Basic Fuel Pricing Formula Change; Auditor General’s Report on the South African Diamond Board: briefing

Meeting report

MINERALS AND ENERGY PORTFOLIO COMMITTEE
26 February 2003
BASIC FUEL PRICING FORMULA CHANGE; AUDITOR GENERAL’S REPORT ON THE SOUTH AFRICAN DIAMOND BOARD: BRIEFING

Chairperson: Mr MT Goniwe (ANC)

Documents handed out:
Memorandum: Response to the Auditor General’s comments as reported on the audited financial statements for the year ending 31 March 2002 (see Appendix 1)
Basic Fuel Pricing Powerpoint presentation
Amended Committee Programme - 2003
South African Diamond Board: Budget for the financial year ending 31 March 2004  (email [email protected] for document)
Department website info on Working Rules To Administer The Basic Fuels Price Methodology

Business Day News article: Diamond regulator's finances fail to shine

SUMMARY
Briefing on basic fuel pricing formula
This briefing was arranged in response to the announcement of a new formula for calculating the price of liquid fuels.  It sought to appraise members of the context in which the Department had replaced the in bond landed costs (IBLC) -based formula, calculated according to posted crude oil prices, with the Basic Fuel Pricing (BFP) formula calculated according to spot crude oil prices.  
 
Briefing on Auditor General’s report on the South African Diamond Board
The serious implications of comments in the Auditor General’s report for the future of the Board were addressed during the course of this briefing, which focused on financial statements for the year ending 31 March 2002 and a budget for the year ending 31 March 2004.  The suspension of the former CEO, the meeting of its tax liabilities and a review of the role and functions of the Government Diamond Evaluator (GDE) were noted.  The issues of the Board’s turn-around strategy, management systems and ‘Kimberley Process’ for certifying rough diamond exports will be addressed at a follow-up briefing yet to be arranged.

The Democratic Party accused the Department of downplaying its concerns about the management of the Diamond Board over the past three years. The Director General conceded that there had, indeed, been cause for concern over the Board over which the Department does exercise fiduciary responsibility.

The Chair asked members to consider carefully how best to engage all bodies over which this committee had oversight, suggesting that the budgets of these institutions might need to be examined as part of the overall departmental budget briefing process

MINUTES
Adoption of committee minutes
Noting that official records of meetings of the committee are now being kept, the Chair advised that, as a matter of procedure, minutes will in future be considered and adopted before attending to the business of the day.

The minutes of the 19 February 2003 meeting of the committee were adopted without amendment.
  
Briefing on basic fuel pricing formula
Dr R Crompton, Deputy Director General of the Department of Minerals and Energy, presented an overview of the context in which it had been decided to review the formula to calculate liquid fuel prices, based on in bond landed costs (IBLC),  and the process followed to arrive at a new formula.

Referred to as the Basic Fuel Pricing (BFP) formula, it is anticipated that this new formula will generally result in lower liquid fuel prices.  However, noting that the manufacture of liquid fuels in South Africa is largely dependent on imported crude oil, it is impossible to predict the impact of international events on market forces and the extent to which these could negatively affect the spot prices on which the new formula is based.

The extensive consultation and research processes underpinning the Department’s review of the IBLC-based formula had pointed to significant savings with the introduction of a formula based on spot prices as opposed to posted prices, benefiting consumers and the economy as a whole.  This notwithstanding, in the longer term a formula based on spot crude oil prices would probably reduce income to the refining industry and could therefore impact negatively upon its future.  The new formula could also have negative implications for the implementation of Black Economic Empowerment (BEE) policy in the sector, noting that liquid fuel retailers have, to date, relied heavily on IBLC-formula-related discounts that will fall away under the BFP system.  Synthetic fuel producers without marketing operations elsewhere in the world could also suffer.   Despite these concerns, however – and noting that every one cent per litre reduction in the price of crude oil means a saving of R150 million per annum nationally – there had been widespread support for the new formula among all stakeholders in the industry.

Discussion
Mr I Davidson (DP) expressed surprise that a formula with so many obvious benefits to the economy as a whole had not been introduced earlier.

Mr E Lucas (IFP) enquired to what extent other elements of the ILBC-based formula could be reviewed in order to further reduce the price of liquid fuels.

Prof I Mohamed (ANC) asked how extensive the consultation process underpinning the formula review had been.

