Electricity sector reform by sdsdfqw21

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									Electricity sector reform
  a DA discussion document
          April 2008
1. Introduction


The energy crisis has had a devastating effect on South Africa. Besides destabilising the
fluency of everyday life, the crisis has had drastic implications for growth, industry and
employment. Furthermore, Eskom’s own calculations show that, despite the expenditure
of billions of rand, it will not be able to keep up with demand over the next seven years –
and its reserve margin will actually decrease.


It is now well established that the energy crisis has dampened South Africa’s growth
prospects. Economic growth is projected to remain well below the six percent target
required to halve poverty by 2014.


Most economic sectors have been affected. The mining sector has been unable to
benefit fully from record high gold prices amid Eskom-imposed electricity rationing and,
in January 2008, gold production fell 16.5 percent. In March 2008, Eskom announced a
four to six month countrywide moratorium on all new construction projects bigger than a
residential home, which the industry claims has already cost hundreds of thousands of
rand in delayed or cancelled projects.


In response to unreliable supply, consumers would normally seek out an alternative
service provider. However, in the energy sector, Eskom enjoys a government-protected
monopoly (Eberhard, 2006). Eskom provided 95 percent of South Africa’s electricity in
2006 (Department of Minerals and Energy, 2006a). In addition, although Eskom has now
conceded that it will need help from the private sector in meeting the country’s power
supply demands, new power generation capacity continues to be apportioned between
Eskom and IPPs at a fixed rate of 70:30 – thereby continuing to entrench Eskom’s
majority supply rights.


South Africa’s severe electricity shortage is attributable to Eskom’s monopoly. By its own
admission, the energy utility has been unable to keep pace with growing energy
demand. As such, it is of paramount importance that Eskom’s monopoly as the sole
purchaser of electricity in South Africa is done away with, and that conditions that
encourage competition and private sector involvement be created.




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The following proposals will be discussed:


    •   Unbundling transmission from generation and creating equal access to the
        grid: The natural monopoly of transmission needs to be unbundled from the
        potentially competitive activity of generation. We propose that Eskom’s
        transmission division be transformed into a separate state-owned company. In
        addition, conditions that enable a regulated third party, such as a foreign IPP,
        equal access to the transmission system must be created. IPPs will be more
        likely to enter the sector if Eskom (as the dominant power player) does not own
        the national grid.


    •   Revoking Eskom’s designation as the single-buyer of electricity: While
        provision is made for IPPs to generate up to 30 percent of South Africa’s total
        electricity output, the power generated must be sold to Eskom and not to any
        other users. This current model is not adequate for attracting the significant
        investments in generation that are needed and is one of the fundamental reasons
        why we are faced with such a severe shortage of generation capacity. We
        propose that Eskom’s designation as the sole purchaser of electricity be revoked
        to enable private producers to either feed power back into the national grid, or
        alternatively, sell generated capacity directly to large consumers.


2. The consequences of Eskom’s monopoly


Cabinet has designated Eskom, as per the 2006 Electricity Regulation Act, as the sole
purchaser of electricity generated in South Africa (Davie, 2008). Thus, while provision is
made for IPPs to generate up to 30 percent of South Africa’s total electricity output, the
power generated must be sold to Eskom and not to any other users. In addition, Eskom
determines the price at which it will purchase electricity from IPPs: IPPs will have to sign
long-term power purchase agreements with Eskom.


Eskom’s stranglehold over generation is proving catastrophic. As far back as 1998, the
Energy Policy White Paper1 warned of looming power shortages and emphasised that


1
 The White Paper is freely available at:
http://www.info.gov.za/documents/whitepapers/index.htm#1998


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investment decisions regarding new generation capacity were needed (by latest) end of
1999. (Department of Minerals and Energy, 1998, pg. 53)


The government delayed this decision, and between 2001 and 2004 its stated objective
was to reform the energy sector through the development of a power exchange2, and
greater private sector investment and competition (Eberhard, 2008c). During this time,
the government seriously considered moving to a competitive electricity market. This
would have entailed breaking up Eskom and allowing private generators to compete with
the energy utility in a power exchange where consumers would have a choice of
electricity supplier (Eberhard, 2006).


Over this period, government prohibited Eskom from building new generators – claiming
that the facilitation of a competitive electricity market would attract private sector
participation. However, at the same time, it did not commit itself sufficiently to creating
the conditions that would have encouraged the development of this market, and private
power companies were unable to secure power purchase agreements that reflected the
cost of their investment in new power stations (Eberhard, 2008b).


By 2004, it became clear that South Africa was running out of generational capacity – a
fact Eskom had warned about for years. In response, government lifted the moratorium
on Eskom building new capacity and approved a large investment programme. At this
point, government’s work on partially privatising Eskom was overshadowed by the
urgent need to restore supply security (Eberhard, 2008c).


But Eskom has continued to hold tightly onto its monopoly, and has done little or nothing
to encourage independent sources of electricity generation. Government pricing policies
have helped it to keep out the competition.


