Electricity Distribution Industry Goals: Department of Energy & SALGA briefings

Meeting report

Chairperson’s opening remarks
The Chairperson noted that the meeting would be considering the position with distribution and transmission of electricity, now that the Regional Electricity Distribution (RED) programmes had been withdrawn, and after dissolution of Electricity Distribution Industries (EDI) Holdings. He noted that energy distribution had been raised in previous budget meetings and planning sessions. The Committee hoped for the assurance that the challenges and problems in this area would be addressed at both the national and municipal levels, although it was recognised that this would be time-consuming and arduous.

Department of Energy briefing
Mr Ompi Aphane, Acting Deputy Director General: Electricity, Nuclear and Clean Energy, Department of Energy, outlined that in 2003, Cabinet adopted the EDI restructuring blueprint. On the supply side, six rates were proposed, with an emphasis on maximizing economies of scale. At the same time, the then-Department was going to deal with supply-side challenges. At that point, Eskom was being considered for restructuring into three clusters, all of which would have included a component of Black Economic Empowerment (BEE), ultimately leading to full competition on the supply side. That would also work on the basis of a deregulated day-ahead market, similar to those in Western Europe, rather than on a tariff structure. However, it became clear that South Africa’s industry was not yet in a position to accommodate such changes. The supply side decisions were thus reversed in 2005, but it was decided to continue with the Regional Electricity Distributors (REDs).

Mr Aphane noted that distribution to homes and business was largely controlled by municipalities, from a customer perspective, whilst Eskom dealt with the assets. Eskom and the municipalities shared revenues, with Eskom taking 60% of the revenues and 40% of the customers.

Mr Aphane then set out some of the key statistics around energy distribution. The industry generated R40 billion per year, with 9.2 million customers. The industry employed approximately 31 000 people. Replacement value of assets, in 2008, was estimated at R260 billion. In 2008, energy purchases amounted to 224 gigawatt hours. There was over 400 000 km of distribution lines, and 210 000 km of distribution cables. However, the average age of the asset base was 45 years old. This was not a healthy state of affairs.

Mr Aphane said that EDI was not structured in a manner to support South Africa’s aspirations of providing economic growth and a reliable supply of energy. Both of these remained as outstanding problems. When it was realised that South Africa could not continue with this blueprint, there were plans to transfer assets from Eskom and the municipalities to new public entities, REDs. However, this decision was not pursued, and in 2010 Cabinet decided that EDI Holdings, the management company managing the REDs, would cease operations. The Department of Energy (DoE or the Department) was then tasked with the asset rehabilitation mandate.

Mr Aphane said that national intervention was needed, and a massive financial investment was needed to mitigate the risk of power failure. There were instances when the distribution side failed the customer, when demand exceeded supply.

Mr Aphane outlined the fundamental problems that had faced EDI Holdings, which mainly related to tariffs and their vast range of cost recovery. He cited an example that two homes, on the same street in the same municipality, might be charged differing rates, because of the tariff differential between Eskom and the municipality. Energy restructuring would not achieve its aims unless there was tariff restructuring. He added that there were also differing standards for providing Free Basic Services across the differing municipalities. The DoE had seen unacceptable deterioration in the quality and liability of the distribution services. On the supply-side, there was a problem with building power stations. South Africa had now put huge amounts of money into this. It must also deal with the issue of reliability.

He noted that the Department had analysed the employment force, noting that most of the electricity technical staff responsible for looking after the network were nearing retirement age. There was thus an urgent need to create more opportunity to bring skills into the sector. Most staff wanted to work in urban areas, meaning that many areas were left without skilled workers.

The Department was taking Free Basic Electricity (FBE) and Free Basic Alternative Energy (FBAE), very seriously, believing strongly that it had a responsibility to cushion the poor and the indigent through providing Free Basic Services. More than 70% of indigent households were receiving FBE and about 5% were receiving FBAE, which may include those people that were not connected to the grid. It was necessary to continue with these programmes, even as the Department increased the tariffs to economically sustainable levels elsewhere. The bottom line was that the leakage in FBE was huge, so the question became one of financial sustainability.

He noted that it would also be necessary to secure the capital costs for rehabilitation of energy infrastructure for the targeted communities that qualified for FBAE services, namely provision of gas, paraffin, ethanol or gel-run devices. Transaction costs must be taken into account, and if people did not collect tokens because of lack of infrastructure, the whole FBAE programme would be compromised. Municipalities were given an unconditional grant for this, and should be using the grant money for its intended purpose. Some municipalities were providing top-up funding for FBE and FBAE, but this, too, should be precise. In the end, everything was dependent on the country’s ability to finance the issues. If South Africa could not fund the network rehabilitation, maintenance, and FBE, this would lead to a vicious cycle.

