited

Eskom Enterprises, domiciled in South Africa,was registered to accommodate all the non-regulated energy-related activities of Eskom in South Africa and its energy-related activities outside of South Africa.

The group performance exceeded expectations, with core businesses contributing to the improved performance. Rotek Engineering (Pty) Limited made a significant contribution to the results due to an increase in activities relating to the Eskom capital expansion programme. During the review period Arivia.kom (Pty) Limited bought back its shares from Denel (Pty) Limited which increased Eskom Enterprises’ shareholding from 45,06% to 58,50%. The results of Arivia for 1 March 2006 to 31 March 2006 contributed R210 million to revenue and a net loss of R1 million to the group.

Eskom Finance Company (Pty) Limited

The Eskom Finance Company was established as a vehicle to achieve Eskom’s commitment to enabling its employees to have access to accommodation while optimising costs to Eskom and its employees. The company makes home loans available at favourable interest rates to employees of the Eskom group.

Eskom, the shareholder of Eskom Finance Company, has taken a decision – in line with the Department Department of Public Enterprises’ strategy – to dispose of this company as a going concern, subject to the continuation of the current services it delivers to Eskom and its employees. To implement this decision, the joint transaction team of senior officials from the Department of Public Enterprises and Eskom are implementing a project to effect the disposal within the next 12 months and appropriately position the company after disposal in line with its strategic intent in a manner that will address concerns from all major stakeholders.

Escap Limited

Escap was established in 1993 to reduce Eskom’s overall cost of risk management and insurance. It forms part of the risk financing strategy to formalise the insurance function and acts as a vehicle for creating reserves and additional insurance capacity.

During 2006, the following issues in the insurance portfolio were reviewed:

the Eskom group insurance and risk financing strategy
the need for two captive insurance companies
the level of deductibles that divisions should carry to promote comprehensive risk management

The results of the reviews going into 2007 are as follows:

better use of captive reserves as the total asset class risk retention was increased by 100% and various increases in other classes
use of Escap as the main insurer of Eskom risks
use of Gallium significantly reduced
substantial increases in divisions’ deductibles based on their loss profiles
capacity of the divisions to afford self-insurance levels

Escap’s results show a small underwriting profit of R9 million. Therefore, the net profit after tax of R116 million mainly reflects the effect of investment returns of R145 million for the period.

Gallium Insurance Company Limited

Gallium, a captive insurance subsidiary of Eskom registered in the Isle of Man, was established in 1995. It has provided cover for less predictable
risks and for those risks where insurance cover is generally not available. In future, these risks will be covered by Escap while Gallium will be used for longer term liabilities, such as environmental liability.

Gallium’s results show a substantial underwriting profit of R258 million, mainly due to the lower claims experienced during the period. Net profit of R342 million is also positively influenced by investment returns of R86 million for the period.

Balance sheet
	Group		Company
	March	March	March	March
	2006	2005	2006	2005
	Rm	Rm	Rm	Rm
Assets
Property, plant and equipment and intangibles	65 475	59 523	64 128	58 288
Investments	214	370	2 114	1 300
Future fuel supplies	2 657	2 471	2 657	2 471
Deferred tax	205	139	–	–
Financial instruments at fair value	28 027	18 345	27 892	18 254
Financial instruments at cost	20 133	18 475	16 969	15 563
Trade and other receivables	5 358	5 151	4 884	4 988
Loans to subsidiaries	–	–	2 311	2 351
Inventories	3 681	2 868	3 259	2 800
Loans receivable	–	2 464	–	–
Assets classified as held-for-sale	2 402	–	–	–
Total assets	128 152	109 806	124 214	106 015
Equity	50 562	47 233	48 263	44 714
Liabilities	77 590	62 573	75 951	61 301
Financial instruments at fair value	17 746	11 379	17 939	11 613
Financial instruments at cost	29 683	24 328	29 439	24 047
Deferred tax	7 490	6 908	7 173	6 569
Deferred income	3 043	2 432	3 043	2 432
Retirement benefit obligations	4 848	4 980	4 718	4 800
Provisions	6 660	6 337	6 262	5 938
Amounts owing to subsidiaries	–	–	561	465
Trade and other payables	7 452	6 162	6 181	5 437
Taxation	644	47	635	–
Liabilities directly associated with non-current
assets classified as held-for-sale	24	–	–	–
Total equity and liabilities	128 152	109 806	124 214	106 015

