Energy recommendations 2012/13 by Financial and Fiscal Commission

Energy

20 September 2011
Chairperson: Mr S Njikelana (ANC)
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Meeting Summary

The Financial and Fiscal Commission (FFC) outlined that energy supply and charges for services were intrinsically linked with the local government fiscal framework, and the vertical division of revenue and sustainability of municipalities. It had examined the impact of electricity reform on municipalities, mainly through an inter-governmental perspective, and the effect of climate change from an intergovernmental financial perspective. It was stressed that electricity was one of the functions assigned to local government, and it was classified as a free basic service after 1994, which affected municipalities’ ability to raise revenue to pay for it, which meant that it was subsidised. Municipalities had to decide how to provide services within the budget allocated, and the reality was that only the metros were really able to cross-subsidise. The history of the proposals to introduce Regional Electricity Distributors (REDs) and the reasons why they were abandoned, were outlined. The FFC had highlighted the dangers and had proposed alternatives, including a recommendation that government should do a regulatory impact analysis to assess the causes of poor performance, before transferring that function to a sphere of government. The FFC highlighted that climate change was a threat to every economy, as it undermined development in urban areas. There was an important two-way relationship between climate change and energy. Inefficient land use, particularly the building of housing on the periphery of cities, and urban sprawl, impacted on public transport. Other problems highlighted included the maintenance and rehabilitation costs of infrastructure, and grant funding needed to be considered. Public hearings would be held in October on the local government fiscal framework.

Members noted that there needed to be a collective effort from all spheres of government including the National Energy Regulator of South Africa, sought clarity on the decline in revenue, and on the fact that the responsibility for maintenance was unclear, and asked what force the FFC’s recommendations had. They asked how densification could be encouraged, and wondered if the incorporation of local government into the intergovernmental system would have a direct bearing on what was spent on infrastructure, and asked how this could be monitored. A Member pointed out that municipalities had no incentive to encourage energy-saving if they earned their revenue from energy consumption, wondered if the legislation needed to be amended, whether the network would be audited, and suggested a Smart Grid system. They asked if funding could be sourced from elsewhere, suggesting that perhaps water, refuse and sewerage costs were too low, and considered the debt collection of municipalities. The FFC pointed out that some municipalities would always have a limited ability to recover, no matter how good their management, because of where they were situated. Some problems with Eskom were cited and the FFC proposed that perhaps a hot line for reporting of problems was needed. The recommendations from the meeting would be consolidated, and it was suggested that the FFC needed also to present to other Parliamentary Committees.

Meeting report

Financial and Fiscal Commission (FFC) recommendations on energy: 2012/13 financial year
Ms Tanya Ajam, Commissioner, Financial and Fiscal Commission, extended an apology for Mr Bongani Khumalo, Acting Chairperson of the Financial and Fiscal Commission (FFC or the Commission), who was out of the country. She noted that the Commission’s interaction with this Committee could guide the Committee’s forthcoming research strategy, and was aimed at giving a better understanding of the most important issues.

Ms Ajam noted that often there was a lack of understand of what the FFC had to do with energy. However, as would become clear from the presentation, there were in fact a number of links across sectors. For instance, the water and electricity crisis had a major impact on municipalities, and on the local government fiscal framework. The FFC was particularly interested in how water, electricity and other forms of utilities and user charges impacted on the local government fiscal framework, and on the vertical division of revenue and sustainability of municipalities. The FFC also looked at the impact of electricity reform on municipalities, mainly through an inter-governmental perspective, to see what it meant for different powers and functions across the different spheres of government. FFC also looked at issues of climate change. She pointed out that although climate change had been discussed intensively from an environmental perspective, there had been very little discussion about the intergovernmental finance perspective. The FFC, in its annual submissions, wished to stress this point. FFC recommendations also looked at the impact of inefficient land use on energy consumption and climate change. The presentation further considered conditional grants.

Ms Ajam pointed out that the FFC would make its submissions about ten months prior to the start of the financial year. It started its research 20 months before making a presentation. It therefore needed to focus on only certain topics in each year. The FFC felt that climate change was very important. The Conference of Parties (COP17) conference was being held in Durban, which served to confirm FFC’s belief that a climate change research focus would be important in future.

Mr Vincent Makinta, Programme Manager, FFC, gave a presentation on the local government fiscal framework issues. He noted that after 1994, one of the functions assigned to local government related to electricity. At that point it was classified as a free basic service. The Commission advocated that any recommendations related to water and sanitation as a free basic service might spill over to electricity. Local government was given the power to tax and receive revenue.

