Electricity Restructuring: EDI briefing

PROVINCIAL AND LOCAL GOVERNMENT PORTFOLIO COMMITTEE
29 May 2007
ELECTRICITY RESTRUCTURING: EDI BRIEFING

Acting Chairpersons: Mr M Lekgoro (ANC) and Mr W Doman (DA)

Documents handed out:
EDI Restructuring presentation
Municipal Fiscal Powers and Functions Bill [B9-2007]
Municipal Fiscal Powers and Functions Bill: suggested amendments by National Treasury
National Treasury Response to public hearings on the Bill

SUMMARY
EDI Holdings gave an overview of its structure and mandate, and the current electricity supply industry structure. Challenges facing the electricity distribution industry related to an inefficient fragmented industry structure at present, inadequate maintenance of networks, inequitable treatment of consumers across the country, inconsistent electrification performance and slow and inconsistent rollout of free basic electricity.

The restructuring objectives, as contained in the White Paper of 1998 and the Blueprint of 2001, were set out, and the history described up to the Cabinet decision of 2006. That decision had resolved that six wall-to-wall Regional Electricity Distributors (REDs) be established. The factors behind the decision and the key considerations and implementation enablers were tabled and explained.

EDI Holdings then described the future REDs and the key enabling legislation. The Bill should be introduced by mid-2007 and the harmonisation of the pricing structure should be finalised by early 2008. The new REDs would be public companies with shareholding by Eskom and national and local government. Each would encompass about 40 municipalities. Municipalities would continue to derive electricity income. The system would be phased in over four main stages. Some municipalities had already gone through the processes to ring fence their electricity business while others still needed to sign the agreements and prepare themselves. Eskom was 95% ready. Active participation from all was vital and the Local Government Association had been cooperative. R2.1 billion had been allocated for the set up of the REDs. 

Questions by Members addressed the recruitment processes to the REDs, the outstanding legislation, the problems in RED1, the possibility of constitutional challenge, the shareholding and board membership, how the boundaries of the REDs had been set, and whether this would affect cash flow of municipalities. The distinction between subsidies and dividends was explained, as was the decision to use public rather than municipal entities. Further questions related to the costs of set up, the transfer of assets and personnel, the form of the Memoranda of Understanding, metered billing, credit controls, public participation and information, free basic electricity services and control of surcharges.

The Committee adopted various Minutes from October 2006 to March 2007. The Committee Report and further consideration of the Municipal Fiscal Powers and Functions Bill would stand over to the next meeting. 

MINUTES
Electricity Distribution Industry (EDI) Holdings: Restructuring Briefing
Ms Phindile Nzimande, CEO: EDI, briefly outlined the historical background to EDI Holdings, which was set up to manage electricity distribution and to achieve successful transfer from the current to the new systems. She explained that Eskom handled around 60% of the distribution and 40% was handled by municipalities. She noted that between the municipality and Eskom there was a combined revenue of around R33.5 billion, and asset value of around R30 billion.

The Electricity Distribution Industry (EDI) faced many challenges. Because of the fragmentation, the industry was inefficient. A network would operate best on economies of scale, and that did not currently exist. Because there were so many entities there were differing standards of maintenance. EDI Holdings had calculated that there was around R5 billion in backlog of maintenance, and the impact of the supply interruptions was currently costing R2.9 to R8.6 billion per annum. A further challenge lay in the inequitable treatment of customers, with a wide range of tariffs. The higher end of tariffs tended to be in the rural areas. This was partially due to the history of the supply, but also because local government was able to determine its own tariffs. There was still not sufficient access to electrification, although access had improved to 73% nationally. Institutional misalignment added complexity. The government had decided upon the principle of free basic electricity (FBE) but because different institutions were responsible for distribution there were problems in quantum and practices of this service.

