Independent Systems Market Operator (ISMO) Draft Bill: initial briefing

Meeting report

Draft Independent System and Market Operator Bill: briefing by Department of Energy
Mr Ompi Aphane, DOE Acting Deputy Director-General: Electricity, Nuclear and Clean Energy, said that the Draft Bill had to be put into context. The Electricity Regulation Act would be amended. The establishment of the Independent System And Market Operator (ISMO) as a national public entity would necessitate changes. The process was with the Executive at this time. The legislation talked to some of the concepts. More capacity was needed but Eskom could not provide this. New options outside Eskom had to be facilitated. Government could not raise the revenue required. There would be certain increases to the tariff to support the capital expansion programme. Such increases would have social consequences. Ultimately exports might be influenced due to high energy costs to manufacturers. Eskom's financial position had to be considered as well. The results for the previous financial year had been announced recently. Although they looked healthy this would not always be the case.

Mr Aphane said that Government supported Eskom, but there was limited ability to increase the current level of support. The pricing would have to be reviewed regularly. There was an intention to build smaller power stations to spread the risk of failures. There might be resources outside Government to make this possible. IPPs would help reduce the financial burden on the state in terms of the building of new generation capacity.

The Acting DDG said that the concept of an ISMO was not a new one. It was already being done within Eskom. There would now be a separation from Eskom. The ISMO would be responsible for daily production of energy needed to satisfy demand. The ISMO would do a short-term forecast of power requirements and then utilise stand-by generating capacity. This was a new concept where the ISMO could buy and sell electricity independently of Eskom. There were electricity imports, but municipalities were also part of the system. The monopolistic tendencies had to be addressed. There was a perception that the monopoly generator would dominate the market. An ISMO would still be a 100% state-owned entity. Eskom, as the national transmission company, would retain this position. The ISMO Bill would not contemplate any separation of the transmission business from the Eskom balance sheet. There would be no impact on Eskom. Instead, people and computers would be moved with a particular mandate.

Mr Aphane said that the new state-owned entity (SOE) would be responsible for planning. The DoE had led the process in the past as this function could not be left to a commercial entity. The ISMO would still have to use the Eskom network capacity. Eskom could not have control over this network. The concept of buying was defined in the Electricity Act. All electricity being produced at present was being sold to one buyer, namely Eskom. There was no other buyer that could compete with Eskom, which already had 44 000 MW power generation capacity, most of which was already paid for. It would always compare its own capacity to the product put up for sale. Eskom would then have to sell its product to an ISMO

Mr Aphane said that if Eskom could not build all the new power stations, then independent power producers (IPPs) would be needed. If Eskom could not do this, then IPPs would have to work with Eskom. The integrated resource plan (IRP) also addressed renewable energy options. Coal was still the cheapest option resulting in a 97% reliance on coal-fired power stations. This is not what government wanted. The ISMO would be best placed to ensure that renewable energy sources were utilised. The biggest hurdle to introducing IPPs was that Eskom controlled the distribution grid. Equitable access was a concern. There was an issue over the predictability of costs and risk allocation.

Mr Aphane said that when electricity was produced it had to be used. It could not be stored. The critical question was who would consume the electricity. If an IPP could not guarantee that its power would be despatched, it would not be financially viable. Supply agreements would be signed with IPPs. The monopoly situation resolved the problem with long-term agreements, but this would be coupled to a predictable tariff. Unless there were policies to enable the introduction of IPPs, the issue would continue to be a stumbling block. The introduction of an ISMO would make it easier to predict tariffs and costs. There was also an issue of autonomy. The playing field had to be levelled to allow IPPs to invest.

The Acting DDG said that the ISMO Bill would create an entity that would undertake the listed functions. This would send a message that South Africa was serious about facilitating electricity generation by IPPs and investment could be attracted. This could be established within four months. The next phase would be population. The ISMO would then need to acquire the necessary people and equipment. This would take time, up to two years. This would mean a transfer of up to R500 million of computers and software from Eskom. This would be at the National Control Centre in Germiston. There were some risks. Eskom was assessing the risk of imbalance in the system, which could lead to disruptions. This process had to be well managed. Renewable energy transactions were being discussed at present. He envisaged that Eskom would take up these contracts initially and then pass them on to ISMO. ISMO would maintain and operate the National Control Centre to control generation and the transmission system. There was a R40 billion question on the ownership of the network. This debate might only be started within three years.

