Department of Energy + Central Energy Fund 2016/17 Annual Report, with Auditor-General input

Meeting report

Department of Energy (DoE): AGSA audit outcomes overview

Ms Margaret Phiri, Senior Manager: AGSA, said the Department had experienced regression due to the R98 million irregular expenditure on the 2016/17 audit outcomes. There had been an improvement of 47% in entities, and some like the National Energy Regulator of South Africa (NERSA), National Nuclear Regulator (NNR), PetroSA Ghana, and the South African National Energy Development Institute (SANEDI) had maintained a 40% performance. Concerning the quality of financial statements, annual performance reports and compliance, she said the Department needed to improve on its performance information and compliance with legislation. There had been material findings on the usefulness of its annual performance reports.

The Department had received a qualified opinion with a finding. Entities like SANEDI, PetroSa Ghana, Radioisotopes, and Gammatec had recorded an unqualified outcome with no findings, while other entities like the Central Energy Fund (CEF), the Equalisation Fund (EQF), the Strategic Fuel Fund (SFF), PetroSA, and the Nuclear Energy Corporation of South Africa (NECSA), registered an unqualified opinion with findings. The Electricity Distribution Industry (EDI) audit remained outstanding since the 2013/14 financial year. There was a cabinet decision to close the entity and an administrator was appointed in this regard. AGSA was informed the annual financial statements would be prepared and submitted for audit, as the liquidation process had recently been finalised.

Ms Phiri reported 83% of occurrences on irregular expenditure were caused by non-compliance with supply chain management (SCM) legislation. There was non-compliance with legislation on contract management. The Department was the highest contributor to irregular expenditure and was followed by PetroSA, the National Radioactive Waste Disposal Institute (NRWDI) and NERSA, respectively. 100% of occurrences on unauthorised expenditure were caused by overspending of the budget. The Department was the highest contributor. It overspent by R35.7 million due to compensation of employees and issues related to overtime payments.

There had been a slight improvement in fruitless and wasteful expenditure. Litigation and claims payments caused 95% of fruitless and wasteful expenditure. PetroSA was the highest contributor with a figure of R16 023 000. The Department and entities had recorded improvements on compliance with legislation and poor quality of financial statements. It was noted the SFF did not inform National Treasury of its participation in a significant partnership arrangement relating to the procurement and sale of crude oil, as required by Section 54 2(b) of the Public Finance Management Act (PFMA).

The most common findings on SCM were around three written quotations not obtained and deviation not justifiable; awards to service providers who were close family members/partners/associates of persons in the service of auditee; procurement from suppliers without SA Revenue Service (SARS) tax clearance; and contracts amended or extended without approval by a delegated official.

The Department and entities had remained good in maintaining internal controls, except PetroSA, which was of a concern. AGSA further reported the management of the Department and entities did not respond with the required urgency to its messages about addressing risks and improving internal controls. There was a lack of consequences for poor performance and transgressions.

She said AGSA had recommended that the Committee should request management to provide feedback regarding the progress made on the implementation of the action plans to address poor audit outcomes during quarterly reporting. It must request quarterly feedback on the progress of filling vacancies at the Department and CEF Group, and a list of action taken against transgressors must be provided quarterly for follow up on all irregular and fruitless and wasteful expenditure incurred.

She said AGSA had met the Minister and had expressed concerns about disagreements they had had regarding the outcomes. The Minister had promised to respond to the findings of the AG. AGSA was happy with the audit report. The Department had engaged with AGSA and provided additional information, but nothing had changed the results of the audit.

Central Energy Fund (CEF): Annual Report 2016-17

Mr Godfrey Moagi, Acting Chief Executive Officer (CEO): CEF, reported that during 2016/17 there were a number of activities that had occupied the board’s and management’s time in relation to the overall management of the CEF Group. These related to both internal and external elements critical for the long term sustainability of the group. He said they were envisaging there would be no retrenchments, and they planned to move PetroSA out of the “intensive care unit”(ICU).

The African Exploration Mining and Finance Corporation (AEMFC) and SFF reported zero disabling injuries and environmental incidents. PetroSA had two fatalities, plus a total of 17 disabling injuries and five environmental incidents. The Black Economic Empowerment (BEE) spend had been improved through better focus and coordination. The CEF Group had 1 976 employees, with 29% being women. R44 million had been invested in youth development, including sponsorship. All the subsidiaries of the CEF Group had received unqualified audit opinions.