In response, Dr Crompton commented that the size of the liquid fuels industry and the magnitude of its investments is such that an extensive process of research and consultation had been imperative before recommending a change in the pricing formula.  This process had also been informed by global market trends with serious implications for the South African economy that were completely out of Government’s control.  For these reasons, the Department had considered it prudent to err on the side of caution.

The Chair enquired about the implications of the new pricing formula for workers in the oil refining industry and whether the Department had secured any commitments from industry management that would protect workers from large-scale retrenchments in the event of downsizing.

Dr Crompton assured him that that the Department and representatives of the oil refining industry are committed jointly to investigating the longer-term implications of the new formula with this and other issues in mind.

Regarding the extent to which other elements of the IBLC-based formula could be reviewed to further reduce liquid fuel prices, he advised the committee that those falling within the ambit of the Department are already in the process of being reviewed. Elements of the formula for which other government departments are responsible are being reviewed separately.

He reassured Prof Mohamed that extensive consultations across the full spectrum of stakeholders had, indeed, taken place.
 
Mr G Olifant (ANC) reiterated concerns expressed in previous meetings about the committee’s perceived exclusion from processes such as the one under discussion and the urgent need for the timely communication of information vital to the committee’s role and functions.   He also observed that the new BFP formula would probably be affected by the rand-dollar exchange rate as much as the IBLC-based formula it sought to improve upon and replace.

Mr Davidson (DP) asked why the Mediterranean and Singapore markets had been selected for spot price calculations, noting the dangers of commenting on the perceived advantages of the new formula without insight into liquid fuel pricing mechanisms used by other developing countries with refineries.

Mr J Nash (ANC) expressed frustration about the extent to which the process of arriving at a new liquid fuels pricing formula had attempted to address the concerns of the oil refining industry and synthetic fuel producers.  In his view, both sectors had benefited disproportionately from the IBLC-based formula and the posted crude oil prices underpinning it, which could well explain why there had been no political will on the part of the previous government to review the formula.

Responding to the selection of specific markets for spot price calculations, Dr Crompton commented that the Mediterranean and Singapore markets are best suited to South Africa’s requirements and economic conditions as part of the global economy.  Markets selected for posted price calculations in terms of the old, IBLC-based formula had suited South Africa’s very different needs when the formula had last been reviewed in 1995.  Developing countries located near South Africa and most affected by its liquid fuels pricing policies had, indeed, been consulted by way of briefings to the Inter-State Oil Committee.

He referred the committee to the Department’s website for documentation providing more detail on the formula review process since time constraints would not allow him to elaborate further.

The Chair noted that  while the Director General of the Department, Adv S Nogxina , had been invited to participate in a briefing on developments at the South Africa Diamond Board, his input on the issue of the BFP formula for liquid fuels would be appreciated.

Responding to concerns expressed about the need to review other elements of the IBLC-based formula to further reduce liquid fuel prices, Adv Nogxina endorsed Dr Crompton’s comment that most of these fall outside the Department’s policy-making ambit.  He reassured the committee that the lobbying of other departments does nevertheless take place at various levels despite the potential for conflicts of interest on certain policy issues.

He said that the Department remains committed to co-determination in policy development.  Nevertheless, regulatory decisions with economic implications must be handled with due sensitivity.  He reminded the committee that the inopportune release of information can cause unnecessary panic in certain markets, referring to reactions to premature pronouncements on the Mining Charter as one example.  He undertook to discuss other communication process difficulties with the committee chairperson, encouraging members of the committee to approach the Department at any time for information.

Regarding the long and time-consuming departmental process of arriving at the BFP formula for liquid fuels pricing, Advocate Nogxina re-emphasised the need for due caution when dealing with economic regulatory issues.  He noted that, that, since the crude oil price is still denominated in dollar terms, the liquid fuel pricing formula will continue to be affected by market trends and volatility. 

Briefing on Auditor General’s report on the South African Diamond Board
The Chair welcomed representatives, apologising to the committee for a procedural oversight in terms of which the Office of the Auditor General should have been invited to elaborate on the report prior to a briefing by the Board itself. The magnitude of problems besetting the Board had been such that it was to be hoped that this procedural oversight would be excused.

