Eskom Special Appropriation Bill [B16-2015] and Eskom Subordinated Loan Special Appropriation Amendment Bill [B17-2015]: public hearings

Standing Committee on Appropriations

19 June 2015
Chairperson: Mr S Mashatile (ANC)
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Meeting Summary

The Committee heard three submissions on the Eskom Special Appropriation Bill and Eskom Subordinated Loan Special Appropriation Amendment Bill.

The Council for Scientific and Industrial Research (CSIR) presentation set out the state of South Africa's renewable energy sector, and its contributions to the power supply in 2014. The CSIR's analysis indicated that the cost per kilowatt-hour of solar- and wind-generated electricity produced by independent power producers had decreased over the last four years to the point that it was now cheaper than coal and gas new-build options. The supply of energy from renewables had ramped up in 2014, from 48 megawatts (MW) in January to 343 MW in December, representing about two percent of the total electricity demand. As the year progressed, renewable supply began to take over the burden carried by the expensive diesel-fuelled open-cycle gas turbines, resulting in a net benefit of R0.8 billion to the economy. The cost of producing electricity for Eskom's current fleet of power plants was about 62c/kWh, of which 44c was the cost of generation, 7c transmission, 8c distribution and 3c customer service and other costs. No new-build option would be able to match this cost, as a matter of mathematical fact, which meant that a tariff increase was simply unavoidable, but he projected that this would not increase indefinitely and would probably stabilise at around R1.10/kWh in real terms. The outlook for renewables was bright and was likely to exceed the 2030 projections, with 40% being considered realistic. CSIR warned that investment into transmission infrastructure should not be overlooked, as it was vital for ensuring that new generating capacity was connected to the grid. Committee members asked for clarity on why new-build options were more expensive per kWh than existing options, and heard that the main reason was that the new-build costs incorporated capital expenditure. Members also asked whether renewable sources had any distinct advantages when it came to supplying outlying and/or mountainous areas with power, and Members discussed the long-term outlook for renewable energy. They asked how many wind farms were operating that were not connected to the grid, whether private investment into renewable energy was being encouraged and asked about the lifespan and maintenance costs of renewable energy infrastructure. Members asked if there were lessons to be learnt from elsewhere and the presenters suggested that it would be useful for South Africa to look to socio-economic peers, like Brazil and China, and USA Europe and Japan. who had driven renewables in the past.

The Energy Research Centre, University of Cape Town, described the background to the setting of electricity tariffs in South Africa, and how they were regulated. Eskom and local government were the only bodies licensed to supply electricity to consumers and they were authorised to set prices that covered the costs of their operation. The National Energy Regulator of South Africa had been established as independent regulator to set tariffs, but from around 2008/09, the tariffs set bore almost no relation to the tariffs that Eskom requested to cover its costs, and the Centre drew attention to some serious unintended consequences of these tariffs and appropriations. The appropriations undermined the independent regulatory framework that the country had established, and had the unintended result of benefitting not the poor, but the energy-intensive sectors of  industry, who consumed an estimated 70% of total supply, giving them in effect a non-transparent, “out-of-policy” subsidy to the energy-intensive sector of the economy, paid from taxes. It was recognised that at this point government really had no option other than to have these Bills approved, but there was serious concern that the Eskom Subordinated Loan Special Appropriations Act of 2008 was not being adhered to. Members discussed  the adequacy of the R23 billion to be appropriated according to the Special Appropriation Bill and the history of state subsidies to Eskom. One Member said it was imperative that mechanisms of oversight were put in place to ensure the R23 billion was wisely spent, and that it was important in general for taxpayers to know about conditions on loans and cash injections.