The Department had done some assessments in the “ top priority” economic activity cities, and assessments were also done before the World Cup, in the host cities, focusing on asset management strategies and plans to deal with municipal electricity distribution. The Department also examined Eskom’s practices in relation to distribution. Eskom was responsible itself for4.5 million customers, mostly in rural areas. The assessments showed that neither the municipalities nor Eskom were providing sufficient investment.

Mr Aphane reiterated that the average age of infrastructure was 45 years, but some, including in Johannesburg, dated back to the 1930s, and were liable to be disrupted by bad weather or wind. Although South Africa was aiming to expand its economy, it was not making the necessary infrastructural investments to facilitate economic growth.

The Department was tracking outages in certain areas, although it was sometimes difficult to determine the exact cause, which could be related to load-bearing capacity, theft or other issues. Overall, the provisions of the legislation were neither sufficient, nor conducive, to enforce conditions on distributors. There was a dual regulation system, involving both the municipalities and National Energy Regulator of South Africa (NERSA), and it was difficult to pinpoint how they linked. NERSA, for example, could set tariffs, but the municipalities could deviate from them. Municipalities tried to recover extra revenue from the utilities to fund other services.

Mr Aphane said the Department’s focus was not so much on the structure of the industry, but on the regulatory issues related to maintenance backlogs, infrastructure rehabilitation, and investments that were needed to strengthen the system, via its Approach to Distribution Asset Management (Project ADAM). Some ground work already done by EDI Holdings in this regard would now be taken further and located in the DoE.

Mr Aphane noted that approximately R30 billion (increasing at 2% per annum) was required to remedy the maintenance backlogs. This was very little when seen in the context of the overall costs in the industry, and the R300 billion already spent on infrastructure, and was necessary to complete the loop.

He emphasised that the Department already knew where the problems were located, and where to prioritise. Unless something was done urgently, there was a risk of deepening the crisis. Business plans had been completed, as phase one, and critical short-term interventions were needed in phase two. He indicated that NERSA did an audit after a major incident at City Power. It also held a maintenance summit several years ago in regard to distribution issues, and needed to take it even further to reach a holistic programme that would deal with maintenance, rehabilitation and human capital, in order that the country could now move forward. In the third phase, the Department intended to implement a national refurbishment programme targeting all municipalities. The Department was looking at a number of financing options in terms of financing, and had had positive interactions with National Treasury and other development financial institutions, including the World Bank.

Mr Aphane thought that an examination of the national energy tariff alone was not significant, and a combination of tariff and other measures might be a better option. The Department believed that it could make interventions to the tune of about R2 billion for rehabilitation, maintenance, and strengthening, and would hope to start on this very soon. Some other funding from the R1.4 billion made available by NERSA four years ago was still available for immediate use.

Mr Aphane pointed out that now that the Department was in phase 2, it could pilot some of the proposed initiatives in this year. However, the Department could not do so alone, and would require participation of all key stakeholders, including South African Local Government Association (SALGA).
This programme would also have positive job creation impact. The Department would be proposing some amendments to improve the regulatory environment of the distribution sector. Human capital interventions, through education, were equally important, to build capacity.

South African Local Government Association (SALGA) briefing
Mr Mthobile Kolisa, Executive Director: Municipal Infrastructure Service, South African Local Government Association (SALGA), noted that local government had acknowledged the problems in EDI and was committed to participation in the restructuring of the electricity industry.

SALGA thought that there were four main and subsisting problems. The first was misalignment between the EDI and the current architecture of the local government fiscal framework, which was very important from the perspective of local government, and was key to some of its problems. The second problem was the inefficiency in the industry, due to fragmentation, with 178 different distributors of different sizes in the country. Thirdly, there was lack of ability to leverage economies of scale in regard to asset investment, sharing facilities, services, and people. Fourthly, there was unequal treatment of customers –and he reiterated that NERSA may set out what it considered appropriate as a tariff for one distributor, but may not be for another distributor with a different consumer base. For instance, in Mbizana, about 85% of consumers were indigent and required to be subsidised from the tariffs of the other 15%. However, Eskom, in the cities, was gaining more revenue overall from the wealthier customers and would not need to use as much for subsidisation.