Regarding transformation initiatives and corporate social investment, PetroSA had upgraded 21 Early Childhood Development (ECD) centres in Mossel Bay and surrounding areas. The total investment was R1.5 million. The programme included purchasing educational material, playground equipment, security upgrades and infrastructure of the centres. The SFF investment in the National Multi Product Pipeline (NMPP) line fill had protected consumers from possible fuel price inflation, as the oil industry would have recovered such from the consumer if the SFF had not invested the R1.2 billion. Support had been provided to the creation of black industrialists in the oil and gas sector’s PetroSA through the Department of Trade and Industry.

Mr Moagi said the CEF was in search of appropriate energy solutions to meet the future energy needs of South Africa, the Southern African Development Community (SADC) and the sub-Saharan region, including oil, gas, electrical power, solar energy, low-smoke fuels, biomass, wind and renewable energy sources. The key drivers were around developmental objectives, commercial viability, governance, and a collaborative operating environment.

He touched on the CEF’s operating environment during 2016/17. It had been characterised by a number of key dynamics from a global, local, internal, external, strategic and operational perspective which all influenced their business activities and was best elucidated through the energy sector value chain. The CEF Group operated in a dynamic, capital intensive, competitive, dollar based and price sensitive industry that was dominated by multinationals. There were some trends they had witnessed during the 2016/17 period. For example, transport fuel was likely to be replaced by electricity and gas. Biofuels had the potential to play a meaningful role in the transportation fuel market. However, its implementation in SA had been slower than anticipated. The electricity demand had decreased significantly due to the slow economic growth. The development of a new build electricity infrastructure would be slow in the short term and may pick up after 2019.

On managing stakeholder expectations, he said that during 2016/17 they had made the best efforts to contact as many people and organisations as possible, especially those that affect and were affected by their decisions. The entities were consulted on a number of issues and projects ranging from strategic, operational and governance related matters. The CEF believed a structured stakeholder relationship served to strengthen the resilience of the company and its ability to adapt to the increasing demands placed on them amid the uncertainty of the current business environment.

Mr Moagi took the Committee through the 2016/17 comprehensive income statement. The group had made an after tax net loss of R599.5 million. The performance had been adversely affected by the collapse in the gross profit margin, which had decreased from 22% to 5%. For the first time in the history of the group, PetroSA had reported a gross loss of R475 million. The decrease in gross profit by 77% was due to the changes in the operating model for the refinery which was necessitated by the declining gas reserves. The new model had partially converted a gas to liquid refinery into a condensate processing refinery. This change had had a negative impact on the gross profit margins because the cost of the new feedstock was higher than the cost of the indigenous gas.

The operating expenses had decreased from R5.4 billion to R1.8 billion. The decrease in costs was due to the once-off transfer of R2.1 billion to the state which was recorded in the 2015/16 financial year. The group revenue had been declining since 2015, but during 2016 it was high due to the rotation of strategic stock. The decrease in revenue was due to the lower production of petroleum products as a result of declining reserves. The revenue was expected to stabilise when the conversion of the refinery had been completed.

The group’s assets decreased by R3 billion, from R36 billion to R33 billion. The decrease in assets was due to the decrease in property, plant, equipment and current assets. The liabilities of the group decreased from R21 billion to R19 billion. This was due to the rehabilitation provision and repayment of the reserve-based lending. The group had further generated a R1.2 billion cash flow from operating activities when compared to the R7.5 billion of the previous year. The decrease in cash from operating activities was due to the deteriorating gross profit. The group’s cash balances had remained more or less constant compared to prior years.

Mr Moagi concluded that despite the various strategic challenges the CEF Group faced, it remained a going concern and that meant the group would continue to operate in the foreseeable future. The assertion of a going concern was premised on the fact that the group gearing ratio was low and the assets of the group exceeded liabilities by R14 billion. The bulk of their assets comprised cash of R15 billion which was available for use in furthering their mandate. He indicated they were confident the planned review of the group operating model would yield positive results and take the CEF Group to new heights.

Discussion

AGSA Presentation

Mr G Mackay (DA) asked why the Department was denying irregular expenditure, whereas the AG had said it was irregular expenditure. He also wanted to know who was responsible for the irregular expenditure.

Ms Phiri replied that AGSA had had engagements with the Department and the audit committee of the Department. It was only the management of the Department that could provide an answer. She said the accounting officer or Director General was the one responsible for identifying transgressions, looking at the information, and taking action. The Minister had not been happy with AGSA's opinion and would like to do an independent review on the work done by the auditors.

Ms Z Faku (ANC) asked for clarity on the irregular expenditure by NERSA, and asked why money was not approved by the Minister. She also wanted clarity on PetroSA's irregular expenditure.
Ms Phiri, on NERSA, said those who were at NERSA were not sure whether the approval was the responsibility of the Minister. She would send a written response to the Committee. Regarding PetroSA, she indicated the entity had got its own SCM policies. If the AG during the audit discovered it did not follow its own policies, then that was regarded as irregular expenditure. Its policy had to be aligned to Treasury regulations.