Key numbers
	Target	Actual	Actual
	2006	2006	2005
	(12 months)	(12 months)	(15 months)
Key ratios
Return on assets
Eskom Holdings Limited, %	≥ 9,10	9,95	11,46
Eskom average total cost
of electricity, R/MWh	146,09	147,57	136,48
Solvency ratios
Escap Limited, %	40¹	74	51
Gallium Insurance Company Limited, %	100²	>100	>100
Debt: equity
Eskom, excluding long-term
provision	≤ 0,05	0,05	0,04
Eskom, including long-term
provision	≤ 0,30	0,26	0,25
^1. Regulatory target 15,0%. ^2. Regulatory target 5,3%.

The balance sheet for the company reflects a very healthy position. The debt to equity ratio (including longterm provisions) has remained much the same at 0,26, despite the two bond issues during the period of just over R6 billion.

In compliance with IFRS, the useful life of all property, plant and equipment had to be reviewed and the expected residual value used to recalculate
depreciation backdated to the date of purchase. This resulted in a favourable variance against budget for depreciation in the current period, and an
adjustment to the accumulated depreciation to the prior period and retained earnings. Refer to note 39.

Valuation of assets
Although there is cross-subsidisation between certain customer categories (depending on customers’ electricity consumption levels, geographical
location and voltage supply levels), Eskom recovers all costs of supplying electricity to its customer base as a whole, and earns a positive return on
assets. On this basis, the directors believe no adjustment is required to the value of assets relating to any particular customer category.

The directors believe that, based on the principle of cross-subsidisation, there is no need to raise a provision for the impairment of certain classes
of property, plant and equipment in the current period. Depending on how the electricity distribution industry restructuring takes place, it might be necessary for Eskom to raise a provision for impairment in future years.

Impairments

Investment in Eskom Enterprises

Eskom’s investment in Eskom Enterprises has been reviewed for impairment, by ensuring that the investment is at least equal to net assets of the Enterprises consolidated group, although two investments by Eskom Enterprises still remain impaired.

Full services network and second network operator

Eskom Enterprises invested R760 million in the full services network, ahead of the introduction of a second telecommunications network operator in South Africa. Initially scheduled for May 2002, the issuing of a licence to the second network operator was issued by the Independent Communications Authority of South Africa to the second network operator on 9 December 2005.

The intended sale of the Eskom portion of the full service network is in progress. The carrying values of all assets, including the fibre optic network, have been reviewed for impairment. The delay in negotiating the asset sale prompted the Eskom board to take a conservative view and leave the full impairment provision of R760 million (2005: R760 million) against this investment.

Mountain Kingdom Communications (Pty) Limited (MKC)

In 2002, Eskom Enterprises invested R216 million in MKC, a company registered in Lesotho.

The Telecom Lesotho licence issued by the Lesotho Telecommunications Authority (LTA) stipulates system expansion targets and to the extent
that these targets are not met, penalties are payable to the LTA. During the review period LTA informed MKC that based on a revised agreement the connection targets, other than those relating to year one and two, have been met.

The impairment provision previously raised has been reduced from R208 million to R181 million at 31 March 2006 in the Eskom group financial statements.

Embedded derivatives
Eskom has entered into a number of agreements to supply electricity to electricity-intensive industries, where the revenue of these contracts is based on commodity prices, foreign currency rates or foreign production price indices that gave rise to embedded derivatives. The net impact for the 12-month period was a fair value gain of R1 418 million (2005: 15-month period: R72 million) to the income statement of Eskom and a fair value gain of R1 322 million (2005: R4 million loss) for the group. The impact on the balance sheet remained significant. The embedded derivative assets for Eskom were R6 417 million (2005: R5 076 million) and embedded derivative liabilities were R4 927 million (2005: R5 004 million). The group numbers for embedded derivative assets were R6 419 million (2005: R5 081 million) and embedded derivative liabilities were R5 101 million (2005: R5 085 million).

Provisions
The provision for decommissioning for power station-related environmental restoration at 31 March 2006 was R3 896 million (2005: R3 316 million).
The provision for mine-related closure, pollution control and rehabilitation was R968 million (2005: R786 million). The discount rate for these provisions was changed from 5,0% to 4,2%. Refer to note 2.22 and 21.

