ESKOM REDUCES TARIFF HIKE REQUEST, LOOKS FOR PRIVATE

UNCLAS SECTION 01 OF 03 PRETORIA 002498 SIPDIS SENSITIVE STATE PLEASE PASS USGS DEPT FOR AF/S, ISN, EEB/ESC and CBA, and OES/EGC DOC FOR ITA/DIEMOND DOE FOR T.SPERL, G.PERSON, A.BIENAWSKI, M.SCOTT, L.PARKER TREASURY FOR D.PETERS, P.STEWART E.O. 12958: N/A TAGS: ENRG EPET EMIN EINV ETRD ECON SENV PGOV SF SUBJECT: ESKOM REDUCES TARIFF HIKE REQUEST, LOOKS FOR PRIVATE CAPITAL, AND JOUSTS WITH GOVERNMENT REF: A) Pretoria 2315; B) Pretoria 2166 and previous This message is sensitive but unclassified, not for Internet distribution. ¶1. (SBU) SUMMARY: State power utility Eskom backtracked on its controversial 45 percent tariff hikes for each of three years, at the last moment revising its application to the regulator down to 35 percent per year. At the same time it announced a number of new strategic initiatives, a desire for private investment, and delays in some projects. Many stakeholders deemed the revised rates still too high and inflationary. Separately, the SAG released some details of its newly Cabinet-approved Integrated Resource Plan, with timeframes for some projects differing from Eskom-announced plans. The Energy Minister highlighted security of supply for pursuit of nuclear and other projects despite budget woes. USAID Southern Africa is currently exploring the possibility of providing assistance to the SAG under its Africa Infrastructure Program. End Summary. -------------- Never Mind 45% - We Want 35% -------------- ¶2. (SBU) Eskom, South Africa's state-owned power utility, made a number of significant announcements on December 1. Eskom submitted a last minute revised tariff application to the National Energy Regulator of South Africa (Nersa),reducing its requested rate increases to 35 percent from 45 percent per year over the next three years. To budget for lower tariff increases, the utility announced that its second proposed coal-fired power station - Kusile - will be phased in one year later than originally planned, and that a private equity partner will be sought for as much as 30 percent of the 4,800 MW power plant, initially scheduled to start coming on line in 2013. In addition, Eskom is recommending that South Africa postpone its already-delayed nuclear power program, new gas-fired peaking plants, and a wind project at Sere. -------------- Strategic Shift -------------- ¶3. (SBU) Acting Executive chairperson Mpho Makwana characterized the decisions as marking a "significant strategic shift" for Eskom, mainly referring to the quest for private investment in some projects. The local investigative paper Mail & Guardian depicted Makwana as a new super hero "Mister Electricity" providing new "energy" sorely needed at the utility. Eskom forecast a budget shortfall of $1.9 billion over the next three years, less than the $4.0 billion originally projected. Eskom announced that it will reduce the shortfall, despite the slower rate increases, through project-level private equity partnerships, project deferrals, and power conservation and demand management initiatives. Makwana warned that the revised funding plan was based on finely balanced assumptions on economic growth and the cost of primary energy. An Eskom spokesperson asserted there was no short-term threat to security of supply, but admitted the system would remain vulnerable from 2011 through 2012 when the first turbine of the Medupi coal-fired power plant comes on line. She said strong demand-side initiatives were essential to help mitigate any vulnerability. A power analyst at Frost & Sullivan still predicts power outages from Qpower analyst at Frost & Sullivan still predicts power outages from mid-2010 to 2012. -------------- Not so Fast - Government does Policy -------------- ¶4. (SBU) On December 3, Energy Minister Dipuo Peters released some details of the SAG inaugural integrated resources plan (IRP1),which had been approved by President Zuma's Cabinet December 2. It appeared that the SAG was reasserting its preeminence on strategy in announcing this long-anticipated planning document, which presented some misalignment with Eskom's announcements in conjunction with the revised tariff request in the same week. According to Minister Peters, the IRP1 is premised on no delay in Kusile or the other projects that Eskom proposed delaying to make its numbers work. Minister Peters said the SADOE believed that all the projects are necessary to "keep the lights on." She added, "We cannot stop planning [for security of supply] simply because there is no money. In my view you have to plan and then look for the money based on the PRETORIA 00002498 002 OF 003 plan." SADOE acting Deputy Director General (DDG) Ompi Aphane, who has overseen drafting of the IRP1, indicated that Nersa will use the IRP1 to make its determination on the capital project aspect of Eskom's application. Aphane said the SAG would begin broad stakeholder consultations in January to formulate a second stage IRP2. Aphane also announced that an Independent System Operator (ISO),separated from Eskom in a phased procedure, would be created. -------------- Negative Reactions to Tariff Hike -------------- ¶5. (SBU) Meanwhile, business, labor, and politicians were almost uniformly critical in their reaction to Eskom's revised 35 percent tariff hike request. Business Unity SA (BUSA) said, "We view the revised proposal as still being on the upper side. It could have unintended outcomes on the economy." The Agricultural Business Chamber said, "The revised price hike is very high - probably too high." Labor federations, other business groups, the ruling African National Congress party and opposition parties all took issue with the requested hikes. -------------- Inflation Worries -------------- ¶6. (SBU) Economists agreed that the scale of South Africa's impending electricity tariff increases are the biggest single threat to the country's inflation outlook. Eskom has hiked its power prices 91 percent since 2005. Many commentators have opined that the requested tariff hikes will be inflationary, but it is not clear how much sophisticated analysis of direct and indirect costs have been modeled. ABSA Capital said the revised 35 percent increase in electricity tariffs would directly contribute 0.6 percentage points to the inflation rate over a full financial year. A Barnard Jacobs Mellet analyst told Deputy Economic Counselor that with a 35 percent nominal tariff increase, he would expect inflation to remain within the 3-6 percent target band for most of 2010 and 2011. Nonetheless, Eskom had told the analyst that the 35 