Government had decided some years ago that there was need to transform the sector. The White Paper of 1998 identified the problems and the Blueprint was adopted in 2001, which followed the objectives in the White Paper, and noted that the transformation must be managed in a planned and non-disruptive manner. The history from the early 1990s was tabled. Cabinet had taken a decision on 25 October 2006, based on the financial viability of the different regional electricity distributors (REDs) and the response of the various models to restructure policy objectives, to establish and implement six wall-to-wall REDS, with Eskom being a shareholder in the interim period. The REDs were to be established as public entities. The Department of Minerals and Energy (DME) would oversee and control the REDs, and a strategy must be developed to deal with capital investment requirements, a national electricity pricing system and set up legislation.

The map of the six REDs was tabled. Their areas were set taking into account economies of scale, benchmarking and critical mass. An urban and rural balance was sought, so that rural electrification could be achieved. The implementation costs should not violate significant geographical boundaries, and the re-configuration of the network was minimised. Financial viability was an important factor, as each RED must be able to fund its ongoing operations. The statistical information for each RED was tabled.

The key considerations and implementation enablers were presented. It was decided that governance would be fully set out in the EDI Restructuring Bill, which was currently being developed by DME and which should be introduced by mid-2007. A framework had to be developed for transfer of assets. National Treasury was working on this. The pricing system was driven by the energy regulator (NERSA) and the harmonisation framework and tariff should be finalised by the first quarter of 2008. There would be a pricing system for the whole country, setting out the supply costs of customers and what cross-subsidisation measures could be applied. There also needed to be salary harmonisation across municipal entities and Eskom. The capital investment strategy would be attended to in the business case. The surcharge principles were being addressed in the Municipal Fiscal Powers and Functions Bill.

Ms Nzimande described the future REDs. They would be created as new companies, to which the electricity distribution businesses of both Eskom and municipalities would be transferred. Shareholding would be split between Eskom, National and Local Government. They would be service providers of choice to the service authorities. Municipalities remained as the service authorities and the REDs, as service providers, would collect surcharges, pay dividends, govern the relationship between REDs and municipalities and streamline the services to reduce duplication and create clear accountability. The areas covered by each RED were large so decentralised service delivery was important. They would enable implementation of government's social policies of electrification and free basic electricity and would be able to support Government objectives of universal access to electricity by 2012. They would become more efficient and be better able to service customers at realistic tariff levels. Local government would not be adversely affected as municipalities could continue to derive income, using the current audited revenue as a base for calculation.

The RED future business model was tabled, but not dealt with in depth. It was noted that the wires business and the retail business would be retained.

Ms Nzimande set out the principal legal instruments that would govern the operation of REDs. These included the Public Finance Management Act (PFMA), Companies Act, shareholder agreements, the King II Report, the Service delivery agreement and the NERSA distribution licence. These pieces of legislation and agreements would drive the various relationships between stakeholders.

Four phases were anticipated in establishing the REDs. In phase 1 readiness of entities was being addressed, and this included ring-fencing electricity services at municipalities in order to create the entities and transfer across the assets. Phase 2 was the day on which the hand-over would occur. In Phase 3 the various municipalities (about 40 for each RED) would be gradually absorbed during consolidation.  The final phase dealt with business efficiency improvement.

Some municipalities still needed to sign the accession agreements for participation in the RED, to comply with the Municipal Systems Act, to ring fence their distribution entities and to go through a due diligence summary. EDI Holdings had created tool kits to assist the municipalities through these procedures. The progress to date was summarised. Most of the metros had moved well on the process, and Eskom had already amended its operational boundaries and were 95% ready on the ring fencing.

EDI Holdings noted that it was not a distributor. It was dependent on active and constructive stakeholder engagement. It had created a methodology and processes. It would create a regional engagement forum in each place, and thereafter there needed to be a steering committee and sponsors committee established, followed by creation of technical committees and other working groups. Local trade unions would be consulted. EDI Holdings would also work closely with the municipalities themselves, and through the South African Local Government Association (SALGA) who had been very cooperative. It could also address the MinMEC. It also dealt with Premier's Coordinating Forums to ensure involvement of all levels of government.