Revenue management
The board is responsible for establishing systems, procedures, processes and training programmes to ensure efficient and effective revenue management. Adequate cash collection and investment management processes and procedures were in place during the period.

The collection of revenue from small power users in Soweto remains a challenge. The enhancement of credit control strategies and monitoring of payment levels in Soweto continue to receive constant management attention. The payment levels from these customers, expressed as a percentage of billed revenue, decreased to 34% (2005: 38%).

Trade debtors and other receivables at the end of the period are summarised below:

Trade debtors and other receivables
	Group		Company
	Actual	Actual	Actual	Actual
	2006	2005	2006	2005
	(12 months)	(15 months)	(12 months)	(15 months)
	Rm	Rm	Rm	Rm
Trade debtors and other receivables	6 816	6 513	6 190	6 206
Soweto, takeovers and suspense accounts	1 101	982	1 101	982
Other trade debtors	3 375	3 436	3 119	3 178
International debtors	380	295	242	151
Trade debtors	4 856	4 713	4 462	4 311
Other receivables (including interest receivable)	1 960	1 800	1 728	1 895
Provision for doubtful debt, including interest	(1 458)	(1 362)	(1 306)	(1 218)
Local trade debtors	(1 320)	(1 208)	(1 192)	(1 086)
International trade debtors	(24)	(41)	–	(22)
Other receivables	(114)	(113)	(114)	(110)
Movement in bad and doubtful debt	191	134	174	93
Local trade debtors	169	255	152	233
International trade debtors	–	(122)	–	(133)
Other receivables	22	1	22	(7)

Management of credit risk

Credit risk is managed as part of the integrated risk management process, which tracks major risk issues, designs mitigating strategies and continually
monitors their status.

Capital expenditure
Over R10 billion was spent on capital projects during the review period as stated in the table below.

Funding
As the approved build programme requires significant additional borrowings in the near future, a decision was made to take advantage of favourable local and international market conditions. Eskom entered into a prefunding strategy to reduce liquidity risk in future.

In June 2005, the Eskom board approved the prefunding strategy, taking cognisance of medium-term funding requirements, economic fundamentals, management of liquidity risk and current investor demand. Although the net funding requirement for the review period amounted to R1,7 billion, Eskom successfully started the new funding cycle.

Capital expenditure
Description	2006	2005
	(12 months)	(15 months)
	Rm	Rm
Generation division	5 008	2 968
New capacity	2 370	–
Technical plan projects	2 382	2 624
Asset purchase and other	256	344
Transmission division	1 246	1 565
New strengthening projects	1 030	1 405
Land and rights	18	41
Production equipment	55	55
Capital spares	110	19
Asset purchase and other	33	45
Distribution division	4 014	4 449
Direct customers	949	899
Strengthening	873	749
Refurbishment	760	847
Electrification	496	866
Continuous improvement	184	231
Asset purchase and other	752	857
Other	187	(85)¹
Subsidiaries	412	102
Total	10 867	8 999

^1.Represents the net movement in work under construction.

Eskom registered a R65 billion multi-term note programme with the Bond Exchange of South Africa in March 2006. The volume was based on bond profiles approved by the board which allow future flexibility. On 15 March 2006, Eskom launched the first bond in the programme – the ES33 – which has a maturity date of 15 September 2033 (a 27,5-year bond). This is the longest tenor bond in the history of the South African bond market. This issue of R2,5 billion with a coupon of 7,50% paid semi-annually and an issue price (yield) of 7,48% was oversubscribed.

A benchmark seven-year maturity bond issue of €500 million was almost three times oversubscribed and priced at SA government’s foreign euro issue +10 bonus points. The issue has a 4% coupon and matures in March 2013. It was priced at Euribor +50 bonus points and at Jibar +58 bonus points after the currency risk and interest rate was hedged.

Export credit agency financing was also negotiated and will be drawn down in the new financial year on delivery of the open cycle gas turbine assets.

Proceeds were invested favourably to minimise the carry cost of the strategy.

Standard and Poor’s foreign and local currency ratings are BBB+ and A- (A minus), respectively; and Moody’s foreign and local currency ratings are
A2 and A1, respectively. FitchRatings local currency rating is A. All ratings carry a stable outlook.

Demonstrating a prepaid meter to a newly electrified customer

Camden power station refurbishment in progress

Treasury risk management
Eskom has endorsed the benefits of a centralised treasury function where financial market risk can be consolidated and efficiently managed.