Mr A Chikane, the Diamond Board chair, outlined mechanisms that have been introduced and changes that are being made with a view to ensuring compliance on the part of the Board with all its statutory requirements.  In particular, issues relating to the role and functions of the Government Diamond Evaluator (GDE) are in the process of being resolved.  He expressed confidence that the ‘Kimberley Process’ aimed at implementing a certification scheme to monitor all rough diamond shipments from South Africa and elsewhere will further stabilise the industry during the course of the year as more countries endorse it by introducing and implementing the necessary legislation themselves.

Mr L Selekane, Acting CEO of the Board, then presented an overview of the financial statements for the year ending 31 March 2002 in response to which the Auditor General’s comments had been made.  He assured the committee that the debt trap into which the Board had fallen was being addressed and a turn-around strategy was firmly in place.  In particular, the Board had now met all its Value Added Tax (VAT) liabilities for the financial year in question as well as its obligations to the Inland Revenue Services (IRS).

Discussion
Mr Davidson (DP) welcomed the changes being implemented, commending the parties concerned for their efforts.  He nevertheless expressed dismay at the extent to which questions he had been raising for the best part of three years on the management of the Board had been downplayed or even dismissed by the Department when it was now very clear that they had been fully justified.  The suspension of the former CEO and a review of the role and functions of the GDE would, in his view, ensure a healthier future for the Board since together they had been widely perceived to be at the root of its problems.

Mr Davidson then enquired where, in the budget for the year ending 31 March 2004, the seventeen million rand in VAT still owed to the IRS had been reflected.

He also enquired whether the fee structure for the GDE has itself been reviewed as figures in the budget appear to suggest.

Mr Lucas (IFP) suggested that, notwithstanding reservations about  the extent to which Mr Davidson’s longstanding concerns about the Board might well have been overlooked by the Department, new management structures at the Board should be given the opportunity to prove their bona fides.

The Chair noted the need to ensure a systematic and ongoing review of all bodies falling within the ambit of the committee’s oversight role.

Professor Mohamed (ANC) expressed serious reservations about the integrity of the GDE and enquired whether all related issues have really been resolved.

In response, Mr Chikane advised the committee that an independent audit jointly commissioned by the National Treasury and the Department had recently released a report that should answer all these questions.  This report would soon be made available to members of the committee.

Regarding the seventeen million rand owed by the Board to the IRS, Mr J Mtetwa, Acting Financial Manager of the Board, advised the committee of the termination of  an arrangement in terms of which a company owned by the GDE had been conducting diamond evaluations for the Board for a fee.  Since 01 October  2002, monies previously dedicated to the payment of this fee had instead been utilised to pay the IRS.  It was anticipated that the amount outstanding would be paid in full during the current financial year.

Mr Davidson (DA) enquired how the IRS would be paid in the event of the GDE’s company being declared insolvent.  He was assured by Mr Mtetwa that, under such circumstances, the IRS would liquidate the company  and confiscate its fixed assets.  There was an understanding in place between the Board and the IRS that the Board’s liability in this regard amounted to no more than ten million rand.

Mr Olifant (ANC) requested an assurance from the Board that its arrangement with the GDE and his company had been adequately addressed and that appropriate measures were being taken to introduce a new diamond evaluation system.  He also requested an undertaking from the Board in respect of the suspension of its former CEO, expressing the hope that this matter, too, had been fully and finally resolved.  

Mr Davidson enquired when interim arrangements for the offices of CEO and Financial Manager would be end and the necessary appointments made.  He also asked whether the GDE function would be advertised internationally.

Mr Chikane responded that the Acting Financial Manager had been seconded from the Board’s auditing firm so that systems and controls required in respect of the turn-around strategy could be put in place.  The Board and the Department were currently discussing the appointment of a CEO.  However, since the acting CEO had been seconded from the Department  as had been deemed appropriate at the time, there was no urgency in that regard.  He advised the committee that the Board had followed appropriate legal processes in respect of its contract with the GDE and his company, which was due to expire the following week.  The requirements of Act 56 of 1986 were being thoroughly investigated to ensure full compliance on the part of the Board in arriving at a new diamond evaluation arrangement.  The relevant documentation would be made available to the committee. 

Mr Olifant asked representatives of the Diamond Board when the committee could expect to be briefed on its turn-around strategy, the ‘Kimberley Process’ and the new management systems currently being implemented.

The Director General suggested that this should be arranged for another mutually convenient day.