Mr Kolisa summarised that municipalities in general provided about 38 functions. They generated 90% of their revenue from consumers in that particular municipality, and 10% from national sources. The 90% was largely derived from property rates and electricity distribution income. Other municipal services, like water and solid waste management, were basic services that were needed by all households, but operated at break-even or had to be subsidised, and were difficult to price. Electricity distribution thus became a key contributor to the provision of services in all other areas.

He said that a significant portion of the electricity distribution industry income accrued to Eskom, which, although providing electricity to 40% of consumers, collected 60% of the industry’s income, which was therefore not available for the benefit of municipalities. Some municipalities were unable to gain any revenue benefit from the industry. In addition, key industrial customers were Eskom customers, and medium and small municipalities were not licensed to be distributors.

Mr Kolisa summarised that the architecture of the electricity distribution industry did not link properly to the framework of local government finances. Eskom tended to see itself as an authority on its own, only accountable to NERSA, and municipalities were not able to influence Eskom. Eskom had even refused to sign service level agreements with municipalities in areas where Eskom was a provider, so that the municipalities were unable to account to consumers and communities about the Eskom activities in their areas. This compromised the authority of the local government in key areas, although people would still blame the municipality for any Eskom failures. This had to be addressed during the restructuring.

In regard to investment in infrastructure, Mr Kolisa said that from the municipalities’ perspective, there had been a significant under-investment in infrastructure. In 2000, when municipalities were established in their current form, there were huge imbalances in access to services. During the attempts to extend services, rehabilitation and maintenance of the existing structures was neglected. Expanded coverage affected maintenance, and there was now a maintenance backlog of R27 billion, growing at R2.5 billion per year. This figure could not likely be paid for through tariffs alone.

Mr Kolisa noted that both electricity and water were expected to be self-financed through tariffs, but water prices at present made this impossible, and imposing high tariffs on electricity could make the service unaffordable for users and undermine the growth of South Africa’s economy. There was a need to find contributory funding to finance the backlog. Most municipalities, in practice, did not have the capacity to borrow what was required.

Mr Kolisa noted that the debate about protecting the poor from high costs became even more important in the face of rising electricity prices. In February 2010, NERSA required Eskom to implement an Inclining Block Tariff (IBT) to all conventionally metered domestic customers, and later required the same for all domestic customers (even those receiving services from municipalities). However, that approach raised concerns, and certain issues could have been better handled. NERSA had relied on Eskom data, but that was not relevant to individual municipalities, in terms of the distribution of consumer income. In addition, NERSA had removed the previous capacity-related signals, including existing tariffs, particularly in holiday towns where it was likely that the supply would be used intermittently. The design of the IBT also led to non-poor consumers benefiting from the tariff structure, with associated leakage issues. The IBT was, in addition, designed according to RED areas, rather than on groupings of similar municipalities based on their income distribution characteristics. Eskom said that it had to charge a further 4.6% over and above the average increase granted by NERSA, to cross-subsidise consumers, and this had a substantial impact on small municipalities, who had to charge even more to consumers in order to survive. If this model were to be perpetuated, prices for high consumers would become unaffordable, with a result on the economy. The result of the IBT application in municipalities was likely to be a loss of domestic revenue by 25%,  a loss as a percentage of total revenue of about 10% and a loss, as a percentage of non-domestic revenue, at about 25%. SALGA had attempted to engage with NERSA on these challenges, because it directly affected the financial viability of municipalities.

SALGA also raised the issue of electricity theft, which had led to huge revenue loss for municipalities. Cape Town and Johannesburg lost about R121 million and R250 million worth of electricity respectively, due to illegal connections.

Another area of focus was the Integrated National Electrification Programme (INEP). There were cases where municipalities had to implement INEP projects where Eskom was a distributor, which stretched their capacity. Slow spending of INEP allocations was also detected.

Mr Kolisa said that there was a structural problem linked to the skills issues. Some municipalities distributing electricity did not have electrical engineers, forcing them to rely completely on consultants. SALGA felt that there may be a misalignment of priorities between the consultants and these under-capacitated municipalities, and it was critical to address this capacity gap. Another point was that South Africa must scale up its investment in energy efficiency, as part of the climate change initiatives, and this could resolve some infrastructure constraints that limited energy distribution.

SALGA therefore summarised the four main areas for focus. Firstly, an alternative to the REDs must be found whilst solving the problem of electricity distribution inefficiency, and this would involve addressing the structural efficiencies, financing the backlog and future investment needs, responding to pricing needs, and exploring possibilities of establishing province-wide municipal-owned electricity services. Secondly, there was a need to upscale the energy efficiency programmes and investment in alternative energy. Thirdly, addressing electricity theft would relieve capacity constraints. Fourthly, all new councillors would need to be capacitated to engage and lead their municipalities.