percent increase is in real terms, which would represent about a 41 percent rise in nominal terms. Reserve Bank Advisor Brian Kahn said publicly that tariff increases of 30 percent would probably see inflation remaining just below the 6 percent inflation target ceiling. Therefore, any higher increase could prevent the country from attaining sustainably lower levels of inflation in the medium term. The Reserve Bank assumed a 25 percent tariff increase in its latest economic projections. -------------- - Private Project Capital, but not Privatization -------------- - ¶7. (SBU) Most commentators were positive about Eskom's decision to seek private project capital, but skeptics noted the failure to set up any independent power producers (IPPs) in the past. Government policy has long targeted up to 30 percent provision of power by IPPs, but it has been unable to set up a transparent environment to attract investors. For example, the then-Department of Minerals and Energy tender for peaking power plants failed to negotiate a contract with preferred bidder U.S. firm AES, which eventually Qcontract with preferred bidder U.S. firm AES, which eventually dropped contract negotiations, or with runner-up Suez of France. The newly-approved Integrated Resource Plan has been promised to provide the framework and policy for engaging IPPs and developing nuclear and renewable energy. According to aspects of the IRP1 released, there is only 1,100 MW set aside for renewable energy, cogeneration, and conventional IPP power between 2010 and 2013. SADOE said the IRP2 planning for post 2014 would quantify power arising from IPPs as "likely to be far more material". ¶8. (SBU) Neither the SAG nor Eskom has broached privatization of Eskom itself. Some economists have suggested that Eskom be broken up and listed, but discussion of privatization of Eskom and parastatals generates knee-jerk negative howls from many sectors of the South African scene. One of the sources of Eskom's challenges is that government's attempts to involve independent power producers were not successful, for a number of reasons, and many stakeholders became disillusioned. Delays in capacity investment during that period allowed demand to overtake supply, discrediting the potential of private power in the eyes of many. Eskom and other South African parastatals have boards that ultimately defer to the single powerful "shareholder" - the government. As one commentator noted, "the PRETORIA 00002498 003 OF 003 government wields power without responsibility; the boards have responsibility without power." -------------- Nuclear and Renewable Energy -------------- ¶9. (SBU) Energy Minister Dipuo Peters has reaffirmed the SAG's commitment to nuclear and renewable energy in public comments. Speaking at a recent nuclear conference, she said that the SAG had taken the lead in formulating the process for selecting a technology partner for providing up to 20,000 MW of conventional nuclear power plants. (The Eskom turn-key tender was cancelled in December, 2008.) The SAG is still expected to announce the way forward by March 2010. The Minister said the first new nuclear power plant would be up and running by 2020. Westinghouse remains well positioned to be a technology supplier, given its global track record in technology transfer. The SAG is still determining its level of support to the new fourth generation Pebble Bed Modular Reactor, which is still many years away from commercialization for power and industrial process heat. ¶10. (SBU) With regard to renewable energy, Minister Peters reaffirmed at the nuclear conference that the SAG aimed to install 10,000 gigawatt-hours of renewable energy capacity by 2013, introduce one million solar water heaters by 2014, advance demand side management (DSM),and introduce new energy efficiency initiatives. She also cited the importance of climate change negotiations and South Africa's Long Term Mitigation Scenarios. While the regulator has established viable renewable energy feed-in tariffs (REFIT),thus far South Africa has had only very modest success in implementing renewable energy projects, largely due to uncertainty about Eskom purchase agreements for independent producers and other aspects of SAG policy. -------------- COMMENTS -------------- ¶11. (SBU) Tariff tussles and management turmoil at Eskom are likely to continue to slow strategic planning at the utility and in government to establish a fruitful framework for engaging the private sector and diversifying the energy mix, not to mention mitigating carbon emissions. The boardroom struggle at Eskom that led to the departure of the CEO and Chairman (Ref A) resulted from ambiguity and meddling from the highest levels of government. This kind of institutional uncertainty could continue to discourage private investment. ¶12. (SBU) Continued negative reactions to proposed tariffs may force Eskom to further pare its rate increase proposals, perhaps to 25 percent per year. This is a tricky balance, to allow tariffs to reach a more normal market basis to improve Eskom's balance sheet and attract private investment while keeping the impact reasonable on inflation, the economy, and consumers. South Africa's electricity pricing is complicated by municipalities and residential/industrial/concessionary considerations, but even after two years of significant increases, current prices are among the world's very lowest. Three years of significant increases would move them much closer to international parity. Prices that would allow private investors more profitability could make a difference Qallow private investors more profitability could make a difference in attracting outside capital, as well as encouraging conservation and improved efficiency. Without private capital, demand may again outpace supply, resulting in new capacity shortfalls and new threat of load-shedding. ¶12. (SBU) U.S. ASSISTANCE, OPPORTUNITIES FOR U.S. PRIVATE SECTOR: U.S. investors will continue to look seriously at the South African market, but will be looking for clarity on tariffs, regulatory, and policy frameworks. USTDA is looking at opportunities to provide feasibility studies and or technical visits to facilitate U.S. exports or investment related to power projects. USAID Southern Africa is currently exploring the possibility of providing assistance under its Africa Infrastructure Program to the SAG. The current situation strengthens the case for such assistance. The USG also aims to launch a bilateral strategic energy dialogue and implement a recently-signed nuclear energy R&D agreement. Gips