Mr R Mavunda (ANC) asked for clarity on the R98 million in irregular expenditure, and wanted to know if the disagreement with the Department was the reason for not including the irregular expenditure in the AG's report. On SCM, he wanted to know if it was assumptions or real facts that were contained in the report. He asked why accounting officers had been given performance bonuses, yet they had not performed.

Ms Phiri said the irregular expenditure had been the basis of the qualification. The Department had not wanted to disclose it. On assumptions and real facts, she said that these were real findings. If the Departments or entities did not provide satisfactory budget expenditures that were in line with Treasury regulations, that would be classified as non-compliance with Treasury regulations. Concerning performance bonuses, she explained this area was audited in detail, making sure performance agreements were in place. In terms of the work done, the audit did not identify areas related to the performance bonus payments.

Mr Mackay asked for clarity on the information technology (IT) contracts between the Free State province and the Department regarding the procurement system for nuclear. He also asked for clarity on AGSA's engagement with the Department. He wanted to know why there had been under-spending on clean energy and overspending by R35 million on the administration programme. Who was responsible for the irregular expenditure of R24 million on the IT contracts? Was the Department prepared to pay up for the remainder?

Ms Phiri said AGSA had they asked the IT team to analyse the terms of reference for the two IT contracts to ensure they were not the same. When the AGSA had concluded the opinion, the other concerns were around the price and specifications. They were not the same. The Free State wanted to do work in phases at a total cost of R171 million, but the Department wanted to do it at one go instead of phases for the very same price of R171m.

Ms Sibongile Lubambo, Corporate Executive: AGSA, referred to AGSA’s engagements with the Department, and said their first engagement was with the CFO and audit committee in July 2017. The feedback was given to the Director General and senior management. AGSA received confirmation from the Department that it was agreeing with the AG findings. Later, the Department told AGSA the management was disagreeing with them regarding the irregular expenditure and contracts. AGSA then had to withdraw its statements. AGSA then had a meeting with the Department regarding the IT contract to inform it the specifications were not the same. AGSA had another meeting with the Department to inform it of its opinion. The Department had not changed its stance regarding irregular expenditure. She added that AGSA had a risk unit and a quality control unit which were responsible for concerns raised by the Department. These units had identified no gaps in the report submitted to the Department.

On underspending on clean energy, she said the Department had disclosed the details for underspending. Concerning overspending on the administration programme, this was due to the compensation of employees. Pertaining to the R24 million in irregular expenditure, the accounting officer had to account if he/she did not identify the person responsible for the wrong actions. The Department should be asked if the R24 million had been paid. AGSA only monitored the investigations when it did the audit, and it reports on actions the Department has taken.

The Chairperson wanted to know if the report was going to change on the basis of the concerns of the Minister, if the report was final. This needed to be clarified before the Committee engaged with the Department. The Committee was going to engage with the Department on the basis of the report from the AG. He informed the acting Director General that when the Committee interacts with the Department, he must come with the answers to the concerns raised by Members which AGSA could not answer.

Mr Mackay wanted clarity on specifications provided by the IT operations specialists on the procurement system for nuclear.

Mr Pule Luvhimbi, Senior Manager: AGSA, said there were terms of reference as annexures to both contracts. The terms of reference for the Department were for project management: planning to deliver at a higher level. The Free State had its own concerns that were different from those of the Department. The Free State wanted their system to be able to interface with the Construction Industry Development Board (CIDB) only, and the Department had to have any other, e.g. SARS or the CIDB. The Free State wanted the system to be hosted on the cloud, while the Department wanted a physical structure. This meant different architectural infrastructure. The cloud one required more procurement. The Free State was paid R61 million because it did not complete the other phases, whereas the Department had done the work in one go and was paid R171 million. The Free State had other concerns, because it indicated there were additional funds that were needed because the project was going to be hosted on the cloud.

The Chairperson wanted clarity on procurement and sale of crude oil between the SFF and the Nigerian company.

Mr Luvhimbi said it was a kind of partnership agreement with a Nigerian oil company. More details would be forwarded to the Committee in writing.Central Energy Fund (CEF)

Mr Mackay remarked that the SFF had signed a partnership agreement with a Nigerian company for exploration and acquisition. The entity was signing agreements by itself which no one knew about. The relationship between the SFF and the CEF Group was strange. He commented the group was a going concern, not PetroSA, because it brought 70% of the revenue to the group. And there had been no explanation for the shortfall. He said that the Board of PetroSA might be removed, but no one knew when that would happen because there were still pending court cases. The Committee was dealing with a troubled entity which was becoming a liability. He also wanted to know if there was strategic stock within the SFF.