A joint submission was then made by the CPUT Energy Institute and Econometrix. They noted that many of Eskom's operational decisions in the last few years had been politically, rather than financially motivated, citing the delay in the building of new power stations in the early 2000s, which had led to a loss of skills after the completion of the Majuba power station. The provision of free basic electricity had resulted in a culture of non-payment and was seen as unfair by those who had no electricity at all. The below-cost tariffs of the past were now being offset by steep tariff increases. The fact that the renewable energy programme was run by the Department of Energy, not Eskom, had led to delays in bringing renewable energy onto the grid. Large volumes of coal were being purchased from small, black-owned coal mines, sometimes at more than three times the normal price per tonne for a sometimes inferior product and whilst the reasons were understood, it still made for an expensive option. Ballooning debt from municipalities also had to be taken into account. It was suggested that the current crisis could present an opportunity to implement some form of financial restructuring of Eskom to make oversight easier. The submission then set out a proposal for restructuring that would split Eskom's three principal operating areas (generation, transmission and distribution) between three separate organisations: an electricity supply company (Esco, generating power in open competition with other suppliers), an electricity transmission commission (Etcom, a national resource with a monopoly in its market) and an electricity distribution company (Edco, distributing power in competition with other distributors). Esco and Edco would be expected to return a profit, like any company, while Etcom would be a cost-plus operation, rather similar to the way national roads are funded.

Members of the Committee explained that some of the political decisions referred to in the presentation had been publicly recognised as mistakes. Others, however, were a matter of state policy, such as the sourcing of coal from emerging coal mines, and had to be adhered to even if they had unintended consequences. The presenters agreed, and said that the problem was mainly one of accounting. Members also requested more details and the full report on an analysis that predicted heavy losses to the economy resulting from commitment to renewable energy. The Chairperson indicated that restructuring the electricity supply industry dealt with broader energy policy, rather than the matter of the two appropriations Bills, but he appreciated that the presentation looked toward the future. The Committee asked whether any research had been done into the consequences of restructuring the power industry in the manner proposed. Members asked if South Africa was training enough engineers to fill the skills gap and alluded to systemic racism against black people in higher education engineering programmes. The presenters clarified that they were not suggesting that Eskom be privatised, in whole or in part, but were rather suggesting a public-private partnership, and Members asked for further details and a copy of the full report from which the statistics and information were gleaned.

Meeting report

Eskom Special Appropriation Bill and Eskom Subordinated Loan Special Appropriation Amendment Bill: Public hearings
Council for Scientific and Industrial Research (CSIR) submission

Dr Tobias Bischof-Niemz, Chief Engineer, Council for Scientific and Industrial Research (CSIR) Energy Centre, presented the submission on behalf of this Council. His presentation began with a long-term view of the electricity sector in South  Africa, and followed this with a consideration of electricity tariffs and the cost of new building, before looking at some issues specific to Eskom.

The CSIR's analysis indicated that the cost per kilowatt-hour (kWh) of solar- and wind-generated electricity produced by independent power producers (IPPs) had decreased over the last four years, to the point that it was now cheaper than coal and gas new-build options. The decrease was especially dramatic in the case of solar (photovoltaic) electricity, which had decreased by a factor of three. This decrease was steeper than had been forecast, and in 2014 this cost was even less than the lowest prediction of the 2010 Integrated Resource Plan (IRP). Similarly low costs had been observed for wind power. These figures would be fed back into the model used to make cost predictions. The cost of renewables in 2014 was now comparable with conventional new-build options (coal, nuclear and gas).

Dr Bischof-Niemz illustrated the ramping up of supply from renewables in 2014, from 48 megawatts (MW) in January to 343 MW in December, representing about 2% of the total electricity demand. As the year progressed, renewable supply began to take over the burden carried by the expensive diesel-fuelled open-cycle gas turbines (OCGTs). In general, the supply of electricity from solar and wind plants could have three effects on the electricity system in the short term. These were discussed in order of increasing value. First, in periods of low demand it could carry some of the generating load of coal-fuelled plants, saving coal. Second, in periods of high demand it could replace expensive diesel-fuelled open-cycle gas turbines (OCGTs). Third, in periods when the demand exceeded the supply available from conventional sources, it could prevent load-shedding. Dr Bischof-Niemz illustrated each of these three cases with actual examples of days in 2014. The CSIR's analysis indicated that renewables had saved R0.4 billion in coal, R3.3 billion in diesel, and R1.7 billion in avoided load-shedding. Subtracting R4.5 billion in tariffs to renewable energy suppliers resulted in a net benefit of R0.8 billion to the economy in 2014. Taking into account that these tariffs were effectively at the 2011 level, the future for renewables looked attractive.