Mr Aphane said that the comments phase on the Bill had been concluded mid-June. There would be a formal presentation once the Bill had been tagged. If the Bill was in place it would send a positive message to IPPs. An enabling environment would be created. There was a perception that Government was not serious on the issue.

Mr Aphane said that there would be certain spin-offs. These would be unknown benefits. The biggest would be an improvement in the creditworthiness to the buyer. Eskom had been put on a credit watch by the rating agencies. This was a caution to investors as the agencies felt that Eskom might not be able to meet its obligations. One of the big issues was that once Eskom was back in a positive cash position, there would be renewed investor confidence. It was a critical issue, and applied to the country as a whole. There was a link between Eskom and the national rating. When ISMO started it would be in the same credit risk category as Eskom. However, Eskom was currently one big organisation. When it had a problem in one of its operations, everything came to a halt.

Mr Aphane said that Government needed to support the expansion of infrastructure. The budget of approximately R1 trillion was deployed on various priorities such as health and education. Investment in energy might be able to be diverted.

The Acting DDG said there was an issue on cross-subsidies. This happened at various levels. Where a company like BHP Billiton had a contract at a certain tariff, he asked if such a user would continue to subsidise rural consumers or if this was the other way round. Government would also benefit by having to spend less on infrastructure. Risks would be reduced as there would be cheaper power purchase agreements. Government had given risk guarantees to Eskom. All of these risks were unquantified. Diversification was needed.

Mr Aphane said that there would be a positive impact on government. ISMO would be a SOE. It would act as a referee in the market unlike the current situation where Eskom was both player and referee. ISMO would be accountable to the state and not Eskom. Eskom would be more self-reliant.

Mr Aphane said that there would also be a positive impact on IPPs. There would be economic stagnation if Eskom was unable to expand. Governance was an issue between Eskom and the regulator. Transfer funding was a difficult issue. Eskom would not be impacted adversely, but there would be benefits to clients, suppliers and staff. At present the National Energy Regulator of South Africa (NERSA), like other similar organisations in the world, was populated by people working for Eskom. This new approach would draw from other sectors.

Mr Aphane outlined the current structure. Eskom Holdings was responsible for production, transmission and retail. There were some IPPs. The impact would be on the system operator portion of the system. The generators produced power which went into the grid and from there to customers. The National Control Centre would maintain a balance between supply and demand of electricity. Eskom Holdings collected money from the customers and used it to maintain the system. What the DoE wanted to do was separate the system operations aspect. It would include the Integrated Resource Plan (IRP) function. The wholesale function would be under system operations. At present, key customers were all captive to Eskom distribution. 10 000 customers consumed 80% of electricity production, typically on long-term contracts with favourable prices. Eskom was still responsible for electricity in rural and township areas. The distribution in this sector was complicated. ISMO would buy from all producers, but had to have access to key customers. The National Control Centre could become a subsidiary of Eskom in the short-term leading to total independence.

The Acting DDG said that national control should remain an Eskom function. ISMO had to understand the risks involved. This was a candidate area for a service level agreement. Government had a standing policy of IPPs providing 30% of power capacity, but this could be revised. It would be a function of how much Eskom could deliver.

Mr Aphane said that there was international experience in this field. Turkey was an example. They had moved from a similar vertical structure to a system involving IPPs. Generation and transmission had been separated. A state owned transmission company had been created. The situation in Thailand was closer to the South African situation. The Norwegian model was similar to systems used in the United States of America (USA). It used the concept of a power exchange. Anybody could generate power and feed it into the system. The current South African objective was to ensure that a proper basis was in place.

Discussion
Mr D Ross (DA) understood that the goal of ISMO was to ensure an adequate supply by focussing on IPPs. He hoped that it would lead to more favourable prices. He was perplexed to hear that Eskom would buy from IPPs, as this would negate the desired situation. He believed that there would be a bidding process. He had hoped that ISMO as an independent operator would conduct this. He asked if Government would move carefully as it moved towards a free market situation while being mindful of socio-economic conditions.

Mr S Motau (DA) was excited by the concept.

Mr J Selau (ANC) referred to the Turkish model where the system had been unbundled. In the proposed South African system, the focus was on how the system operator function would move away from Eskom. EDI Holdings had been closed down. He understood that ISMO would buy from Eskom, from imports, from IPPs and from refitted stations. He wanted to know what ISMO would do with this. If it would do the distribution, he was worried about the distribution function contained in Eskom. He asked how distribution would be consolidated in the future.

