Department of Public Enterprises on the Procurement Leverage Programme; Briefing by Transnet on the Infrastructure Build Programme

Meeting report

Briefing by the Department on the Procurement Leverage Programme
Mr Edwin Ritchken, Strategic Project Manager for the Department of Public Enterprises (DPE), informed the Committee that Transnet and Eskom were going through a major process of developing their next generation supply development plans. These would be ready in September or October 2011. His expectation was that the plans would provide a qualitatively and quantitatively new level of detail about the direction State Owned Enterprises (SOEs) were going to be taking in relation to procurement leverage.

Mr Ritchken stated that between 1994 and 2004, infrastructure investment was below 5% of the country’s Gross Domestic Product (GDP), which created a significant backlog in infrastructure. After 2004, infrastructure investment increased slightly due to SOE and government investment. Had the government invested 10% of the country’s GDP into infrastructure between 1994 and 2009, they would have had to invest another R1.5 trillion in 2010. Members had to understand that there had been a gap in investment and the country now had a lot of catching up to do. A key strategic insight was that there was an industrial complex associated with infrastructure development. Skills development also followed infrastructure development. This had declined with the fall in infrastructure investment. The impact on supplier industries was seriously exacerbated by the “lumpy nature” of the procurement process. For example, the government procured up to 250 locomotives in a single year between 1970 and 1985. There was a real, large, lumpy programme of locomotive procurement. From 1987, the programme just ended. Had the government procured at an average of 80 locomotives per year, it would have sustained the industry and maintained the skills. However, by virtue of lumpy procurement, the government put a lot of investment in one industry and demand absolutely collapsed. As a result, the industry collapsed with it. The government could not allow these lumpy procurements to happen again, as they resulted in exaggerated imports and did not allow for the emergence of sustainable industries.

Infrastructure investment was an extremely leveraged mechanism to stimulate economic activity. The role of SOEs in industry policy was to drive and leverage investment infrastructure, enabling an infrastructure driven growth and industrialisation process. The increased investment in infrastructure could be channelled through a procurement leverage programme. The programme would consist of unlocking investment in “customer” industries through providing additional capacity, improving productivity of operations in the infrastructure service provider, unlocking investment in supplier industries through increased demand, and realising externalities associated with network industries. This would result in increased GDP, employment and associated tax collection. Sustained growth required continuous investment.

The Competitive Supplier Development Programme (CSDP) had the objective of laying a platform for investment and learning by suppliers in the SOE supply chain. The objective of the intervention was to develop a procurement toolkit and supporting measures to promote investment and the development of internationally competitive capabilities in supplier sectors to the SOE’s capital and operational spend. The aim was to reduce costs through increasing efficiencies, reduce dependency on imports and foreign exchange exposure, and developing niche export areas. As there was no simple text-book methodology, the first phase of the Programme was designed to enable a “learning by doing” process for the SOE. It allowed SOEs to develop an effective operational approach and associated management capability to accumulate experience and learn, so they could find out what works within the constraints and opportunities of their environment. The second phase of the Programme focused on manufacturing partnership capabilities, which included the ability to identify key fleets and fleet requirements, identify a standardisation methodology to ensure economies of scale, to develop a long term funding strategy, and to define a procurement vision. The third phase looked at innovation capabilities. This phase focused on the identification of a design capability vision, structuring of design partnerships and management of design technology transfers. The DPE was in the process of moving from phase one to phase two; however, enterprise capability was weak and very uneven. There was continued focus on entrenching supplier development at a transactional level.

The higher the degree of industrial complexity, the more government intervention was required. “Shallow” manufacturing required proper planning and communication, which was within current industry capability. “Intermediate” manufacturing meant that investment requirements were within the company’s capability, but clear medium term procurement commitment was required. “Advanced” manufacturing meant that the project was commercially viable but that government investment was required in the plant, specialised skills and technologies. “Globally leading” manufacturing meant that a project was not commercially viable in the short term and government driven investments were needed for strategic economic purposes. For example, Eskom’s CSDP would focus on intermediate manufacturing. Eskom had leveraged over a billion Rand of investment in manufacture from the present build programme, although interventions had been largely ad hoc. Eskom had also leveraged the training of 6130 people by suppliers. The majority of the training that took place was for welders, boilermakers, riggers, fitters, technicians, laboratory technicians, and quantity surveyors. Eskom had also established component hubs to enable the identification of supplier development opportunities for specific components.