The board approved a mandate to enable the treasury department to react timeously to market conditions and business needs. The mandate sets out the fundamental parameters, supported by detailed instrument, counterparty, volume, tenor and transaction limit profiles. The mandate defines exposure, interest rate sensitivity and duration limits and requires ongoing benchmarking against international best practice. The treasury department complied
with its approved mandate during the period. Refer to note 14.

Eskom actively managed financial market risks (liquidity, interest rate, foreign exchange rate and commodity) during the period. All fixed and ascertainable foreign and short-term commodity exposures were hedged, which minimised the effect of volatility on operational activities because of currency fluctuations. Refer to note 14.

Value-based management
Financial sustainability over the long term is measured by the value-based management approach, implemented in 2003. Measuring economic performance enables management to identify focus areas for value creation and areas where value is not being added. The major factors influencing Eskom’s economic performance are cost of capital used by the business and reported asset lives. Based on the approved targeted weighted average cost of capital, Eskom’s economic performance for the 12 months ended 31 March 2006 reflected a marginal reduction in value in comparison to the prior period, mainly due to lower sales growth, increased maintenance costs and increased fuel costs because of changes in production plant mix. Certain economic measures were used as performance indicators in the short-term incentive scheme for employees in the review period

Supply-chain management
Eskom has initiated a strategic sourcing optimisation project known as Sisonke to improve the efficiency and effectiveness of the procurement and commercial processes. A major benefit of this initiative will be the streamlining of the commercial process and technical specifications resulting from in-house synergies and closer working relationships with major suppliers.

A salient feature of this initiative is the implementation of cross-functional and cross-divisional teams to develop appropriate sourcing strategies for complex and costly commodities. Savings targets have been set for each division to deliver a total saving of R490 million in 2007 and R7,0 billion over the next four years to March 2010.

Price regulation

Average price increase and economic regulation

In 2006, a multi-year, incentive-based methodology for price adjustments was introduced by the NER (now Nersa¹) to replace the annual rate of- return methodology. This significant transition was implemented over a relatively short period, when measured against international examples.The first multi-year price determination applies from 1 April 2006 to 31 March 2009.

The major differences between the two methodologies are that the new one is more incentive-based and applies to a longer period (1 April 2006 to 31 March 2009). It applies a real (inflation adjusted) rate of return to assets that are inflation indexed. The allowed rate of return for 2007 is 7,3% on a real basis before tax (5,1% after tax).

In February 2006, Nersa announced its final price determination of CPIX² + 1% (including the cost of electricity distribution industry restructuring). under the new method are shown in the table below.

Price increase
	2004	2006³	2007	2008	2009
	%	%	%	%	Rm
Price increase, %	2,5	4,1	5,1	5,9	6,2
1. The formation of the National Energy Regulator of South Africa (Nersa) is effective from 1 April 2006 and will regulate three sectors: electricity, piped gas and nuclear. ^2. CPI excluding interest rates on mortgage bonds (CPIX) is derived by excluding interest rates on mortgage bonds from the basket of goods and services which is used to compile CPI. ^3. Price increase for the period 1 January 2005 to 31 March 2006.

The price increases for 2007 to 2009 are not absolute and will vary in line with actual CPIX figures.

The 2006 financial year will be the last year to which the “clawback” mechanism under the rate-of-return methodology will apply, in terms of which Eskom was deemed to have over-recovered revenue from customers if the actual regulated return earned exceeded that allowed by Nersa. These over-recoveries were used to reduce future price increases.

Under the incentive-based methodology, the clawback changed from a rate of return mechanism to a revenue cap mechanism, with certain designated items qualifying for remeasurement and correction. These items include among others the changes in: CPIX; the cost of electricity purchases from independent power producers (IPPs); fuel cost related to electricity sales volume changes; transmission losses; changes in municipal taxes and demand-side management achievements.

The allowed rate of return for 2006 was 11,1%³ on a nominal basis before tax (7,9% after tax). Eskom earned marginally higher returns of 11,49% resulting in an over-recovery of regulated profits of R219 million during the current period.

In terms of IFRS, the clawback is not recognised as a charge to the income statement, nor is the corresponding liability raised.