SALGA had indicated from the start that national government would need to fund the transfer to the REDs and R1.2 billion had been given to EDI Holdings from 2006-09 to fund these activities. This would be dispensed to various levels. EDI Holdings welcomed the Cabinet decision which had created certainty. It was committed to working with all stakeholders, and would welcome the opportunity to report progress from time to time to this Committee. She noted that EDI Holdings had a limited life span geared towards project-management and bringing the REDs into operation. 

Discussion
Mr M Likotsi (PAC) referred to the challenges faced by EDI Holdings. He had not heard any mention of the composition of the REDs. He noted that there had been promises made and some councillors had been released so that they could join the REDs, without any certainty as to the position. There had also been some political problems affecting minority political parties. He agreed that it was necessary for all to committed to the process so that it could be effective.

Ms Nzimande said that the resistance to change had been anticipated. EDI Holdings would need to have some structure to deal with tensions and appointments. A robust process of recruitment would ensure the best people would get the jobs. She indicated that constructive tension could lead to robust discussion, and this would be encouraged where it could lead to positive results. With regard to the potential abuse of office, there were sufficient rules to deal with this. Profitability and sustainability were key issues, so all municipalities needed to participate fully, and all offices would be used to encourage participation.

Mr B Solo (ANC) indicated that this was a very technical presentation, and he appreciated the interaction with EDI Holdings. The Committee had previously been advised that one of the other Portfolio Committees would be passing the legislation, but then there were also conflicting reports about whether the municipalities were obliged to use REDs. He noted that there were still numerous outages in the townships.

Ms Nzimande indicated that the outstanding legislation had been challenging, but that DME, who were to introduce and apply the necessary legislation, had indicated that it should be finalised this year. EDI could not take this particular aspect further, but it believed that the targets would be met.

Ms Nzimande reported that in regard to the conflicts and outages, she could confirm that RED1 was established as a pilot, in the absence of various legislation. Such lack of legislation caused a problem, which was why the new plan indicated that the legislation should be in place before proceeding further. There were problems in RED1 with the contracts being called off, and eventually RED1 had closed.

Mr Solo asked what was meant by the income being based on the current audited revenue and asked what year would be used to set the base.

Ms Nzimande responded that current numbers indicated in the books were to be audited and used as a basis.

Mr Solo asked what exactly would be changed, and asked for an indication of the customers.

Ms Nzimande said that municipalities had not really been focusing specifically on account payment and their ability to enforce payment at the moment was a challenge. However, distributors, because they were dealing with specific issues, would be more focused, and should also be able to implement packages that could help the poorer customers.

Mr Solo asked about shareholding, how the board members would be appointed, whether this would be the responsibility of the Minister, and whether there would not be further capital required to pay those Board members.

Ms Nzimande stated that the appointment of board members and the shareholders' agreements would regulate the board processes. The process of appointments would need to be transparent. She noted that there was precedent for this; the Board vacancies in RED1 had been advertised, stakeholders were involved, people were interviewed and the Board was then appointed. Shareholders were able to influence the board decisions. The costs for board members were regulated by National Treasury. At the moment the rates were at about R3 800 per meeting. The costs related to bringing in members of the Board would not necessarily create a problem as they were in fact less than hiring in expertise. Benefits would be gained in getting people from the private sector to share their experience with government.

Ms L Mashiane (ANC) asked what informed the boundaries of the RED. She wondered if there had been any correlation between the decision for six REDs and the new provincial demarcations.

Ms Nzimande indicated that the reasons for the decisions were indicated on slide 15 of the presentation, and  were essentially technical. These criteria and the recommendation for 6 wall- to-wall REDs was taken long before the debate on provincial boundaries and the numbers were sheer coincidence. Electricity was a monopoly network business, and tended to have its own boundaries. The decision on the REDs tried not to interfere with those. She indicated that a town in Northern Cape, Muir, was in fact supplied not by Eskom but by Namibia Power. The electricity systems were  not based on political boundaries, but on technical considerations. In fact, the absolute ideal would have been five REDs, but this would have involved two metros under one RED, and therefore was not adopted.

Mr W  Doman (DA) asked if there was likely to be any constitutional challenge.