Transnet had secured three major CSDP transactions. The current CSDP plan with Electro-Motive Diesel (EMD) was finalised in November 2009. The second CSDP transaction included the procurement of fifty “like new” locomotives. The third transaction was the contract for the building of 100 locomotives awarded to General Electric (GE). This was signed on 17 December 2009. In addition to the CSDP transactions, Transnet had made significant progress in enhancing procurement capability and engaging with suppliers.

A key challenge was that SOEs’ complex procurement capabilities were historically weak, as there was a gap between their aspiration and capability. SOE governance was seen as a process, but was not substance orientated, and SOE culture was inward-looking, which limited their ability to learn. A fleet referred to any long term equipment of a similar function that was essential to maintain an operation or service. The fleet or programmatic procurement process was developed to ensure that the impact of the key strategic procurements could be optimised. It included the development and disclosure of long term fleet plans, a standardised strategy that had to accompany the fleet plans, a credible funding mechanism that had to be in place to support the procurement plan giving suppliers a degree of certainty that the programme would be sustained, supplier industry consolidation, and the ability to structure and manage the procurement of complex systems that include technology transfers and investment in industrial capability. Presently, none of these fundamentals were in place.

A draft policy was developed based on managing the quality of the procurement process. It provided a definition of the information required by decision-makers, who would be organised in review panels, at key moments or milestones in the relevant process. Depending on the nature of the transaction, there were three key processes that could be followed each with different milestones. They included the programmatic processes, the transactional processes, and testing for innovation. The objective of the programmatic/fleet policy was to enable long-term fleet procurement with significant developmental impacts. The objective of the transactional policy was to integrate supplier development concerns into all procurements where there was no value leverage. The objective of the innovation policy was to allow for testing of a local product within an operational environment.

A centre of excellence would be established to support organisations undertaking complex procurement. The centre would be responsible for supporting the selection of an external review panel, providing focused support for fleet procurements, creating mechanisms for knowledge accumulation and sharing, conducting benchmarking of procurement capability, and providing support and facilitating training on complex procurement. SOE procurement leverage and the locomotive fleet procurement are cornerstones of the IPAP strategy.

By the end of September, both Transnet and Eskom would have prepared their next generation supplier development plans. It was proposed that the Committee call for presentations of these plans.

Discussion
The Chairperson asked what challenges the DPE had experienced with the CSDP. He also wanted to know what the DPE's long term plan was for assisting local suppliers with their capacity problem.

Mr Ritchken replied that problems occurred when entities lost their ability to build on very complex projects, and when entities did not have a learning period. It also happened when entities did not “pay their schools fees” on earlier projects. It required a high level of capabilities when entities entered into a process of managing the design and construction of a highly technologically sophisticated project. These capabilities were in short supply, particularly because they were “closed down” in both Eskom and Transnet in 1994. The DPE was called the Office of Privatisation back then.

Mr A Mokoena (ANC) noted that the DPE's presentation was very informative, and that their infrastructure plan elevated procurement to a very high level. He asked the DPE to elaborate on the procurement strategy that the country had in 1994. What informed the strategy for “lumping” procurement during that time?

Mr Ritchken replied that as Transnet opened up new railway lines in the past, it bought new locomotives. There was a commodities boom during that period and the country was awash in cash, which allowed government to spend money in that area. So, there were approximately 27 different classes of locomotives on Transnet's fleet at the moment; there was no standardisation at all. At the time, Transnet believed it was doing the right thing.