Present electricity prices are unsustainably low. Prices are based on Eskom’s low depreciated asset base, valued at historical net book values. The cost of building a new fossil-fuel power station is six to seven times that of the average cost of the existing power station per megawatt of capacity. The South African economy is continually growing, resulting in the need for significant investments in electricity infrastructure to meet continued growth in demand. The reality of the cost of new capacity will therefore have to be reflected in the future pricing of electricity.

Tariff restructuring

Cost-reflective tariff structures provide pricing signals that promote the sustainable, efficient and effective use of electricity. This principle is entrenched in the energy white paper and forms part of Eskom’s strategic pricing direction.

Eskom’s tariff restructuring plan (for the period January 2005 to March 2006) continued the work started in 1996.

The changes brought about by this plan have resulted in signals to manage the overall use of electricity more efficiently, not only from an energy perspective but also from a network perspective, which will encourage efficient investments in electricity.

The following is a summary of approved changes in tariff structures that became effective for the period under review:

Unbundled network charges for Megaflex, Miniflex and Nightsave (urban).
The abolishment of consumption-based rebates on monthly connection charges for Megaflex, Miniflex and Nightsave (urban).
The levy paid towards subsidies was made transparent for Megaflex, Miniflex and Nightsave (urban) and shown as a rate-rebalancing levy.
Alignment of the strength of the power-factor correction signal between time-of-use and non-time-of-use tariffs, ie the reactive energy charge for Megaflex, Miniflex and Ruraflex will only be applicable in the high-demand season.
A rand/day charge instead of a rand/month charge for service, administration and fixed network charges.
Withdrawal of the piloted tariff for rural seasonal use (SeasonSave).
The notified maximum demand rules that will govern the notification of demand.

Integrated risk management
The integrated risk management process is embedded in the organisation and takes into account risks and opportunities to which it is exposed. The risks and opportunities identified are reviewed for clarity on the elements affecting the potential impact to the business, then risk mitigation or control measures are designed to reduce the probability, frequency or impact of the event. Accountability to manage each is noted to clarify responsibility to manage the risk.

Integrated risk management expertise within Eskom is growing and internal training continues to enhance processes. Each division and main subsidiary has a risk coordinator. Communication flows from the integrated risk management corporate office through these coordinators down the line and back up to board to ensure a common message.

The Eskom capacity expansion programme, during which some R97 billion will be spent, will be a focus area for the integrated risk management teams for the foreseeable future.

Eskom’s major risk process continues to identify the key risks that face the organisation.This review is conducted twice a year and follows a bottom-up process from both line and functional areas. The risks identified by divisions and subsidiaries are ranked, and then assessed by senior management to arrive at the major risks.

The identification of risks is an exercise that focuses the organisation on the priorities that become the emphasis of performance. The risks are evaluated in terms of the mitigating factors in place together with the potential impact. The risks identified do not necessarily equate to shortcomings but rather priority focus areas. The major risks are reflected in the table below.

Major risks

	Risk	Risk-mitigation measures
1	Short-term system capacity management – delivery to customers over the next five years and keeping stakeholders informed	Enhanced maintenance management Awareness of potential system constraints Stakeholder communication Improved business continuity and emergency planning Enhanced demand-side management
2	The new build programme relating to capital expenditure to increase capacity (cost and on time) – capital expenditure of R97 billion is anticipated over the next five years and the potential impact of project delays as well as increasing costs have been identified	Initiation of the environmental impact assessment process as well as land and servitude acquisitions during the prefeasibility and feasibility stages of projects Implementation and monitoring of a recruitment strategy including succession and skills development Establishment of integrated project management approach, including managing contracts and contractors Enhanced procurement strategies
3	Adequacy of skills for the business – retention of skills and maintaining a suitable pipeline of staff	A full skills plan is being developed to clearly identify future business needs. Managing human resources has been established as a board priority for 2007
4	Sales and revenue – managing external demand for electricity, collecting of revenue and debt management	A number of initiatives are under way to improve debt management, cost management, sales forecasting and security related to electricity theft
5	Occupational safety – the potential exposure of increasing numbers of accidents as the new build programme continues	A recruitment drive to ensure sufficient skills and resources is in progress Safety committees are in place in the affected areas, which track all activities and manage safety-related risks Training staff and contractors to improve awareness
6	Long-term capacity beyond 2010 – having the right capacity in the long term to meet customer needs, noting the long lead times of installing new capacity	Closer integration of transmission and generation capacity planning Diversification of fuel sources Review of long-term coal-sourcing strategy under way, and increased involvement with mines to manage coal costs Initiation of environmental impact assessment process at feasibility stage Investigation of advanced technology options Investing in low capital expenditure projects for additional reserve margin Ongoing research and continued close liaison with the Department of Minerals and Energy
7	Information and communication technology related to business interruptions – critical systems and managing of information	A full review was completed on information and system risks from a business continuity perspective. Implementation of recommendations are under way
8	Electricity distribution industry restructuring – managing people risks related to the electricity distribution industry and potential cost of these changes	Eskom remains a significant stakeholder and advises on issues and risks in the various risk disciplines as they are identified
9	Changing environmental legislation – potential long-term risks and costs of additional compliance arising from changing environmental legislation	Eskom will continue to monitor implementation of and comment on new or revised environmental legislation, in particular the air quality act The shareholder will be kept updated on the potential of increasing costs of compliance The impact of delays in environmental impact assessments relating to the new build programme has been highlighted as a separate element of this risk
10	Managing accelerated economic growth – the ability to meet accelerated GDP growth in South Africa and supply electricity needs	Acceleration of new capacity project development Streamlining investment decision-making Building flexibility into projects to delay or accelerate commissioning