Mr Aphane replied that there were constitutional complications on the distribution side. Electricity reticulation was a municipal function. That would lead to 187 licensed distributors. It was a critical matter. The problem was much bigger than distributing electricity. The regional electricity distribution (RED) concept should have dealt with this. There was a massive backlog with infrastructure. The ISMO was just one element in a big problem. Supply was the problem. There was an asset redistribution programme. Mr Selau was correct. The end user could not see the reason for power outages, whether this was due to an imbalance of supply and demand or simply poor maintenance of infrastructure. If Eskom was to continue in the distribution sector, there would be a contradiction in terms of the Constitution. There was a history, however. Eskom would need to be compensated if it lost this function. There were big problems in the sector. Unless this problem could be resolved, Eskom would remain in the equation.

Mr Aphane said that ISMO would not be in the business of consuming power. It would have to sell all the power it bought. Key customers comprised 80% of demand at a wholesale level. Municipalities were also regarded as key customers. Municipalities sold power on to individual customers. ISMO had to sell to the market to make the system viable. This should be on a cost-effective basis. Eskom would say that the heart of Eskom's revenue would be ISMO. This would trigger negative pledges in Eskom's load cover. The company had long-term bonds. If its revenue was threatened there might be problems. This could be dealt with. As an SOE, ISMO could make representations at national level. On the other hand, ISMO needed a market. There was potential for a vicious circle to develop. Due diligence was needed.

Mr Aphane said that small business would either form part of Eskom's distribution network or would purchase from municipalities. The proposed legislation in 2003 could have addressed the issue. Reserves were needed. High tariffs could be charged by IPPs in this position. Plants were built and suppliers competed in international models. The plant suitable for short-term competition was the one with low capital costs. It did not matter so much in these cases if operating costs were high. This is one reason why gas turbines were so popular, especially in countries where gas was easily available. No-one would compete with gas by using nuclear or other expensive capital plants using renewable energy. There was a massive market in Europe. South Africa was very much an island by comparison.

The Acting DDG said that ISMO would be a buyer. At the moment Eskom bought and the DoE regulated. The current system would disappear when ISMO was in place. ISMO would be able to negotiate with sellers. Transactions could be brokered on an unbiased footing. ISMO was an attempt to balance supply and demand.

Mr Selau said that more uncertainties were being created by the DoE's responses. He asked what the implications were of ISMO taking over Eskom's market for the workers. There might be retrenchments.

Ms N Mabedla (ANC) asked for clarity on the impact on other Eskom stakeholders.

Mr Aphane replied that the control function was being run by fifty staff. He could see that more people would be needed to execute the additional mandate. They would not be involved with buying or planning. He foresaw a bigger role requiring more staff. There was a related human resources problem. Eskom was an established brand. People who had been working with Eskom with pensions and other benefits would like to see these transferred to any new entity. There might be an argument that the new entity would not have the same brand and people might be hesitant to make the move from Eskom to ISMO. The level of skill within ISMO would be very high. Qualified experts would be needed. The problem would be a nation-wide one. It would be a problem to attract more experts, while some would be lost. A lot of foreign money would be used. These investors would be tempted to raid SA human resources. It would be a positive problem.

Mr Ross asked if consumers could have a choice of supply, whether from ISMO or from individual suppliers. If the ISMO was fully operational, he asked if they would take over some of the responsibilities of NERSA.

Mr Aphane said that in terms of retail competition, the answer was complex. One could not have retail competition that contradicted the Constitution. This said that electricity reticulation was the sole responsibility of that municipality. One could not buy from another municipality, but each municipality could choose its supplier. At present, Eskom Holdings was in charge of the whole system. Every three years they went to NERSA and asked for tariff increases to cover its costs. This role would disappear when ISMO came to fruition. The new system would result in transparency. Where there were cost overruns at a particular facility, inefficiencies would be exposed. ISMO would be a regulated entity. NERSA would have a different function. Licences would be issued to each generator. Regulations were being prepared.

Mr Motau asked where the responsibility for power purchase agreements (PPAs) would fall.

Mr Aphane replied said that this would be in contracts between ISMO and the buyer. ISMO could ask Eskom to enter into agreements for each generator.

The Chairperson said that the tabling process would take four months. The Bill still had to be submitted for tagging. It would be part of the Committee's third term programme. This Bill still had to be submitted to the Office of the Speaker. Public hearings would have to be considered. Both local and international interests were at play.

Adoption of Strategic Plan
The Committee's strategic plan could not be adopted due to a lack of quorum. The Chairperson urged Members to consider the plan during the forthcoming constituency period.

The meeting was adjourned.