Dr G Koornhof (ANC) stated that the whole country had to be involved in the DPE's initiatives on fixed capital formation, not only SOEs. SOEs played a big part but this was a national initiative. He wanted to make sure that this was a national initiative where all forces were mobilised to grow the South African economy. He also wanted to know who was going to fund this initiative. Parallel to this process was a Presidential Review Commission. He was eager to see that bridge between the fixed capital formation initiative and the report that the Commission was going to draft at the end of the year.

Mr Ritchken responded to the question on fixed capital formation. He said that Transnet was committed to this partnership approach. He believed that programme looked at the building of partnerships with national and international suppliers, and original equipment manufacturers. The DPE was also committed to building a partnership with its customers. The DPE also had to bring in its sophisticated and developed financial services to the community, which would allow for honesty and participation from all entities within the country. The DPE was focused on unlocking all sources of capital in a partnership-type way. The DPE was engaging with the Presidential Review Commission and sharing experiences and views with them. The DPE viewed the Commission in a very positive light.

Ms G Borman (ANC) liked the idea of putting emphasis on the quality of things that the country was producing, as it would yield good returns. She was concerned that the DPE's initiatives needed money, but that the government was not pumping money into SOEs. She asked for more clarity on this.

Mr P van Dalen (DA) stated that when entities such as Eskom and Transnet were granted funding from international entities, the grants usually came with conditions. How would this affect local procurement? The Committee had visited Transnet Rail Engineering and had been told that they did not have an order book for locomotives, and that they were struggling because nobody wanted to buy into their programme. He asked why they were procuring locomotives from GE when they could manufacture them in South Africa. How much did it cost to buy a locomotive from GE and how much did it cost to manufacture one in the country?

Mr Ritchken replied that this was a problem; the money had to be raised within the country. Conditions from a foreign country were always there to push that country's interests, and the development of the South African industry was not going to be part of the funding agreement or conditions. This was why the money had to be raised within the country.

He said that GE's role was only to do the assembling of the locomotives. The price of a locomotive was between R25 million and R40 million depending on whether it was diesel or electric. When South Africa initially had a rushed order for 100 locomotives from the international community, they were estimated at a certain price. Then the global recession happened and the government had time to re-submit the order, while at the same time increasing the amount of localisation. The price dropped by approximately 25%. Bad planning caused the inflation of procurement costs. If an entity had a good procurement capability then they would benefit.

Ms C September (ANC) welcomed the presentation that was made. The presentation gave the Committee an opportunity to talk to economic infrastructure. The DPE's five-year plan amounted to a few billion Rands, which was earmarked for transport and electricity. She asked if everything contained in the presentation was built on this five-year plan or if the information in the presentation signalled a completely fresh start. If so, what happened to the five-year plan? She would prefer if future presentations focused more on other economic activities, and not only the locomotives industry. There was a report that the South African Reserve Bank (SARB) brought out every year that focused on economic infrastructure in the public sector. She thought it was a good idea to include this report in the DPE's presentation so the Committee could see if it influenced the DPE at all. She wanted a report on the long term relationship between the economic infrastructure and real GDP of the country. She also thought the presentation had to include the need for infrastructure investment from the national level to the municipal level. The national level had to be in sync with what was happening at local level or vice versa. 

Mr Ritchken replied that the presentation added to the DPE's five-year plan for Eskom and Transnet. The point of the programme was to ensure that the investment money that the DPE spent was going to be spent in a way that optimised value for money and the impact on the economy. The SARB had used data it had received from the DPE. The SARB graphs showed that while public expenditure was flattening out and private expenditure was declining during the recession, Transnet and Eskom, in particular, retained their momentum in terms of fixed asset investment, which cushioned the blow. 

Mr Ritchken addressed the statement concerning the long term relationship between infrastructure and GDP growth in the country. He said that a lot of econometric models were developed on this relationship. Infrastructure could either be a constraint or it could encourage economic growth.

The Chairperson thanked the DPE for their presentation. He said that if there were any unanswered questions, the DPE should forward the answers to the Committee.