The Chair asked members to consider carefully how best to engage all bodies affected by its oversight role and functions, suggesting that the budgets of these institutions might need to be examined as part of the overall departmental budget briefing process.

He then invited members to question the Director General on any issues of concern not already addressed.

Mr Davidson (DA) reiterated his frustrations about the extent to which questions about the management of the Diamond Board had apparently been down-played or dismissed by the Department over a period of nearly three years prior to the release of the Auditor General’s report.  In this regard, he expressed dismay at the serious implications for the Board of an apparent failure on the part of the Department to implement the recommendations of the Taljaard Report on corporate governance. The suggestion that, prior to the secondment of a financial manager from the Board’s auditing firm, no appropriate systems and controls had been in place was a sad indictment of the manner in which the Board had been managed for which, in his view, the Department could not escape culpability.

In response, Advocate Nogxina conceded that members of the committee did, indeed, have cause for concern since, despite the fact that the Board is not a component of the Department for which the office of the Director General has full managerial responsibility, it is nevertheless an associate body for which the Department does exercise fiduciary responsibility. Conflicts of interest can and do arise in respect of Board members’ responsibilities to the Department and the Board and the process of determining what action to take in such circumstances is complex and challenging.  This applies to a range of institutions falling within the ambit of the Department.  In this regard, the extent to which the recommendations of the Taljaard report on corporate governance were implemented by the Department and have since been found wanting need to be explored.

Mr N Ncgobo (ANC) commented that the crisis in the Diamond Board had clearly demonstrated the need to strengthen the inter-relationship between authority, responsibility and accountability.

Professor Mohamed again expressed reservations about the integrity of the GDE, alluding to what appeared to be obvious weaknesses in the evaluation system from which the GDE had possibly benefited.

Advocate Nogxina  undertook to investigate this matter.

The Chair agreed to invite representatives of the Office of the Auditor General to address members’ concerns about the adequacy of the Board’s turn-around strategy and measures.

Amended committee programme for 2003 
The chairman undertook to keep members informed of changes in the dates of programme items.
      
The meeting was adjourned.

Appendix 1:
MEMORANDUM
TO:       THE CHAIRMAN OF THE BOARD - Mr. A Chikane
THE CHAIRMAN OF THE FINANCE COMMITTEE - Mr. M Grote
THE MEMBERS OF THE BOARD
THE ACTING CHWF EXECUTIVE OFFICER - Mr. L Selekane

FROM: THE ACTING FINANCIAL MANAGER - Johnson Mthethwa DATE; 17th September 2002.

RE; RESPONSE TO THE AUDITOR GENERAL'S COMMENTS AS REPORTED IN THE AUDITED FINANCIAL STATEMETS FOR THE YEAR ENDING ON 31 MARCH 2002

3.1 Going Concern Qualification
The management of the Board has decided to revise the income structure in respect of all services rendered to the industry. The increase in service fees which covers a wide range of products, is expected to reduce the deficit to at least zero by by the end of the new financial year in March 2003. The new fee structure is expected to be signed by the Minister of Minerals and Energy into law by the end of September 2002.

3.2        Accuracy of Revenue and Debtors
The invoicing clerk and other finance staff members have been warned against processing unauthorized credit notes. New Credit Note Books have been ordered from suppliers and are being kept under lock and key. All credit notes can only be authorized by the CEO and/or the Financial Manager after a good reason for passing each credit note has been given. In addition, the function of capturing credit notes has been taken away from the invoicing clerk and can only be done by the Financial Manager or any other senior employee.

3.3        Fixed Assets
The fixed asset register has been re-arranged. The re-numbering of all fixed assets is to be conducted hopefully with the help of some temporary employee(s). All assets listed under the wrong categories have to be re-classified. Invoices of all assets acquired during the previous financial years have to be traced and where possible be kept in a separate file for ease of reference. The depreciation on especially old assets, like furniture and equipments, is to be recalculated in order to reflect a much more realistic net book value of all assets carried in the books of the Board.

3.4        Value Added Tax
The short payment of the Vat liability resulted from the worst cash shortage the Board has ever faced. The unbudgeted legal costs which had to be paid urgently did
not allow us time to plan our payments which depleted our funds making it impossible for us to pay the full Vat amounts due. The underpayment was made after a request was made to the Receiver of Revenue to allow the Board to make provisional payments. This request was acceded to by the Vat officials and all Vat arrears and current were settled on 25 August 2002. The Vat account is now up to date.