Mitigation strategies for key risks are regularly reviewed by senior management and presented for discussion to the risk management committee and the board.

Routine maintenance at the Palmiet pumped storage scheme

A rotor from Camden power station is being balanced at the Rotek facility

For the 2007 year, the board will continue to focus on shortterm capacity management, the new build programme and adequacy of skills.

A business continuity management framework, including a major incident management process, is currently under development.

Some of the challenges for the 2007 year include the implementation of this framework as well as the development of a communication strategy encompassing reporting key risks within the organisation. The review of a risk assessment software system, which needs to be aligned to shareholder requirements, is in progress.

5.2 Productivity performance

Productivity measurement provides key insights into business performance by analysing the change in net profit between two accounting periods. It measures the impact of productivity, inflation (price recovery) and growth. It highlights the change in use of resources, benefits to customers and other stakeholders as well as growth in the business.

Productivity improvement occurs through the more efficient and effective use of all resources. Price recovery is the relationship between electricity price increases and inflationary impact on the cost of resources to Eskom. Growth in the business represents the change in net profit when resource quantities and prices change at the same rate as electricity sales quantities and prices.

Productivity improvement creates additional wealth and drives sustainable business performance. Price recovery, on the other hand, indicates how wealth created is distributed to stakeholders, particularly customers.

The change in the financial year from December 2004 to March 2005 resulted in a comparison period of 15 months. This distorts the productivity measurement, and also does not take into account seasonality. For this reason the comparative period used is the 12 months ended December 2004.

Overall Eskom performance is summarised below:


	March	December
	2006	2004
	(12 months)	(12 months)
	Rm	Rm
Profit for the period before tax and adjustments	7 159	6 075
Profit for the previous period before tax and adjustments	6 075	5 245
Change in profit before fair value adjustment	1 084	830
Adjustments not impacting on overall performance¹	(2 693)	(413)
Change in adjusted profit	(1 609)	417
This is attributable to:
Net productivity (decline)/gain	(645)	485
Price under recovery	(1 265)	(508)
Growth	301	440
Total	(1 609)	417

^1. Fair value gains/losses on financial instruments, asset impairments, insurance proceeds, depreciation adjustments per IFRS and other adjustments are specifically excluded from the productivity calculation.

Overall productivity and price recovery
For the 12-month period ending 31 March 2006, Eskom recorded a productivity decline of 2,1% amounting to R645 million. These results have been negatively impacted by the low weighted sales growth of 1,0% compared to a weighted increase in resources of 3,2%. Anticipated sales growth was 3,6% for 2006 and 2,7% for 2004.

There was a price under-recovery of 4,1% amounting to R1 265 million for the year as a consequence of the 3,9% weighted tariff increase being less than the 8,3% inflationary impact on resources. This means that Eskom has had to absorb the difference, thus benefiting the consumer.

The table below shows the contribution to productivity performance from major resource categories and reflects what is attributable to capacity utilisation and efficiency.

Primary energy reflects a productivity loss of 1,4% amounting to R152 million. It has been negatively impacted by the increase in external electricity purchases, and an increase in generation fuel usage. These are associated with the diminishing surplus capacity, the logistics of having to road-transport coal to certain stations and the effects of addressing the Cape incident when all available own generation units, including oil and gas-fired stations, had to be used.