Ms Nzimande indicated that currently local government had administrative authority under the Constitution. Municipalities would be able to choose who ran the electricity services. it would obviously be ideal for them to choose the REDs. The City of Cape Town had used its constitutional empowerment to undermine the government, and EDI would probably advise government to seek constitutional amendments if municipalities did not cooperate. As previously mentioned, full cooperation was imperative to achieve the targets.

Mr Doman was concerned about the cash flow of municipalities, and asked if any decisions had been made on how this could be achieved. He indicated that if the municipalities were to rely on dividends from the shareholding then there might be a problem.

Ms Nzimande said that it was realised that electricity assisted with cash flow as it was easier to collect from electricity than from other services. There were two revenue flows: surcharge and dividends. The surcharge, was a levy imposed on electricity by a municipality. This could be done by way of a percentage surcharge, such as 20% on turnover. Surcharges would be paid on a regular basis. The dividends, on the other hand, would accrue to the shareholders who had contributed their assets to the REDs. EDI Holdings calculated that if municipalities were permitted to impose the surcharges from the outset, they would be able to generate sufficient funds. They would be asked not to take dividends for a period of 10 years, as these would be needed for maintenance and performance levels. The dividend was obviously dependent on financial performance, but it was anticipated that over this period each local authority would grow and the dividend would reflect the growth.

Mr Doman asked why it had been decided to use public entities and not municipal entities as a model for the REDs.

Ms Nzimande replied that both options had been tabled. The Municipal Systems Act (MSA) and Municipal Finance Management Act (MFMA) both prescribed very precise and detailed regulatory regimes for municipal entities, including the necessity to call board meetings, take budgets to various meetings, and consult. It must be noted that each RED would consist of about 40 municipalities, and to create them as municipal entities having to follow every procedure in respect of every municipality covered would be bureaucratically impossible. The recommendation for a public entity was based on practical considerations. A public entity would have a much straighter relationship between state and entity and the shareholder compacts would govern a number of issues. It was a tried and tested regime already.

Mr Doman asked about the costs of setting up the EDI and REDs, asking whether the R1.2 billion allocation was to be the total cost.

Ms Nzimande confirmed that this was so. EDI Holdings had originally made application for a larger amount but R1.2 billion was allocated. This was considered sufficient to move the industry along, even if one or two matters had to be postponed to a later stage when the REDs were self-supporting. EDI Holdings would be able to apply for further funding if desperately needed but did not anticipate doing so.

Mr Doman thought that the transfer of assets and personnel would be a huge challenge, and asked if municipalities would have any leverage.

Ms Nzimande agreed that there were some challenges, but indicated that the transfer of staff would have to comply with the Labour Relations Act. Five  trade unions were involved and EDI Holdings would ensure that issues concerning staff were dealt with in sensitive ways, and that staff would not lose out on pension or leave entitlements. In essence, the leverage of municipalities resulted from the fact that they owned those assets being transferred. EDI intended to adopt the most realistic methods of dealing with both issues. 

Mr Doman asked about the cooperative agreement that municipalities were being asked to sign, and why this was being done before introduction of the legislation.

Ms Nzimande indicated that the cooperative agreements took the form of Memorandums of Understanding (MOUs) because the legislation was not yet in place. The Memorandums indicated the steps that Municipalities needed to take in preparation for the legislation, and were high level agreements to cooperate for purposes of moving forward.

The Acting Chairperson asked whether metered billing would be continued.

Ms Nzimande indicated that the national flow was indicated on Slide 6, and both municipalities and Eskom presently undertook the billing. This would be replaced by the REDs.

The Acting Chairperson asked if it was anticipated, in regard to the surcharge, that REDs would continue to collect on behalf of municipalities.

Ms Nzimande said that it was intended that credit control could be offered by REDs to municipalities. It should be possible for municipalities to agree with REDs that they could switch off supply if instructed to do so by the municipality in relation to outstanding charges.