Dr Bischof-Niemz indicated that the cost of producing electricity for Eskom's current fleet of power plants was about 62c/kWh, of which 44c was the cost of generation, 7c transmission, 8c distribution and 3c customer service and other costs. No new-build option would be able to match this cost, as a matter of mathematical fact, which meant that a tariff increase was simply unavoidable. However, it would not increase indefinitely, and would probably stabilise at around R1.10/kWh in real terms.

Turning to the Bills before the Committee, Dr Bischof-Niemz said that although the costs of the expansion of the renewables programmes would be recovered, the primary purpose of the money to be appropriated according to the current Bills was to help maintain Eskom's liquidity in the meantime, while allowing the tariff increase to be slower than it would otherwise have to be. Dr Bischof-Niemz warned that investment into transmission infrastructure should not be overlooked, as it was vital for ensuring that new generating capacity was connected to the grid.

Discussion
Ms E Van Lingen (DA, Eastern Cape, Select Committee Member) asked how many wind farms were operating but were not connected to the national grid. She was concerned because Eskom paid for this electricity.

Dr Bischof-Niemz said he did not have exact figures with him, but he could say that “deemed energy payments” (payments made to IPPs when the grid had not reached them by an agreed-upon date) were relatively small and only had to be paid for short periods. In many cases, the agreed grid connection date was several years away, so although the electricity was not being added to the grid, at least it was not being paid for. Grid connection took a long time, especially for wind farms, which were often located in remote areas.

Ms R Nyalungu (ANC) asked why new-build options were necessarily more expensive per kWh than existing options, and whether this was because they were more technologically advanced?

Dr Bischof-Niemz explained that the main reason was that the new-build costs incorporated capital expenditure. A second reason was that coal would probably not be as cheap as it had been. He also pointed out that the new-build costs were in line with global trends and, in the cases of solar and wind power, even lower because of South Africa's natural resources.

Mr M Figg (DA) asked whether private investment into renewable energy was being encouraged.

Dr Bischof-Niemz explained that the capital costs of renewables in South Africa were carried by the private sector. The government gave a twenty-year guarantee to buy the power at a certain tariff.

Mr Figg asked how the lifespan and maintenance costs of renewable energy infrastructure (wind turbines, photovoltaic cells and others) compared to those for conventional options.

Dr Bischof-Niemz explained that maintenance costs were roughly equal. The lifespan of a photovoltaic power plant was difficult to estimate, because the technology was relatively new, but there were plants that had been running for thirty years without problems. A wind turbine would probably need a major service after twenty years.

Mr Figg asked whether renewable sources had any distinct advantages when it came to supplying outlying areas with power.

Mr N Gcwabaza (ANC) also asked whether they had any distinct advantages when it came to supplying mountainous areas.

Dr Bischof-Niemz said that setting up “microgrids” to serve relatively remote and/or mountainous areas had an important short-term benefit, because extending the main grid was a slow process. But in the long term, connecting the whole country to the main grid was preferable.

Mr Figg asked whether renewable energy could be expected to return a profit from year one.

Dr Bischof-Niemz said that renewable energy had returned a profit in 2014, as he had shown, and said that even greater profits could be expected in the future. He did admit that the benefits were largely a result of the fact that renewables had been replacing gas turbines. In an unconstrained power grid, renewables would not have returned a net gain.

Mr Gcwabaza noted with concern the high cost of gas turbines implied by the graph on page 7 of the presentation.

Dr Bischof-Niemz clarified that this graph did not take into account the volume of power supplied by different sources. Although gas turbines were ten times as expensive to run as coal-fuelled power plants, they only accounted for, at most, 1.5%  of total production. He also pointed out that running the gas turbines was less expensive in the end than the alternative, which was load-shedding.