3.5        Irregular Expenditure
Representations have been made to the attorneys acting on behalf of the creditors requesting them to accept at least R 100 000.00, as a final settlement, of the total amount owing of R 495 340.00. The request is receiving attention by the creditor. The provision for the full amount was made in the accounting records during the Financial Year under review.

4.0        Disclaimer of Opinion
As this decision is based on the findings above, no further comments are necessary.

5.1        Deduction of Income Tax
The advance to the CEO was made in lieu of the salary increase which was to be backdated to a few months back. As the advance was in the form of a short term loan which is due and payable to the Board, the issue of tax did not arise. In order to avoid a possible duplication of the income tax deduction it was decided that the advances be treated as a loan which would be deducted from the back pay, subiect to approval by the Board and the Minister, after tax.

5.2        Weakness in Internal Controls

5.2.1     Supervision and review:
During the greater part of the financial year under review, the Financial Manager Acted as the CEO of the Board which might have led to the non-fulfillment of certain financial management functions. The sudden departure of the Financial manager followed by the unceremonious suspension of the CEO, created a vacuum which, under the circumstances, could only be filled by temporal appointments until the moratorium on new appointments has been lifted. All internal control recommendations are being actioned by the current management team.

5.2.2     Segre2ation of Duties
The shortage of staff coupled with the moratorium on new appointments has forced the Board to make do with what it has. All electronic fund transfers are reviewed by the Acting Financial Manager and authorized by the Acting CEO before any deposits are made into employees bank accounts. This control is now in place.

5.2.3     Income
Computer generated invoices are issued in respect of all services provided by the Board. No manual invoices are allowed. All invoices represent income received
as no services are offered on credit. It has been noted however that due to human error, some income gets misposted which may result in misleading information for decision making purposes. The invoice clerk has been made aware of such incidents. Daily cash takings are reconciled to invoice totals before banking is done. All cash is banked intact.
Plans are underway to get all inspectors to generate their own invoices for their clients. This will ensure that the bottlenecks that result from one person acting as both the invoice clerk and a cashier, are eliminated and at the same time improve the quality of service to clients.

5.3        Non-Compliance with Laws and Re~ulations

5.3.1     Late submission of financial statements:
The absence of a financial manager to oversee the preparation of the year-end results and have same ready for auditing within the prescribed time frame, is to blame for the late submission of the annual financial statements for the year ending 31 March 2002. The Board managed, however, to present a draft of the audited financial statements to the Minister for tabling in Parliament within five months of the end of the financial year as required by section 55 (1 )(d) of the Public Finance Management Act (Act No.1 of 1999). It is expected that the annual financial statements for the year ending on 31 March 2003 shall be presented on time for audit pui'poses.

5.3.2     Budget not approved
The word has it that the budget for the financial year ending on 3 1 March 2002 was submitted to the Minister for consideration and approval but that the signed copy did not reach the Board
The budget for the financial year ending 3 1 March 2003 has been prepared and discussed at Board level and is due for presentation to the department before the end of September 2002 together with the Budget for the year ending 3 1 March
2004.

5.3.3     Internal Audit
Due to the fact that the South African Diamond Board is a relatively small entity to warrant the establishment of an internal audit department, plans are underway to engage the services of the internal audit team from the Department of Minerals and Energy to carry out the audit function and to make recommendations to the Audit Committee.

5.3.4     Audit Committee
The audit committee can only be functional once the services of the internal audit team from the Department of Minerals and Energy have been extended 10 the Board.

5.4        Government Diamond Valuator:
Discussions between the Board and the current Government Diamond Valuator are ongoing. An announcement on the future valuator could be made before the end of the year 2002.


5.5        Possible Fruitless Expenditure
The amount of R 650 000.00 may sound exceptionally high but was absolutely necessary to prevent a complete shut down of the Board if it was not incurred. The latter would have had even more serious consequences to the industry as a whole.

5.6        Suspension of the CEO
No comment.

5.7        Export Duty
The funds totaling R 1107 090.00 which were initially rejected by the Receiver of Revenue because of a mis-understanding. have of late been accepted by the very same authorities. The Board was given permission to pay it off in easy instalments.