Discussion
Ms N Mathibela (ANC) wanted to know if the REDs would have worked. She questioned what the municipalities were doing in regard to theft. She pointed out that in the squatter camps, electricity lines on the ground would be used to tap off electricity, and enquired who was attending to enforcement. Finally she asked if the revenue from the coupons went to municipalities or Eskom.

Mr K Moloto (ANC) believed that electricity pricing should be linked also to provision of water and solid waste. If the problems were not addressed, it would strain the revenue stream. He also wanted to know what challenges were faced in determining an appropriate tariff for these services.

Mr Moloto noted that FBE was an unconditional grant, and wondered if it would be advisable to change it to a conditional grant.

Mr Moloto asked if SALGA had a problem with the notion of core subsidisation, or only the extent of the subsidization. He also wanted to know how NERSA felt regarding core subsidization.

Mr D Ross (DA) agreed that if the total asset value of electricity was R260 billion, then it was vital to spend money eliminating the R27.6 billion backlogs, as well as addressing losses on the networks of between R2 and R8 billion a year.

Mr Ross asked if there were any specific suggestions on financing of projects. He noted that the numerous tariff hikes over the last years, and wondered which would be “the straw that breaks the camel’s back”.

Mr Ross also asked about the future of the assets of the distribution network, and who would assume ownership.

Mr Ross recognised that municipalities had done little maintenance, and asked if an independent body should take over the entire distribution industry.

Mr E Lucas (IFP) said that the decision to cease operations of EDI Holdings took a long time because of the financial investment into the programme. He asked what would happen to its personnel and assets.

Mr Lucas was concerned about skilled workers reaching retirement age, and urged that the Department must address this urgently, as it should already have been preparing and training new skilled workers, and may end up having to import them.

Mr Lucas said that revenue often was not used for maintenance in municipalities. They also often employed consultants, who charged them huge amounts, and this money could better have been used for electrification.

Mr Lucas noted that electricity theft was occurring outside the informal settlements as well as inside. Some businesses connected wiring to bypass the meters, which were not reflecting correct figures month by month.

Mr Lucas said that the councillors were often not expert enough to make the correct decisions on electricity distribution and agreed that more time should be spent educating them, or at least a selected few to deal with essential services.

Mr Lucas said that leaders in South Africa often said that South Africa was offering the world’s cheapest electricity rates, but pointed out that low-paid workers would not agree.

Mr S Motau (DA) asked what progress there had been in criminalising electricity theft.

Mr Motau asked if the Department of Energy knew how much was being given by way of FBE to indigent people, annually.

Mr Motau also enquired if a person wanting to purchase pre-paid electricity, whose account had formerly been blocked due to unpaid rates or levies, would still be able to use pre-paid systems.

Mr J Selau (ANC) also raised concerns about the potential shortage of skilled workers, and asked if the Department had done anything to try to retain the skills formerly residing in EDI Holdings.

Mr Selau said that maintenance was a huge issue. He asked if the municipalities, as fragmented as they were, wanted to take over Eskom, or if they were simply concerned with addressing the infrastructure problems and ensuring that they would be able to sell direct in future.

Mr Selau did not think that payments to consultants were solving any problems. He also did not think that maintenance would be successfully addressed by going out to tender, and thought the municipalities should rather contract with particular people for a particular period, thus also assisting with job creation.

Mr Aphane addressed the questions in categories. In regard to skills, he noted that about 30 people would be affected by the closure of EDI, and the Department intended to include them in the ADAM Project.

Mr Aphane recognised that using electricity as “credit control” was a debatable point. A court case about five years ago had considered the legal principles around whether electricity could be denied to someone with outstanding payments.

Mr Aphane noted that the Department of Energy had communicated with the Director of Public Prosecutions around electricity theft. Initially, there were suggestions that the Electricity Regulation Act should be amended to specify electricity theft as economic sabotage, but the legal advisors determined that this was not in the Department’s domain. Further comment from the legal services was awaited.

Mr Aphane said it was clearly set out in the Constitution that nobody but municipalities would own distribution assets.

Mr Aphane answered questions on financing and tariffs by saying that there were two options - either a tariff, or a tax, and what was most appropriate. One argument suggested that everyone who uses electricity must pay the cost related to it, but some taxpayers were not electricity users, and the debate then was whether it was fair to tax non-users to benefit users. However, about 20% of householders were taxpayers, but not electricity users.