Mr Gcwabaza asked whether the costs per kWh of existing and new-build power plants included maintenance costs.

Dr Bischof-Niemz confirmed that they did.

Mr C De Beer (ANC, Northern Cape, Chairperson of Select Committee on Appropriations) wondered whether there were any other countries that had experienced similar challenges, from which South Africa could learn.

Dr Bischof-Niemz suggested South Africa could look to its socio-economic peers, like Brazil and China. It could also look at countries that had driven renewables in the past, such as the United States of America, countries in Europe and Japan. Data from other countries had to be normalised to account for the different availability of wind and sunlight.

Mr A McLaughlin (DA) asked for a projection on the percentage of South Africa's electricity that could be supplied from solar and wind sources in the short term.

Dr Bischof-Niemz said that 40% by 2030 was realistic, economically and technically, although this would require a significant commitment to renewables. The 2010 IRP planned for 14% renewables by 2030.

University of Cape Town (UCT) Energy Research Centre Presentation
Mr Hilton Trollip, Senior Researcher: Energy Research Centre, University of Cape Town, began by commending Dr Bischof-Niemz for the clarity of his presentation. He said his presentation would try and look at the R83 billion appropriated in accord with the two Bills under consideration, and how it related to the technical issues that Dr Bischof-Niemz had discussed.

He began by describing the background to the setting of electricity tariffs in South Africa, and how they were regulated. Eskom and local government were the only bodies licensed to supply electricity to consumers, and they were authorised to set prices that covered the costs of their operation. In recognition of the fact that this freedom could lead to unfair prices, an independent regulator, the National Energy Regulator of South Africa (NERSA) had been established to set tariffs. Starting in about 2008-09, the tariffs that were set by NERSA bore almost no relation to the tariffs that Eskom requested and needed to cover its costs. In other words, the process of setting tariffs had become disorganised. The current crisis had arisen because the tariffs set by NERSA had been too low, with the result that Eskom had been unable to cover its costs and had been brought to the brink of bankruptcy. The amount of R83 billion had to be seen in the context of Eskom's total revenue, which came to R136 billion last year. It was also greater than the entire budget for primary healthcare, at R77 billion. The system for regulating tariffs simply was not working.

Mr Trollip admitted that the appropriations had been well motivated by National Treasury and that Eskom faced bankruptcy without them. However, he did draw attention to some serious unintended consequences of the appropriations and the low, non-cost-reflective tariffs that had necessitated them. First, the appropriations undermined the independent regulatory framework that the country had established. Second, it was in fact not the poor who were the chief beneficiaries of low tariffs, as was sometimes claimed in their defence, but actually the energy-intensive sectors of industry, who consumed an estimated 70% of total supply. The result was that the appropriations effectively constituted a non-transparent, “out-of-policy” subsidy to the energy-intensive sector of the economy, paid from taxes.

Mr Trollip recognised that, at this point, government had no option but to approve the Bills, but he thought that some very hard choices had to be faced, particularly regarding NERSA. It needed to recommit to setting cost-reflective tariffs if the current situation was not to become the norm and de facto policy. A signal had to be sent to energy-intensive industry that South Africa would no longer offer the effective subsidy resulting from below-cost-reflective tariffs, and the cost of the effective subsidy needed to be recovered. If necessary, further mechanisms to protect the poor needed to be put in place.

Finally, Mr Trollip drew attention to a matter that had been raised by Mr McLaughlin in an earlier meeting. The Eskom Subordinated Loan Special Appropriations Act of 2008 required that the loan agreement (for the R60 billion contemplated in that Act) must provide for repayment of the loan over thirty years at a market-related interest charge. According to a presentation by National Treasury and Eskom on 10 June 2015, Eskom was not paying interest on the loan and that the loan would have no direct cash flow impact on either Eskom or government. It seemed to him that the fact that no interest was being paid must be having an impact on government's cash flow. It seemed that R30 billion was being created from nothing. He was concerned that the law was not being adhered to.