Manpower costs reflect a negative productivity of 4,5% amounting to R379 million. Increased staffing for the return to service of previously mothballed stations has largely contributed to the negative manpower productivity. These resources will only make a positive contribution to productivity once these units are in commercial operation.

Capital reflects a 11,7% productivity decline amounting to R682 million, largely from the interest and finance charges and the increased depreciation on the capital expenditure during the year which was in excess of R10 billion.

Other operating costs reflect a productivity gain of 9,0% amounting to R568 million. Despite the increase in materials and contracts expenditure, the rest of other operating expenses were constrained in response to lower sales growth, yielding the achieved net gain. It is expected that these expenditures
will show a faster upward movement with the imminent increase in the pace of projects.

Despite the current productivity decline, cumulative benefits through productivity improvements have benefited consumers and other stakeholders by R9 736 million (in 2006 rand) over the past 10 years. Productivity improvement over this period has contributed significantly towards absorbing the impact of inflation on the business, and remains a focus area for sustainable business performance.

The imminent capital expansion, including the strengthening of the transmission lines, is likely to affect productivity negatively in the short term until the assets start contributing to revenue. The demand-side management initiative may also have a negative impact on productivity in the short term. However, these initiatives are likely to translate into productivity improvements in the longer term.

The National Productivity Institute has reviewed these productivity results. The review included an examination of the structure of the analysis, the appropriateness of quantity and price drivers, the accuracy of the model and the derivation and presentation of results. In the opinion of the institute, the
productivity statement fairly presents the overall performance of Eskom for the 12-month period ended 31 March 2006.


	March		December
	2006		2004
	(12 months)		(12 months)
	Rm	%	Rm	%
Total productivity (decline)/improvement	(645)	(2,1)	485	1,8

Primary energy (including electricity purchases)	(152)	(1,4)	(32)	(0,4)
Manpower	(379)	(4,5)	349	4,8
Operating expenses	568	9,0	40	0,8
Capital	(682)	(11,7)	128	2,4
Taxation
Total productivity	(645)	(2,1)	485	1,8
Capacity utilisation	189	0,7	588	2,2
Efficiency	(834)	(2,9)	(103)	(0,2)

5.3 Value creation and distribution

Value added is the wealth created by the regulated business through the generation, transmission, distribution and selling of electricity and the non-regulated businesses.

Value created from the sale of electricity is the excess of turnover over the costs of generation, transmission and distribution, comprising raw materials and consumables used, services and abnormal items and the excess of turnover over cost of goods and services of non-regulated activities.

The value added statement shows the total wealth created, how it was distributed to meet certain obligations and reward those responsible for its creation, and the portion retained for the continued operation and expansion of businesses.

Value added statement

	Group		Company
	2006	2005	2006	2005
	(12 months)	(15 months)	(12 months)	(15 months)
	Rm	Rm	Rm	Rm
Value created
Revenue and staff costs capitalised	36 796	43 616	35 733	41 565
Less: cost of raw materials and consumables used, services and abnormal items	(15 381)	(18 192)	(14 650)	(18 927)
	21 415	25 424	21 083	22 638
Value distributed
Salaries, wages and other benefits	7 907	10 497	7 285	9 017
Social spending	111	160
Net interest expense	1 705	1 511	1 902	1 670
Dividends paid	1 643	569	1 643	569
Taxation	2 154	2 313	2 095	2 033
	13 520	15 050	13 036	13 449
Value reinvested in the group to maintain and develop operations
Depreciation and amortisation of property, plant and equipment and intangible assets	4 903	5 532	4 626	5 261
Net profit after dividends	2 992	4 842	3 421	3 928
	21 415	25 424	21 083	22 638
Value created per employee, R	681	808	710	759

General footnotes
^1.The formation of the National Energy Regulator of South Africa (Nersa) is effective from 1 April 2006 and will regulate three sectors: electricity,
   piped gas and nuclear.
^2. CPI excluding interest rates on mortgage bonds (CPIX) is derived by excluding interest rates on mortgage bonds from the basket of goods and
   services which is used to compile CPI.
^3. The difference between the Eskom rate of return of 9,95% and the Nersa allowed rate of return of 11,10% is because of certain costs not
   allowed to be recovered in the tariff, and a lower asset base as certain assets are excluded in terms of the regulatory framework.

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