Ms K Magau (ANC) noted that current challenges included lack of reliability of supply. She noted that, especially in the rural areas, people would complain that they could never get hold of anyone, and if they did, they could not get answers. A number of defaulting customers were simply dissatisfied. There were also problems in billing.

Ms Nzimande said that these problems were noted. At the moment the Municipality was the service provider and the mechanics were a  problem. A separate service provider dedicated to electricity only would mean that all complaints should be directed to a specific number, rather than to a general municipality switchboard. The REDs intended to take the supply to another level. At the moment the Regulator was limited in his ability to influence the municipalities. However, the Regulator would have control over the new REDs and would have the power to impose penalties so these issues should be dealt with by the REDs

Mr Likotsi raised the question of public participation, and noted that people became sceptical of being told after the event what would happen if not informed that changes would occur. He asked how the roll out would happen and how the citizens would be informed what was taking place. 

Ms Nzimande replied that EDI Holdings had plans  for public participation but this was a question of timing.  There would be an information campaign once matters had reached a sufficiently certain stage that questions could be answered, and Members in various areas would be notified.

Mr Likotsi asked for further clarity on shareholding, asking if this would be confined to a particular group, and whether the Broad Based Black Economic Empowerment legislation would impact upon it.

Ms Nzimande stated that the shareholding would be limited. Eskom and government would be the shareholders. National government still contemplated state ownership of electricity and was not intending to privatise. For these reasons the empowerment legislation would not apply.

Mr I Mogase (ANC) noted the large cost to the economy of supply interruptions and asked what steps EDI Holdings was taking to ensure that there were no interruptions.

Ms Nzimande reiterated that EDI Holdings did not have operations within its control so it could only assist entities to ensure that they continued to invest in upgrading and maintaining the services. If municipalities would not maintain their services, then they would receive less contribution, as the value of the assets would be assessed at the time of transfer into REDs. EDI Holdings stressed to current suppliers the need to invest back in infrastructure, and had been assisting , with the Regulator, in setting guidelines.

Mr Solo asked for details of interventions into cable theft.

Ms Nzimande responded that a number of entities suffered from cable theft - including Telecom, railways and Eskom. Copper cable had a high value in the scrap market. All those involved in cabling were discussing measures and would deal with the theft problem.

Mr Doman asked about free basic services, and asked if the municipalities would still get an equitable share.

Ms Nzimande noted that municipalities would be regarded as service authorities and could effectively assist in free basic electricity. It was anticipated that this should carry on.

The Acting Chairperson asked if there was any considerations given to whether the surcharges could contribute to inequities.

Ms Nzimande indicated that the surcharges were a tax, and would be regulated. The reasonableness of the surcharges would be considered taking into account general considerations around economic cohesion and lowering of the costs of doing business.

Municipal Fiscal Powers and Functions Bill (MFPFB)
Mr W Doman took over as Acting Chairperson.

The Acting Chairperson indicated that the caucuses of the different parties would deal with the Bill, which was due to come before the House in the following week. He indicated that the Bill fell under the Portfolio  Committee on Finance but this Committee had received a briefing on the Bill and had received input from National Treasury on its responses to the public hearings.

Mr Solo wondered whether anything further was expected from the Committee.

The Committee Secretary noted that the Portfolio Committee on Finance had met the previous Wednesday, and that some members from this Committee were also present. Their Chairperson had asked this Committee simply to produce a report giving its views on the legislation.

Mr Likotsi indicated that since many members were not currently present, it would be preferable to stand the matter over.

Members agreed with the suggestion, and noted also that they would need to revert to their caucus. The matter would be raised, if necessary, at the following meeting of the Committee.

Minutes of previous meetings: October 2006 - May 2007
The  minutes of the meetings of 17 October 2006, 27 February , 6 March, 7 March, 14 March, 15 May, and 22 May 2007 had been circulated, and were adopted by Members.

Committee Annual Report
The Committee Secretary indicated that the Chairperson, Mr Tsenoli, had indicated that there were one or two matters on the Committee Report that he wished to raise with Members.

It was resolved that adoption of the Committee Annual Report must stand over to the next meeting.

The meeting was adjourned.