Discussion
Mr Figg expressed his agreement with the bulk of Mr Trollip's submission. He suggested that the revenue shortfall resulting from below-cost-reflective tariffs might not be the only reason for the current crisis. He suggested that poor management had had a role as well. He calculated that Eskom still had R27 billion after costs (but before interest payable on loans).

Mr Trollip said it would not be possible to really get to grips with Eskom's costs in a Parliamentary Committee meeting, but he agreed in principle that Eskom's costs needed to be interrogated.

Mr Figg wondered whether the R23 billion contemplated in the Eskom Special Appropriation Bill [B16-2015] would actually be adequate, given that Eskom appeared to require R55 billion. Eskom claimed that it had other sources to bring the amount up to R55 billion, but he worried that Eskom would come back and ask for more money.

Mr Trollip said that Eskom would use the cash injection to improve its borrowing ability.

Mr Figg pointed out that this R23 billion was equity (paid for from the sale of non-strategic state assets, about which the Committee had been given very little information), but that Eskom had not paid dividends for a long time and did not foresee dividend payments in the near future.

Mr McLaughlin asked what other ways to fund Eskom might be found.

Mr de Beer agreed with Mr Trollip that the degeneration of state-owned enterprises and their regulatory environment had to be halted, but he questioned Mr Trollip's contention that there was a systemic problem emerging. This, he said, would imply a coordinated attempt to collapse the system, which he did not believe existed.

Mr Trollip explained that he was not suggesting there was some nefarious “third force” trying to destabilise the system, he was simply concerned that the law was not being adhered to, and that Eskom might have used excessive legal force to get its way.

Mr Gcwabaza said that his interpretation of Mr Trollip's description was that the problem was not at the level of policy framework but rather at the level of governance  and implementation.

Mr Trollip agreed. He did believe the system of state-owned enterprises with economic regulators could work, but there needed to be commitment, otherwise there was a risk of suffering the worst aspects of all systems.

On the question of below-cost-reflective tariffs, Mr Gcwabaza suggested that before 1994, government subsidies had perhaps been affordable, and that it was only now,with Eskom's enlarged electricity supply mandate to supply electricity to the entire population, that subsidies had become problematic.

Mr Trollip said that he had seen this view reported in the news, but not backed up by facts. There had of course been a massive effective subsidy, because the government had not undertaken to supply the entire population, but it had never been government policy to appropriate money for electricity supply. Tariffs had always cost-reflective. This was a new development.

Ms S Nkomo (ANC) said that it was imperative that mechanisms of oversight were put in place to ensure the R23 billion was wisely spent. She also said it was important in general for taxpayers to know about conditions on loans and cash injections.

Joint Presentation by Cape Peninsula University of Technology (CPUT) and Econometrix
Prof Philip Lloyd, Programme Director, CPUT Energy Institute, began by underscoring the importance of electricity to the South African economy. He said that many of Eskom's operational decisions in the last few years had been politically, rather than financially motivated. The current crisis was perhaps the opportunity to implement some form of financial restructuring of Eskom, to make it easier to see where the money was going. Mr Lloyd estimated that the cost to the economy of electricity demanded but not supplied was about R85/kWh. Coping with population growth alone would require an increase of 500MW of base-load capacity per year. The fact that the country's energy intensity was decreasing was misleading, and simply a result of the stagnating electricity supply. It did not mean that the country did not need more electricity.

Mr Rob Jeffrey, Managing Director, Econometrix, said that another reason for the declining South African energy intensity was that the service sector of the economy had grown at the expense of the industrial sector. As an industrialising economy, South Africa needed a greater output from mining, manufacturing and agro-processing.