Briefing by Transnet on their Infrastructure Build Programme
Mr Brian Molefe, Group Chief Executive, Transnet, informed the Committee that Transnet’s key role was to assist in lowering the cost of doing business in South Africa and enabling economic growth through providing appropriate ports, rail and pipeline infrastructure and operations in a cost-effective and efficient manner, and within acceptable benchmark standards. Transnet was a focused freight transport company delivering cost-effective services to promote economic growth in the country.

Transnet had a total investment of R87 billion during the past five years, funded without government guarantee on the strength of Transnet’s balance sheet. Transnet had planned investment of R22.8bn for the 2010/11 year as part of the five-year capital investment plan. Actual investment represented 94% of the planned spend, but this did not compromise capacity creation or customer commitments. Capacity was created in rail and ports. Of the R21.5bn for capital investment, 58.6% was allocated to rail operations, 13.5% was allocated for port operations and 27.9% was allocated to pipelines.

The scope of the New Multi-Product Pipeline (NMPP) project was to build a new 555 km 24 inch diameter trunk line from Durban to Gauteng to address the increased demand for fuel in the heartland of SA’s economic region, Gauteng. This would increase capacity from the existing 4.4 billion litres to 8.4 billion litres. The Harbour Entrance Widening and Deepening (DHEW) project in Durban entailed dredging, deepening and widening of the channel on the north side, with the provision of a new northern groyne, and the improvement and strengthening of the south breakwater. The entrance channel has been widened to 225m and dredged to a depth of 18m. The aim of the Cape Town Container Expansion project was to increase capacity from 700 000 TEUs to 900 000 TEUs and ultimately to 1400 000 TEUs per annum, whilst also providing a platform for further expansionary programmes should future demand exceed planned capacity. Dredging of the basin is 95% complete and 440m of the 1130m long quay has been dredged. The port construction and container terminal project in Ngqura entailed the provision and construction of basic port infrastructure consisting of breakwater construction, dredging of basin and channels, initial landslide infrastructure, as well as pilot boats and tug boats. The last section of the quay wall was completed in October 2010. The Ngqura Container Terminal was a greenfields project with the objective of providing a full service container terminal together with rail links to the Port of Ngqura. The work on the container was substantially complete and phase one of the project has been closed out. The Iron Ore Export Corridor Port project comprises a rail line from Sishen to the Port of Saldanha. The increased demand in basic commodities worldwide has led to the mines increasing their production capacity and has resulted in an increase in volumes to be transported to Saldanha for export. Phase one of the project was still in progress. The Locomotive Acquisition Programme focused on locomotives being acquired to improve efficiency and facilitate “ramp up” in coal export volumes. 60 locomotives had been delivered and the remaining 50 locomotives were to be delivered at four per month over the next 13 months. 

Transnet's five year capital investment plan allocated a total of R110.6bn for investment for 2010/12-2015/16. R21.5bn was allocated for 2010/11, R25.9bn was allocated for 2011/12, R22.4bn was allocated for 2012/13, R24.6bn was allocated for 2013/14, R18.7bn was allocated for 2014/15, and R19bn was allocated for 2015/16. The money would be used for locomotives, pipeline networks, machinery and equipment, wagons, port facilities, and land and buildings. Other major areas of investment were for the coal line, ore line, general freight costs, maritime containers, and the NMPP.

A number of infrastructure development opportunities were identified as part of the Transnet Infrastructure Plan that went beyond the five year capital investment plan. These included developing the Durban airport site into a dig out port, increasing the existing export coal channel, expanding the iron ore channel, and equipping and expanding the Ngqura container terminal.

Discussion
Mr M Nhanha (COPE) asked why another contract had been awarded to Mitsui. He understood that they had been awarded a contract prior to that one; however, it seemed that it was in contravention of the Public Finance Management Act (PFMA) that they were awarded a subsequent contract without going through another tendering process. He felt that the PFMA had been disregarded. It was also difficult to understand why they were allowed to ask that the cost of the deal should be kept private on the basis that the information was economically sensitive. This was difficult to comprehend as the agreement involved public money. Who was Mitsui to tell Transnet not to divulge this information? 

