SOUTH AFRICA: REGIONAL ELECTRICITY DISTRIBUTOR

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E.O. 12958: N/A
TAGS: EPET ENRG EINV EIND ETRD ECON SF
SUBJECT: SOUTH AFRICA: REGIONAL ELECTRICITY DISTRIBUTOR
ESTABLISHED, BUT FRAUGHT WITH QUESTIONS


Summary
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1. (U) On July 4, the government launched the country's
first regional electricity distributor (RED) - known as
RED ONE. For the moment, RED ONE encompasses only Cape
Town and a few nearby municipalities in the Western Cape,
but the plan is for up to 40 municipalities to
voluntarily join. RED ONE is part of a much broader plan
to create six regional distributors that will be able to
provide local electricity service more efficiently than
187 municipalities do now. However, serious legal,
commercial, and operational hurdles must be resolved
before the REDS plan can be implemented. The government
is determined that restructuring take place, and has
promised to apply greater political pressure and amend
municipal law, if need be. The Electricity Regulation
Bill, due in Parliament at the end of August, may be the
first opportunity to resolve some of the legal and
operational issues. End Summary.

BIG RED
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2. (U) On July 4, Minister of Minerals and Energy Lindiwe
Hendricks launched in Cape Town what the government
billed as the first regional electricity distributor (RED
ONE). Actual operations began on July 1. The timing of
the launch met the July 1 deadline that President Mbeki
put forward in his opening speech to Parliament last
February. RED ONE is the first step of a plan to create
six regional distributors by 2007 to manage the supply of
electricity to end users throughout the country.


3. (U) At the launch, Phindile Nzimande, CEO of
Electricity Distribution Industry Holdings, Inc. (EDI, a
government corporation established to facilitation the
creation of regional distributors) said that
restructuring along regional lines should raise the
efficiency, quality, and affordability of electricity for
everyone in South Africa. As larger entities, the REDs
should be able to reach economies of scale, be better
able to build and maintain infrastructure, and harmonize
the 150 plus tariffs that are currently charged across
the country.


4. (U) RED ONE will be managed by a Chief Executive
Officer and a Chief Operating Officer who will report to
a 15-person board. Appointed as first CEO is former Cape
Town Council member Saleem Mowzer. Appointed as first
COO is former Eskom Western Region General Manager Peter
Sechemane. Phindile Nzimande was appointed Chairperson
of the Board. As CEO of EDI, she also reports directly
to Minister of Minerals and Energy Lindiwe Hendricks.
Six other board members have also been named.

OR LITTLE RED?
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5. (SBU) Despite the hoopla of the launch, the truth is
that nothing much has changed from an operational point
of view. RED ONE comprises only the Cape Town
Metropolitan area, already an active municipal
electricity distributor before it became RED ONE. What
has changed, however, is that, legally, the Cape Town
Municipality now functions as a RED. Some forty other
municipalities throughout the Western Cape Province and
the western section of the Northern Cape Province may now
voluntarily join RED ONE. For this to start happening,
however, quite a few issues still need to be resolved.
Still under negotiation is compensation for and transfer
of assets and liabilities to RED ONE, shareholding in RED
ONE, revenue sharing by participating municipalities, as
well as various governance and competition issues.
Moreover, there is still a debate over what type of legal
entity RED ONE should be, i.e., a public enterprise or a
municipality.


6. (SBU) Tom Skinner, Eskom's Project Manager for
Distribution Restructuring, believes that RED ONE
negotiations with Eskom will take at least six to
eighteen months to complete, and that incorporation of
all regional municipalities will take at least three to
five years to complete. In the meantime, Eskom has
agreed to supply RED ONE with electricity for 18 months
in lieu of its commitment to the Cape Town Metropolitan
area.