The Chairperson asked Mr Makinta at this point to clarify what the FFC meant by “inter-governmental fiscal relations”.

Mr Makinta explained that there were three spheres of government – national, provincial and local government. National government collected all revenue for the country. The Constitution assigned different functions to different spheres. Some functions were assigned to national government only (such as international relations) whilst other functions, such as education and health, would be handled also by the provinces. Local government provided basic services that went to households, in the form of water, sanitation and electricity.

He noted that there was a mismatch, called the fiscal imbalance, where a sphere of government might spend more than it could collect. The Constitution had prescribed a system whereby the national government collected for everybody, notwithstanding the fact that spending took place in a different sphere. This resulted in the situation where the provinces were, for instance, offering education and health, but those services did not generate revenue in themselves. The provinces therefore had to depend largely on transfers from the national departments. Municipalities and local government saw a mixture of the two systems, as they could raise revenues from municipal taxes. However, as the Constitution defined electricity as a free basic service, it was not a viable to raise revenue from everyone to pay for electricity, and therefore it had to be subsidised. The important question for municipalities was how to provide the services within the budget allocated. They needed to achieve a balance. He stressed that there was also an imbalance between the ability of some metros and poorer municipalities to raise revenues from basic services.

Mr Makinta proceeded to table the water and electricity tariffs, municipal sustainability and the local government fiscal framework (see attached presentation for full details).

The Chairperson welcomed Hon E Sogoni (ANC, Chairperson of Standing Committee on Finance) to the meeting.

Mr Tebogo Makube, Programme Manager: Fiscal Policy, FFC, then went through slides 5 to 10 (see attached presentation). He noted that in 1998 Cabinet approved the Electricity Industry Blueprint, which stated that Regional Electricity Distributors (REDs) would manage the number of electricity distributors in the country. Each municipality had electricity distribution powers granted by the Constitution. The FFC had the power, under the Constitution, to advise on the division of revenue. He noted that municipalities raised their own revenue. Electricity generally comprised about 60% of municipal revenues. The Commission felt that the creation of the six REDs would impact fiscally on the municipalities and had made a submission on electricity reform and impacts on municipalities. In that submission, the FFC had looked at different components, such as the impact on revenues and on investment. It highlighted the risk that if assets were transferred to REDs, then municipalities would not be motivated to invest in infrastructure, and suggested that the process must be clarified. Subsequent to that, government had decided not to proceed with the REDs, noting that there was a problem of infrastructural maintenance, as no investment had been made in this for several years.

The Chairperson interrupted to ask who had failed to make investment.

Mr Makube noted that no investment had been made by certain municipalities, particularly the rural and poorer municipalities. He stated that the Commission could make the relevant figures available to the Committee.

Mr Makube continued that the FFC had also looked into the issue that 50kWh per month would be made available for free. This expanded the demand side, although on the supply side, municipalities had failed to expand in capacity and had failed to make investment in infrastructure. This led to a difficult situation in many municipalities, although the metros and middle-income municipalities were generally able to cope.

The FFC had highlighted the dangers and had proposed alternatives, including a recommendation that government should do a regulatory impact analysis to assess the causes of poor performance, before transferring that function to a sphere of government. There was no clarity as to the causes of poor performance with regard to electricity distribution. The FFC had recommended a differentiated approach. Certain municipalities did provide good electricity services.

Government had agreed to ‘stall’ the process, but the current position was still not known. There were still challenges embedded in the electricity distribution industry. Mr Makube highlighted issues of access, pricing, and investment in the electricity distribution sector, as well as energy efficiency and demand-side management.

Mr Mkhululi Ncube, Programme Manager: Local Government, FFC, proceeded with the section of the presentation on climate change. He said that the first important question was how important climate change was for South Africa, and the second was whether municipalities paid attention to climate change. The FFC found that climate change was a real threat to every economy, because it undermined development in urban areas. FFC tried to quantify the impact of climate change in the local areas.

He noted that there was a very important two-way relationship between climate change and energy. Climate change had a bearing on energy, especially on the choice of energy sources, whilst consumption of energy had an impact on climate change.

Ms Ajam then dealt with the topic of how inefficient land use affected energy consumption. She pointed out that the FFC had an ongoing programme of research in rural development. It had made various recommendations on the rural issue. Her presentation focused on the urban context, looking at the link between cities, energy consumption and land use patterns.