Mr Molefe replied that there was an allowance for a “consignment” in the procurement rules. A confinement could be done through one or two companies as long as reasons were given to the board or depending on the amount, to the investment committee or acquisitions committee. This was done prior to the acquisition of the asset. This was what happened with Mitsui; therefore, the transaction was not irregular. The correct processes were followed and there was no contravention of the PFMA.

Mr Roderick Wolfenden, Head of Internal Audit:Transnet, added that procurement rules were quite specific about the criteria that needed to be satisfied before procurement could take place under consignment. This would include urgency, restrictive market, whether the supplier was already delivering to Transnet, and the supplier’s capability for supplying to Transnet. This process was followed. The fact that Mitsui was already delivering to Transnet under a procurement programme meant that the criteria were satisfied.

Mr Molefe addressed the concern that Transnet had been told by Mitsui not to divulge the cost of their deal. He said that one of the conditions that Mitsui had before the deal was made was that Transnet had to sign a confidentiality agreement. Mitsui did not want their pricing strategy to be revealed to the market. It was not abnormal for a supplier to say that it did not want its competitors to know its pricing strategy. However, the Committee could see how much Transnet spent on locomotives in its financial records. He assured Members that the price was competitive.

Mr Nhanha replied that the Committee had to check the legality of this confidentiality agreement, as Transnet had used public money.

Ms September concurred, saying it was the Committee’s duty to seek its own legal opinion on the matter.

The Chairperson agreed with the proposal; however, he assumed that Transnet had sought legal council before they entered into the agreement. 

Dr Koornhof asked if Transnet had complied with environmental standards and policies when they undertook to dredge and deepen harbours around the country's coast. He assumed Transnet had analysed the relevant environmental aspects, as the country did not want any ecological disasters twenty years down the line. The DPE once said that there was a possible leakage of highly trained and qualified skills. He asked what plan Transnet had in place to retain its employees. He noted that there was a huge backlog in investment for the railway lines. He asked if there was currently enough rail capacity to support all sectors of the South African economy, and future economic growth.

Mr Molefe replied that Transnet dredged ports as well as beaches. This was why there were white beaches in certain areas.

Mr Komotso Phihlela, Chief Executive: Ports Authority, Transnet, added that taking environmental factors into account when dredging was a matter of procedure. It was part of the project plan to seek approval from all spheres of government and all environmental factors had to be taken into account.

Mr Molefe responded to the question concerning the retention of senior managers. He said that when he arrived at Transnet, most of the senior managers were in acting positions. After two weeks, these employees were shifted around and made permanent. The Transnet executive team worked together very well and he would be surprised if anyone wanted to leave.

Mr Molefe explained that Transnet was unable to meet the current demand for freight train transport for commodities. Until the entity was able to meet current demand, from a freight logistics point of view, he was unable to see the potential that Transnet had to meet future demand. 

Mr Mark Gregg-Macdonald, Group Executive: Planning and Monitoring (Transnet), added that the planning processes for meeting future demand for freight logistics was quite sophisticated. Transnet was in the process of developing demand models that spanned over thirty years. There was a long-term infrastructure plan that was part of the demand model that flowed into Transnet’s five-year capital plan. There were significant studies underway that looked at demand for all major commodities for the next twenty or thirty years. The plan also looked what was needed to satisfy demand in the country, what part of that demand Transnet was going to satisfy and how much of the demand industry had to contribute to.

Ms Borman noted that the cost of the pipeline was R11bn but the media had reported that the cost would be doubling. She asked if this was true as this was an awful lot of money.

Mr Molefe replied that the amount of R11bn was the cost that was remaining, which still had to be spent, not what was spent on the pipeline altogether. Page 29 of the presentation gave a breakdown of the total cost [see presentation].