A Constitutional Matter?
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7. (U) The reason for all of the delay and extended
negotiations is that the establishment of regional
electricity distributors (REDs) flies in the face of the
South African Constitution, which delegates the delivery
of electricity to municipal government. Section 156
states that only municipalities have the authority to
administer "electricity and gas reticulation, and street
lighting." Reticulation is defined as the distribution
of electricity at 380 volts or less. This means that,
short of amending the constitution, authorities have just
two options for establishing a RED: i.e., build a RED on
top of an existing municipal entity; or declare a RED to
be a municipal entity. One way or the other, it is for
the municipalities to decide whether to join.

The Municipal Problem
--------------

8. (SBU) Currently, some 187 municipalities out of a
total 284 distribute electricity at 380 volts or less to
their own and sometimes neighboring municipalities.
Government estimates indicate that 50% of these
municipalities would probably not be economically viable
if revenues from their electricity services were
withdrawn. Because of this, many municipalities have
been very reluctant to accept the idea of relinquishing
their electricity distribution services to a RED, despite
of government assurances of compensation. Even the
National Treasury worries that municipalities without
electricity revenues would saddle the national government
with bankrupt municipalities.


9. (SBU) In the meantime, municipalities seem to be
making a mess of electricity distribution. Knowing that
regional electricity distributors were coming, many
municipalities have failed to maintain their distribution
networks or replace skilled technicians. Deteriorating
infrastructure and capability has led to increasing power
failures, even in larger municipalities like
Johannesburg. Moreover, municipalities have often set
local tariffs according to financial need rather than to
facilitate growth and development. The result has been
that there is a huge differential in prices and service
levels among municipalities, with the poorest
municipalities charging the highest prices.

Municipal and Public Finance Law
--------------

10. (SBU) As government authorities are discovering,
creating REDs based on municipal law creates a number of
problems of its own. Municipal law stipulates that 1)
municipalities must control 51% of the shares in any
joint venture formed, 2) may not make foreign loans 3)
must adhere to a cap on salaries for senior staff, and 4)
must follow certain procedures to obtain approval for
capital expenditures. Both EDI CEO Nzimande and ESKOM's
Skinner pointed out to us that municipal law could
hamstring future RED operations, because it does not
allow for the REDs to make quick decisions, hire highly
skilled staff, or easily acquire advanced equipment.
They want to find a way to incorporate the REDs as state
owned enterprises so that they may more freely operate as
independent, competing public corporations, unencumbered
by the legal and fiscal constraints normally imposed on
local government.


11. (SBU) As it stands now, municipalities have the
constitutional right to opt out of the REDs scheme. They
can continue to distribute electricity even after a
regional electricity distributor is established. Eskom
would still be legally bound to supply electricity to
them. This makes the whole scheme voluntary, and
strengthens the negotiating hand of the municipalities.


12. (SBU) According to EDI's Nzimande, government will
continue to solicit the voluntary incorporation of
municipalities in REDs, using economic and commercial
benefits to persuade them to join. She said that
government was determined that restructuring take place,
and would resort to political persuasion (the ruling ANC
party controls most municipal councils today) and even
amendments to the municipal law, if need be. No one is
talking about amending the Constitution at this time,
since regional electricity distribution does not warrant
the opening of Pandora's Box on other constitutional
questions.

Next Steps
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13. (SBU) The Government knows that it has to finalize a
number of operational and commercial issues before it can
implement its RED scheme. These include: the ringfencing
from a municipal budget point view of municipal services
from electricity distribution, compensation to
municipalities for the loss of electricity revenues,
compensation to Eskom and municipalities for the transfer
of assets to the REDs, RED ownership and how to share RED
revenues among owners, Eskom's role (Eskom currently
supplies directly to some 150 large users such as the
mines and plants),the National Energy Regulator's (NER)
role in determining tariffs, and how to manage
competition between the REDs and Eskom. The Electricity
Regulation Bill, due in Parliament at the end of August,
may be the first legislative opportunity to resolve some
of these issues.

FRAZER