The Chairperson noted that the FFC could provide the Committee with information also on the impact of inefficient land use in rural areas on energy consumption.

Ms Ajam placed emphasis on the importance of densification, as opposed to sprawling land use. She noted that often housing developments were built on the periphery of cities, where land was cheaper. However, this then had an effect on transport, because the further away housing was, the less viable would public transport to that area be. Government needed to pursue a more spatially compact urban form for cities. Life cycle costs of development needed to be considered carefully. It might be that land developers were being undercharged, and that they were being subsidised by ratepayers. Public transport subsidies should also target high density low-income areas. There had been a move for big cities to receive more transport-related functions.

Ms Ajam noted that the FFC would be holding public hearings in October on the local government fiscal framework. These would take place in Limpopo and Ekurhuleni.

Mr Makinta gave a brief introduction in relation to the conditional grants (see attached presentation).

Ms Ajam then presented the areas of ongoing research identified by the Commission. She highlighted the difficulties faced by municipalities in meeting maintenance and rehabilitation costs. Capital grants versus operational expenditure needed to be considered closely.

Discussion
The Chairperson asked Ms Ajam to clarify who she was referring to when she said that “we” should be considering the impact of energy policies at different levels of government.

Mr Makinta explained that policies were introduced at national level, but implementation took place at provincial and local levels. There needed to be a collective effort from all spheres of government.

Ms Ajam added that sometimes services fell through the cracks, owing to overlapping responsibilities. Part of the problem around maintenance was the need to work out who would fund what function, and who would see to performing it. It was also important to look at the impact of maintenance costs on the consumer. She cited an example of delivery protests in Thembisa, as reported in The Star. Residents wanted to pay Eskom’s electricity tariff, not the municipality’s tariff, and in this regard she said that although this had been a technical issue, it had been transferred to a very real political issue in the face of the global recession, the high unemployment, and the squeeze on disposable income. It was necessary to try to arrange the funding to cushion the adverse impact on the consumer, whilst also avoiding waste and inefficiency at municipal level.

Ms N Mathibela (ANC) asked about the decline of revenue, as well as the “cheap” rural land. She pointed out that people in the rural areas tended not to own land.

Ms Ajam apologised if she had not made herself clear about the issue of rural “cheap” land, and said that she was not trying to say that rural land was “cheap”, when compared to urban land. Whether situated in a dense urban or rural area, that land close to the centre of the settlement or town tended to be more expensive than land on the outskirts of the town. Because housing subsidies only funded the top structure, it was left to municipalities to buy the land. Metros could cross-subsidise from other revenue sources, but the poorer municipalities could not, so they tended to buy land on the outskirts of the city.

Ms Mathibela asked for clarity on the REDs, and on the fact that municipalities did not have money for maintenance, nor were they sure who should be maintaining the infrastructure.

Ms Ajam noted that there had been a gap between the vision as set out in the White Paper on Local Government and its implementation, because government was still structured in silos. The budget process was based on an outcomes-based approach. The Commission was able to stand outside the process and provide input into certain issues.

Mr S Motau (DA) asked whether the Commission had a ‘champion’ in Cabinet, and asked how much force and authority the recommendations of the FFC tended to have, and whether they were fully implemented.

Ms Ajam stated that the Commission had no “champion” in Cabinet. The FFC was created by the Constitution as an independent body that must report to Parliament. It was fully supportive of the budget review and recommendations, if only to make departments respond to what was done in terms of its recommendations. It was not appropriate for a specialist committee to enforce the FFC’s recommendations. Although the FFC had expertise in the area, its members were not elected and did not have a mandate. What the FFC should do was to try and speak in plainer language so that people were not put off by jargon. It also needed to be more active in the dissemination of its recommendations.

Mr Motau asked what could be done to encourage people to prefer densification as opposed to urban sprawl.

Mr D Ross (DA) asked whether the incorporation of local government into the intergovernmental system would have a direct bearing on funds that would be used for the rehabilitation of infrastructure. He stated that this would be a step forward in terms of funding. Hopefully a tangible difference would be seen. He noted that local government would be able to spend revenues according to what it thought the needs were. That, however, was a problem, as municipalities did not adhere to the principle that a certain percentage should be spent on infrastructure.