Ms Moira Moses, Group Executive: Capital Projects, Transnet, assured Members that Transnet did everything it could to bring in projects on schedule and within budgets. This was achieved with many of the entity’s projects. However, the pipeline was a complex project and Transnet may have under-estimated the challenges it would experience and the barriers it would encounter while trying to deliver a project of this nature. The Committee had to consider that the pipeline was essential to the lifeline of the economy and the country. Transnet had to ensure that the pipeline was reliable, built to national standards, and that it had sufficient capacity to see the country through for a number of years. The project was designed in such a way that the bulk of the infrastructure was only being put in now, so Transnet could add to the pipeline as capacity grows. The bulk of the cost was already being delivered. She hoped that the project could be delivered at a better cost than what Transnet predicted at the moment. One of the reasons that the cost increased was because the terminal had to be moved, which resulted in the pipeline being moved by 11km’s. Transnet also had to cross approximately 500 wetlands that it had not anticipated during the initial feasibility study. Transnet also had to acquire land from 900 different land owners, which took longer than they thought it would.

Mr van Dalen responded that the Committee understood that certain projects took longer than anticipated, which resulted in the escalation of costs, but the Committee had to send a message that this had to be an exception and not the rule. It seemed that this was a trend with many entities.

Mr Molefe replied that he hoped it would not happen again as Transnet was in a much better position currently. It had the expertise and the knowledge to take on any project.  

Mr van Dalen asked if there were any plans for Saldanha Bay to become an import and export hub for the country. He noted that most of the equipment and machinery at East London’s harbour were not working and this has almost brought certain exports to a halt. Transnet did not mention this in their presentation. He asked Transnet to give a breakdown of the extra money that was spent on the pipeline. 

Mr Molefe replied that there were no plans to turn Saldanha Bay into a multi-purpose harbour.

Mr Karl Socikwa, Chief Executive: Transnet Port Terminals (Transnet), added that Saldanha was a major bulk and break-bulk export port for iron ore and steel coils etc. The five-year plan was to expand the capacity of iron ore exports leaving Saldanha. Transnet was in the process of conducting internal studies to determine the possibility of exporting other bulk commodities from Saldanha. There were no plans to build a container facility at Saldanha Bay.

Mr Phihlela explained that the Member was referring to the grain elevators and silos at the East London port. As part of the export-import terminals that Transnet operated, it also operated agricultural bulk import and export terminals. This was historically used at the East London port for the import of wheat and the export of maize products. There had been significant degradation of machinery at this port over the last few years and following a concern that was raised in 2007, studies were done and the facility was told to stop operations due to critical safety issues. Funding was approved to upgrade the machinery at the facility in East London. Currently, the facility had been brought back into operation.

Ms September noted that one of the IPAP2 commitments was for localisation. She wanted to know the extent to which the information contained in the presentation made progress on this commitment.

Mr Mokoena noted that there was a time when the National Ports Authority Act needed “tinkering” in order for Transnet's operations to run more smoothly. He wondered if the Committee should have a look at the Act to ensure that this decision was carried forward. He realised that Transnet would not have the information at hand, but he wanted to know how Transnet would contribute to job creation. Transnet could tell the Committee the answer at the next meeting that was scheduled with the Committee.

Mr Molefe replied that there were certain issues regarding the National Ports Authority Act that Transnet was taking up with the DPE and the Department of Transport (DoT). The legislation said that the National Ports Authority had to be "corporatised". However, there could be instances where there was already a ports regulator and a Ports Authority. This matter needed further engagement with the relevant departments. 

Mr Molefe explained that Transnet was in the process of taking in and training artisans. They were training more artisans than needed in hopes that they would be taken in by other sectors.

The Chairperson said that Transnet could focus on this question when it reported to the Committee again.

Closing Remarks
The Chairperson thanked the DPE and Transnet for their presentations. The Committee commended them for the seriousness with which they took the meeting. It showed in the work that they did.

He congratulated Transnet executives on achieving permanent positions, but warned that the Committee should not have had to hear about the increase in the cost of the pipeline through the media. Transnet should have told the Committee beforehand.

The meeting was adjourned.