Prof Lloyd gave some examples of political decisions that had effected Eskom's growth, and described their consequences. There was the delay in the building of new power stations in the early 2000s. This had led to a loss of skills in the interim after the completion of the Majuba power station. The provision of free basic electricity had resulted in a culture of non-payment and was seen as unfair by those who had no electricity at all. The below-cost tariffs of the past were now being matched by steep tariff increases. The fact that the renewable energy programme was run by the Department of Energy, not Eskom, had led to delays in bringing renewable energy onto the grid. Large volumes of coal were being purchased from small, black-owned coal mines, that were sometimes paid more than three times the normal price per ton for a sometimes inferior product. He understood the reasons for this last decision, but said that it was very expensive nevertheless. There was also the ballooning debt from municipalities.

Mr Jeffrey's analysis had shown that the cost to the economy of renewable energy, if it was vigorously pursued as a policy, would total R300 billion by 2030, along with 1.5 million jobs. The short-term benefits (as described by Dr Bischof-Niemz) of renewable energy were a result of the constrained power grid. If the impact on fixed investment of various policies were added, the total impact on gross domestic product (GDP) would be R800 billion along with 4 million jobs.

Prof Lloyd said that the size of Eskom had in the past given it a nominal cash flow that had allowed it very favourable borrowing allowances, that the present crisis was now affecting negatively. Its organisational structure had also masked its operational costs. There had been attempts at restructuring, such as the stalled Independent Systems and Market Operator Bill.

He then presented a proposed restructuring of the electricity supply industry that would split Eskom's three principal operating areas (generation, transmission and distribution) between three separate organisations. These would be an electricity supply company (Esco, generating power in open competition with other suppliers), an electricity transmission commission (Etcom, a national resource with a monopoly in its market) and an electricity distribution company (Edco, distributing power in competition with other distributors). Esco and Edco would be expected to return a profit, like any company, while Etcom would be a cost-plus operation, rather similar to the way national roads were funded. NERSA would then regulate the cost of generation, transmission and distribution separately. This restructuring would improve the state oversight of the industry.

Discussion
The Chairperson indicated that some of the matters raised in the presentation dealt with broader energy policy, rather than the matter immediately at hand, which was the consideration of the two appropriation Bills, but he appreciated that the presentation looked toward the future.

Mr de Beer asked whether any research had been done into the consequences of restructuring the power industry in the manner proposed.
Prof Lloyd said it had. In particular, researchers had looked at the restructuring experiment that was taking place in Germany.

Mr de Beer pointed out that some of the political decisions referred to in the presentation had been publicly recognised as mistakes. Others, however, were a matter of state policy, such as the sourcing of coal from emerging coal mines, and had to be adhered to even if they had unintended consequences.

Ms Nkomo asked what might be done to address these unintended consequences.

Prof Lloyd agreed that there were good reasons for the political decision on the sourcing of coal, but said that it had not been properly accounted for by Eskom.

Ms Nkomo asked, in relation to the loss of skills resulting from construction delays, whether South Africa was training engineers to fill the skills gap. She also alluded to systemic racism against black people in higher education engineering programmes.

Prof Lloyd said that there were roughly 15 000 engineers in the appropriate fields in South Africa, with a further 4 000 in training. He suggested that there was an historical problem in schooling that meant black students maybe came to university with weaker education, but it was, in his opinion, beyond the responsibility of the present committee to deal with this.

Ms Nkomo asked whether Esco, Etcom and Edco were existing companies.

Prof. Lloyd explained that they were not, but the proposal to form them in this way was based on global trends. In particular, he stressed that nowhere in the world had an electricity transmission company been formed.

Mr Jeffrey clarified that the presenters were not suggesting that Eskom be privatised, in whole or in part. They were suggesting a public-private partnership.

Mr Figg asked where Mr Jeffrey's figures on the cost of renewables and other policies came from.

Mr Jeffrey explained that he could not go into the finer details here, but said that a full report was available.

Mr Figg asked for the Committee to be provided with the report.

The Chairperson thanked the presenters for their submissions. He said a report would be drafted for the Committee's consideration on Tuesday 23 June, at10am. He reminded the Committee that the Bills would be debated in the National Assembly on Wednesday 24 June.

Mr McLaughlin asked whether the Bills would be debated separately or together.

Mr Gcwabaza said that he thought there would be one debate.

The meeting was adjourned.
 

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