Ms Ajam addressed the question of why municipalities did not fund maintenance. If there were problems in the broader fiscal system, the maintenance budget was often cut. If there was a bloated municipal establishment, and salaries needed to be paid, money needed to be found to pay these. The expenditure and revenue framework of local government needed to be considered holistically. There were no clear benchmarks for maintenance. Maintenance needed to be linked to an overall active life-cycle and management plan. Government needed to build asset management capacity, as well as better monitoring capacity of maintenance. More active oversight of national departments was needed, as well as more pro-active support for maintenance. The FFC had recommended that a national maintenance strategy should be introduced with a closer link between capital expenditure, grants and operating expenditure. That needed to be coupled with better benchmarking and performance indicators. She suggested that it was not really helpful to try to legislate for this.

Mr Ross noted the comment that a concerted effort was needed by all spheres of government, and said that he thought that this should include the National Energy Regulator of South Africa (NERSA). He suggested that amendments were needed to the legislation to strengthen its role, in terms of expropriation, better licensing and expansion of its governmental structure. He asked whether there would be an audit of the network, and whether it would include the competency of municipalities to address the problems.

Ms Ajam said that the FFC had not really considered the role of NERSA in its research to date. The EDI reversal issue was still quite new. The Commission would flag this issue.

Mr Ross referred to the Eskom pricing and the surcharge charged by municipalities, saying that municipalities did not seem to implement consistently.

Ms Ajam noted that the status quo had indeed changed with regard to network audits and the competence of municipalities, and she said that South Africa needed to take stock of where it was, and what could be done, and then chart a way forward. In terms of block tariffs, she noted that, firstly, there was inadequacy of funding, where funding to municipalities for basic services was sufficient for some municipalities. It was also important to consider practical municipal systems such as metering systems, better management and so on. There were issues of capacity and competence in revenue management. The Commission would be concentrating on this area as well.

Mr L Greyling (ID) noted that the presentation was long overdue. The EDI process and the REDs process had set the country back a long way. He noted that the issue was broader than the distribution network alone, but also had to look at funding of local government, and how to create the right incentive structures. Sustainable funding for maintenance was needed, and there had to be incentives for energy efficiency. At the moment there was a perverse incentive, because although grants were available to maximise energy efficiency, electricity was the biggest revenue base of municipalities, so they tended to capitalise on the more inefficient use of energy.

Mr Greyling proposed that incentives be created for installation of Smart Grids, which allowed for two-way metering. At the moment, municipalities did not want to allow two-way metering because if people generated and sold back their own electricity to the grid, the municipalities would lose revenues. Competitive electricity pricing was another issue, as in the past, municipalities had raised most of their revenue from “cheap” electricity, and whilst, ten years ago, it may have been true that front-loading the costs would not affect people, this was no longer so. Electricity was one of the biggest competitive pricing issues for municipalities and for development as a whole.

Ms Ajam agreed that energy could not be dislocated from the overall local government fiscal framework. Government had also spoken about introducing structural changes to the system, for example, altering provinces, altering municipalities, and different tiers of municipalities. The FFC looked at the financing implications of any system. Just as the REDs had raised uncertainties, there were also uncertainties on how the new system would be structured. This issue had prompted the FFC to hold the local government hearings.

Ms Ajam said that the FFC had not really studied the apparent disjuncture between incentives towards efficiency and electricity as a source of revenue. However, she had noted the point, as well as the suggestions on the Smart Grid and competitive pricing issue. Once the FFC had more systematic and consolidated data, it would hopefully provide more informative feedback.

Mr Greyling asked how local government could get funding from elsewhere, and asked if perhaps rates on water should be increased or that more transfers should be made from national government to local government.

Mr Ncube stated that there were various problems related to revenue generation, such as debt collection, and capacity issues, and there was a need to find alternative revenue sources in the local sphere. The local government hearings would attempt to find solutions to these problems. He also said that he had noted the issue of perverse incentives. He said that one suggestion for an alternative source of revenue could be a local government tax. However, he pointed out that people in poor communities were given 50kWh of free basic electricity, but if, after using it, they were unable to pay for further electricity, then their electricity would be cut, and they would find themselves without electricity for the rest of the month.

Mr Greyling stated that electricity was cross-subsidising other services such as water, refuse removal and sewerage. Those services were probably under-priced. We suggested that perhaps the costs of those services could be increased, to try to recoup some revenue.

Ms Ajam pointed out that there had been under-pricing of water. South Africa was inherently a water-scarce country with variability in rainfall, and had to consider how to price water properly. There was much debt owed by municipalities to Water Boards, who seemed to have been cross-subsidising the municipalities. If water tariffs were increased at the same time as electricity tariffs, there would be a significant impact on households. This would also impact on households’ disposable income.