Mr Kolisa then responded to the questions addressed to SALGA. He wished to assure Members that there were no intentions to return to the REDs system. However, the municipalities were rather suggesting, and exploring options around, forming a body or bodies that could cooperate in distribution.

Mr Kolisa noted that there were attempts to identify cases of electricity theft, report them, and disconnect the offenders. However, if there were no other consequences, they would simply re-connect illegally again.

Mr Kolisa confirmed that the money from coupons would go to the distributor, and this would be Eskom in most of the rural areas.

Mr Kolisa confirmed that SALGA had no problem with cross subsidisation, but did see as problematic the way in which IBT as proposed by NERSA was implemented, because it could undermine the sustainability of the programme. To an extent, NERSA had acknowledged these problems. Often, the public benefit of providing water or waste management was greater than the cost of enforcing repayment. Some services, such as water, could not be cut for non-payment. Electricity was one of the only services that could be cut to try to enforce.

Mr Kolisa addressed concerns about the capacity of municipalities for service delivery. He noted that in the past, not only in municipalities, government relied too much on external service providers. IT should be possible, with conscious leadership, to create capacity in the municipalities. Linked to this was the failure of local government to set up long-term arrangements of municipal services, and establish institutions to manage those services.

The Chairperson interjected to ask who was responsible for maintenance. 

Mr Aphane responded that this would depend on who was the licensed distributor in that area. Where Eskom was the distributor, it was also responsible for maintenance.

The Chairperson asked if there was a likelihood that the FBS, currently at 5% of households, was likely to increase.

Mr Aphane noted that for every 100 people, 70 were receiving FBE, while five received FBAE. He said the Department was unsure about the other 25, either because of lack of infrastructure or other challenges. The Department wanted to ensure that everyone who qualified for FBE did receive it.

Mr Moloto said there were challenges in employing a differentiated tariff scheme between municipalities.

Mr Aphane said there were discussions about the economics of providing industrial aid. The Department hoped that, as part of the EDI restructuring, the distribution tariffs would be aligned with the principles established in the electricity distribution strategy. A holistic approach was needed.

Mr Kolisa added to the answers on cross-subsidisation by saying that there was an assumption that the only way of targeting the poor with free basic services was through an indigent registry. However, SALGA had found that administering a registry was very costly, and it would be better to explore other ways to identify the needy. One was the IBT and this had been what NERSA was trying to do, Other suggestions included using consumption as a proxy for providing free basic services to indigent users, as was used in Johannesburg. Others proposed using geographical calculations.

He expanded on the need to address the challenges of inequitable treatment of customers, as highlighted earlier. He said that it would not be possible to resolve the problem of two businesses on the same road paying different rates without rethinking the whole structure of the industry. Eskom had a large percentage of big-business customers, especially compared to the number of poor people that it was subsidising. Every municipality was in a different situation, in relation to Eskom. In addition, Eskom did not have to contribute with other services, as did the municipalities. All Eskom’s income went into distribution, although municipalities must ensure that their revenue provided all the necessary services. Unless the fiscal framework problems were addressed, municipalities would charge higher rates than Eskom. Inequalities were embedded in the structure of the industry.

Mr Motau asked about the relationship between Eskom and SALGA, and NERSA and SALGA. He sometimes felt that SALGA was not taken seriously.

Mr Kolisa responded that SALGA had the sense that NERSA was positioning itself as a regulator of Eskom, because it seemed to put its energies into this when regulating generation. However, when it came to distribution, Eksom was only one of 178 regulators, although NERSA tended not to focus on the others, dealing with them only really when they applied for tariff increases. SALGA thought that there needed to be a refocus and greater recognition of the needs of other distributors.

Mr Kolisa said that the relationship between Eskom and SALGA was acceptable. However, the relationship between Eskom and the municipalities was problematic in that Eskom did not recognise the jurisdictional areas of municipalities have jurisdiction. SALGA hoped to help resolve that issue.

Mr Ross asked what should be done by municipalities lacking the capacity to address their challenges.

Mr Kolisa said that under-capacitated municipalities could outsource by identifying a long-term service provider, which could be Eskom. Municipalities needed to look at the service and determine if they could provide it.

The Chairperson thanked the Department of Energy and SALGA for their presentations, and hoped these would trigger more questions. He noted that energy was a complex matter with several pressing issues in need of attention. He wanted to ensure that all roleplayers were involved.

The meeting was adjured.