South Africa Restructures Its Power Sector

South Africa Restructures Its Power Sector

June 01, 2001

South Africa is in the process of finalizing proposals for restructuring the regulatory framework for the provision of electricity. Under the proposals, electricity generation would be deregulated and electricity distribution reorganized. Significant modifications to the tariff structure have also been proposed.

Background

In 1998, the South African government published a white paper on energy that accepted the need to address tariff, supply and quality distortions in the electricity market. The minister of energy affairs, Phumzile Mlambo-Ngcuka, appointed consultants to advise the government on how to transform the electricity sector. In July 2000, these consultants presented their report to the president’s cabinet. The cabinet referred the report back to the restructuring committee overseeing the process for reconsideration of certain recommendations. In November 2000, the government issued a proposal for restructuring electricity distribution.

The electricity sector is governed currently by the Electricity Act, 1987, the Eskom Act, 1987, and legislation pertaining to municipalities, and it is regulated by the National Energy Regulator, or the “NER.” Electricity is generated in the main through Eskom, a state entity established pursuant to the Eskom Act, as the monopoly generator of power. Some generation facilities are owned by municipalities and certain municipalities are in the process of selling, or have announced their intention to sell, these assets to private-sector investors.

Deregulation

The first step in the deregulation of the generation of electricity has already been taken. In December 2000, the NER approved the first license for power generation by a private sector entity. Another two applications for generation licenses are currently pending before the NER. The NER envisages, in the medium term, an internal pool for electricity trading fed by imported electricity and independent producers, eventually leading to the creation of a power exchange. In addition, a bill has been published for comment proposing the conversion of Eskom from a statutory entity into a company under the Companies Act, 1973. While this step may be a precursor to Eskom’s eventual privatization, the current focus of the reform process is on the regulatory framework for the electricity sector, not on Eskom’s privatization.

Distribution is supplied through Eskom and approximately four hundred municipalities. Proposals published by the government in November 2000 proposed the establishment of six regional electricity distributors, or “REDS,” controlled by the government and to which the electricity distribution assets of Eskom and the municipalities will be transferred.

The government’s challenge is to ensure that electricity provision is expanded to rural areas, where electricity is not generally available and where the ability to pay for electricity is limited. The government is also under pressure to keep electricity prices low, which it has managed to do very well, by international comparison. In January 2000, Eskom’s application for a 7% increase was rejected and a below-inflation increase of only 5.4% allowed. In addition, proposals are under consideration for the implementation of a so-called “poverty tariff” to subsidize power to poor people. Proposals being considered include a direct subsidy from the government, large electricity users subsidizing lower-income users and incremental subsidies, whereby all electricity up to a certain usage is provided free or at low cost.

The government’s proposals are opposed by labor, which fears job losses, and municipalities, which consider the proposals an infringement of their constitutionally-entrenched electricity distribution power. Municipalities in many instances earn a margin on the supply of power, and they are not keen to see their credit ratings affected and their assets transferred to other entities, at least not without consideration. The proposals come at a time when local governments are under pressure to make ends meet and when the municipal system is also in transition due to the re-demarcation of municipal boundaries and the introduction of a new legislative framework for municipalities. The government has enacted legislation relating to municipal structures, municipal systems and property taxes and is currently preparing a draft bill on municipal financial management. The new legislative framework permits the establishment of municipally-owned utilities, and allows municipalities to give guarantees, make investments in generation facilities — among other things — and alienate and encumber municipal assets subject to certain conditions.

There are obvious costs in extending the distribution network and restructuring the sector. These include the costs of building the distribution infrastructure, establishing the REDS and paying compensation to the municipalities. End consumers may be asked to pay these costs. The idea of an electricity levy to finance restructuring — including compensation for municipal assets — has also been raised. Alternatively, these amounts could be raised through taxation. In theory, this burden will eventually be offset by competitive pricing of electricity.

An open issue is how electricity will be distributed during the transitional phase prior to the REDS becoming operational. Initial proposals contemplate a vertically-integrated distribution company owned by the state, comprising the staff and assets of municipal and Eskom distributors that would act as the interim national distributor of electricity. However, the energy minister’s consultants proposed that this company should act as an advisor and implement the establishment of the regional electricity distributors, but should not itself provide electricity. The number of regional electricity distributors also remains to be resolved. The government proposes six regional distributors, while Eskom favors seven.

Timetable

The regulatory framework relating to distribution was supposed to be implemented on April 1, 2001. However, this target date will not be met.

The big question is when developers who want to do business in South Africa will have a clearer idea of the regulatory framework for doing business. The cabinet returned the deregulation proposals to the restructuring committee for further work last year. It will probably be another six months before a revised set of proposals is sent back to the cabinet. Implementation of deregulation itself will take several years.