Mr Ross stated that affordability was an important issue to consider, as well as expenditure management capacity.

Mr Ncube noted that some municipalities were not spending their resources efficiently. The Commission had also looked at the issue of debt management and collection of revenues, to identify where the problems lay.

Ms Ajam noted that some municipalities did show fiscal effort, which meant that they had capacity, but the benefits of that capacity were not reaped. Fiscal capacity depended on distribution of economic activity, and there was a maximum that a municipality would ever be able to get, no matter how much resources and skills were applied. In South Africa, there was still a highly skewed spatial distribution of economic activity. The National Spatial Development Plan highlighted areas of economic growth. Although it was desirable to try to eliminate inefficiency and waste, it was a fact that certain municipalities, no matter how expert their management, would not have fiscal capacity. Demarcation would not help, as it was simply “playing musical chairs” by shifting an unsustainable area from one region to another. It was really only the metros that could be self-sustaining.

Mr Greyling asked about the FCC’s experience with the metros’ funding of maintenance of the distribution network.

Mr Makube stated that metros were doing relatively well. However, the system was under pressure because of increased urbanisation. He highlighted that electricity provision was linked to accessibility, affordability, and reliability. There were problems around affordability and reliability.

Mr Makube also addressed a suggestion that municipalities could spend 10% to 15% of their budget on electricity maintenance. Others had also proposed that there should be a once-off conditional grant. There was merit in both suggestions, but there was a need to exercise care in the final choice. An asset valuation needed to be done. It was also necessary to decide whether National Treasury, or the Regulator, should monitor the municipalities’ spending on maintenance.

Mr Makube stated that it was necessary to consider energy efficiency in households, for heating and cooking, even where there was a conditional grant structure.

Mr Ross cited an example that Eskom had sent suspension of electricity notices to people who had paid. He felt that Eskom was trying to urge communities to get the municipalities to pay for electricity in old age homes and similar structures. He also raised the problems with Eskom’s responsiveness to electricity problems, such as in Kroonstad, where the city was without electricity for about six days. The economic costs were extensive, and there was now a claim against the municipality.

Ms Ajam proposed that a phone number be made available for people to report electricity problems, which should, for instance, be advertised on community radio stations. Cell phone registration, even in rural areas, was very good, and such technology could be used as a mechanism to monitor and respond to electricity-related problems.

Mr Greyling stated that there was a complicated legal issue involving the expected return on national government’s distribution of funds to municipalities to deliver electricity services.

The Chairperson asked when the Blue Print recommendations were being made.

The Chairperson asked what the link was between the FCC’s recommendations for the post-REDs era, and the forthcoming Independent Systems Market Operators (ISMO).

Ms Ajam noted that the FFC had informally made a recommendation on the post-REDs era.

The Chairperson asked whether the FFC had taken into consideration the issue of skilled personnel, the municipalities who were experiencing problems, and capacity issues in general. The Chairperson also wanted to know why municipalities had been excluded in the past, and into what system they were now being included.

Ms Ajam also noted that performance-related grants were also one of the focus areas being considered by the FFC.

Mr Makinta added that in terms of the incorporation of local government into the system, it was noted that  national and provincial spheres of government were spending a lot. Municipalities were left to generate revenue, and to address their own poverty issues. This was done through cash transfer and subsidies.

The Chairperson asked why public hearings were not being held nationally.

Ms Ajam explained that the main reason for not holding hearings nationally was budgetary constraints.

The Chairperson asked whether South African Local Government Association (SALGA) could be involved with the public hearings.

Ms Ajam stated that SALGA was invited to hearings.

The Chairperson asked the FFC to describe who the FFC was.

Ms Ajam stated that the FFC was created in terms of Section 214 (a) to (j) of the Constitution to look at the impact of finance on development, as well as the division of revenue between different spheres of government. It presently had five Commissioners (although there were supposed to be nine). Mr Bongani Khumalo was the Acting Chairperson, and she named the remaining Commissioners. She noted that the FFC looked at the fiscal element of money flow across the spheres of government.

The Chairperson noted that the recommendations emanating from the meeting should be consolidated and a consensus reached at a later stage. He also proposed a joint session with the FFC and other Parliamentary Committees. He also stated that a deeper understanding of municipal financial systems was needed.

The meeting was adjourned.


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