Mr Luvo Makhasi, CEF Board Chairperson, regarding the PetroSA Board, said there was a restructuring process that had been announced by the shareholders. The entity was trying to retain the liquid position of PetroSA based on the decisions they made. He further noted they needed to take a step back and ask if PetroSA could not participate in gas exploration. If the answer was yes, then they needed to find the best model to do that exploration. He said this was a technical discussion he did not want to discuss in public.

The Chairperson of PetroSA said the entity was a national asset built with taxpayers' money and would not be allowed to die. It housed the gas-to-liquids (GTL) technology which was world class. PetroSA had got feedstock which made it a profitable entity. When it was born, it was mandated to do oil and gas liquid explorations. The entity had to define itself properly. It was a gas-to-liquid operation. It consumed gas and liquids as well. It needed to find a gas solution, not crude oil. PetroSA was an integrated business model. In the past, it had tried to do everything under one roof and that model was not sustainable. PetroSA could not work without the CEF. The business would not be able to carry on with costs until it solved the gas matters. It had to look for gas, and that could not be undertaken by one party. The entity had to find indigenous gas, and it had admitted it was part of a group and had got the competencies the group needed.

The PetroSA CEO said the entity carried the costs without leveraging on the group. The existing model determined how they were going to share the costs. The entity was dealing with a new operating model. There was an agreement, but there were commercial negotiations. Constraints dictated how they were going to move the business forward. It was agreed the group was a going concern, but there were interventions on cash management in place. The management had recognised the constraints. The entity was out of the woods, and it was dealing with the challenges.

Mr Qongwa, Chief Financial Officer (CFO): CEF, reported there was no strategic fuel stock that was disposable within the SFF. The stock was kept here in SA, but it did not belong to the country. All investigations that had been commissioned had been completed. At the technical administration level there was no stock, but the court had handed the matter to a senior counsel to come up with its own conclusion. He further informed the Committee that the SFF did not depend on government funding. It created sustainable opportunities within the environment it operated in. It relied on its current infrastructure in Saldanha Bay and Milnerton. It needed strategic partners, especially oil producing companies. There had been engagements with Equatorial Guinea, but no conclusive arrangements had been made. The Minister had requested details of their engagement with Equatorial Guinea and the details had been forwarded to the Minister. Nothing had been done by the SFF under the carpet. The Committee was free to invite the SFF to make a presentation to the Committee.

With regard to the Nigeria partnership, he said the SFF took opportunities that presented themselves. The Nigeria affair was an opportunity that had presented itself and the SFF had made use of that opportunity. It had engaged with the Nigerian company. The AG had raised a finding and it had responded to it. The AG had then rescinded and the SFF had responded. There had been no cash outflows from the SFF. It was looking at the transaction positively. The partner had committed to fund certain areas of the partnership.

Mr Mavunda wanted to find out how many jobs the group had created.

Mr Moagi said 1 333 jobs had been created. 120 jobs were within the AEMFC.

Ms Faku wanted to establish from the CEF why three quotations were not provided in order to comply with SCM procedures, because deviations have not been justified.

Mr Qongwa said this was the only finding they had. It had been an administrative error. The issue was around training. There had been a preference for a service provider. Treasury regulations made provisions for a preference. The officer concerned had asked for deviations.

The Chairperson wanted to know if Africa Exploration was going to be hived off, and if the answer was yes, he asked if that was going to increase operations.

Mr Makhasi said the CEF was aware that AEMFC would be hived off in the next financial year. Whether that was a reckless decision or not lay with the Department.

Mr Mackay remarked that PetroSA had been badly managed for seven years. Negotiations on liabilities had not been successful. A year ago, it stated it had negotiated with Russia on fuel stock, but the Committee had not been briefed on the technicalities. He proposed that the PetroSA Board appear before the Committee quarterly. He also commented that the mandate of the SFF was to manage crude oil infrastructure, because it had no expertise in exploration. It was playing in a space that PetroSA was supposed to operate in.

The PetroSA Chairperson requested the Committee to visit PetroSA to see how far the entity had moved with regard to the implementation of the strategy.

The Acting Director-General said the matters that had been raised were not easy. Work had been done by the collective. He requested the AG finding on SFF be ventilated by the shareholder, instead of the SFF. In the contract review, there was the crude stock matter and other issues that were being reviewed, so not everything had been presented to the Committee.

The meeting was adjourned.