Eskom executive officer Jacob Maroga has insisted that “we welcome IPP”. However, in
practice, “an unattractive regulatory environment and power prices that are too low to be
globally competitive have kept IPPs at bay” (Le Roux, 2008, pg.3). An example of a
recent IPP failure was the Department of Minerals and Energy’s recent termination of a
R5 billion contract with United States power producer AES two build and operate two
open cycle gas turbine peaking power plants – which were expected to be operational

2
    A spot market for electricity in competitive marketplaces


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before the end of 2009. AES indicated that the project was no longer viable because of
changes to the project parameters after the tender was awarded. An energy analyst
revealed that as the gas turbines would have run on diesel, with oil prices reaching
record levels – the IPP would have been hard pressed to generate a decent return with
the current electricity price. (Le Roux, 2008)


3. Into the future: a serious shortfall in supply


In an attempt to improve the security of supply, and in response to South Africa’s
national energy crisis, Eskom has embarked on a massive investment programme, and
has pursued various other initiatives. The energy utility is returning previously
mothballed generation plants to service and intends to build two new coal powered
stations (Eberhard, 2008a).


However, there are various problems associated with Eskom’s contingency plan. Firstly,
these coal powered stations will take several years to build – the first unit is expected to
come online in 2012. In addition, the costs of the installation and running of the power
stations will amount to billions of rand. Eskom has estimated the cost of the capital
expenditure programme at around R350 billion. Furthermore, for coal-fired stations,
adequate supplies of coal must be secured. However, by the time these power plants
are operational, the population – and energy usage – would have increased markedly,
leaving Eskom continually behind in terms of energy provision.


In addition, Eskom has installed new open cycle diesel-fired turbines to help meet peak
demand. The units take 18 months to install (considerably shorter than the coal powered
stations) and more will be built during this year and the next. However, they are
extremely expensive to operate, and as they are operating at their limit, are adding
significantly to Eskom’s operating costs. As such, these turbines cannot fully solve the
current energy crisis. They are supposed to run during peak demand periods and not
supply energy throughout the day. (Eberhard, 2008a)


In a further bid to cope with the energy shortage in the short-term, Eskom has urged the
public to cut down on their electricity usage. The energy utility’s demand side
management entails a subsidy programme for solar water heaters, compact fluorescent



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light bulbs, and other energy efficient devices. In addition, Eskom has invited industry to
construct cogeneration plants. This entails companies using their waste heat streams to
produce electricity. This electricity can then be sold to the national grid. However, these
initiatives, although commendable, are not enough to restore energy supply security in
the long term (Eberhard, 2008a).


On 6 February 2008, EE Publishers conducted an interview with Eskom chief executive
officer Jacob Maroga. Table 1 below was presented to Maroga who stated that: “If one
projects a fixed demand increase of 4 percent per annum going forward, plus the current
planned generation capacity build to 2014, one gets the figures in the table.”


Table 1:       The future generation capacity and reserve margin outlook


                                                                  Ideal
              Forecast                  Year    end   Reserve     capacity
                           New plant                                             Shortfall
Year          demand                    capacity      margin      (15%
                           (MW/yr)                                               (MW)
              (MW)                      (MW)          (%)         margin)
                                                                  (MW)
2008          38287        2024         40548         5.90%       44030          3482
2009          40158        1915         42463         5.70%       46182          3718
2010          41671        1892         44355         6.40%       47922          3566
2011          43238        181          44536         3.00%       49724          5188
2012          44665        1003         45539         2.00%       51365          5826
2013          46430        2422         47961         3.30%       53395          5433
2014          48624        2363         50324         3.50%       55918          5594
Source: EE News


It is evident from Table 1 that, over the next seven years, despite everything that Eskom
can do, it will not be able to generate enough electricity to meet South Africa’s needs.
Moreover, by 2014, the reserve margin will be significantly lower than it is currently –
despite Eskom’s massive capital expenditure programme. The Table emphasises the
argument that a permanent solution to the energy crisis will only be reached by
dismantling Eskom’s monopoly. This should in fact have happened 10 years ago – as
government had envisioned. Even while in the grip of the crisis, the gradual liberalisation




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of electricity generation will provide as rapid a recovery as possible. Eradicating Eskom’s
monopoly is South Africa’s best long-term approach.


4. Restructuring opportunities


Electricity markets can be structured in four ways, reflecting varying degrees of
competition and consumer choice. A brief discussion of these structures is provided
below 3:


    •   Monopoly – a single entity is responsible for the generation of all electricity and
        delivers it over a transmission network to distribution companies;
    •   Single-buyer – an agency procures electricity from competing generators, but
        retains a monopoly on transmission and sells electricity to distributors and large
        consumers
    •   Wholesale competition – distributors are able to buy electricity from competing
        generators and use the transmission network to deliver it to their service areas;
        and,
    •   Retail competition – energy consumers have access to competing generators
        and retailers, and transmission and distribution networks operate under open
        access arrangements.


Historically, a single government entity has owned both the generation and transmission
capacity. The energy utility transmits power to distribution companies that hold the
exclusive right to serve specific regions. However, since the early 1980s, more than 70
countries have implemented electricity reforms. Specifically over the past decade, there
have been significant changes in the view of how the electricity sector should be owned
and regulated (Kessides, 2004).


As previously stated, South Africa has adopted the single-buyer model. As such, Eskom
purchases all generated power. This model is meant to enable IPPs to compete for long-
term power purchase agreements.



3
 Ioannis Kessides, Reforming infrastructure: privatization, regulation and competition,
World Bank Policy Research Report, 2004


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With wholesale competition, local distributors (municipalities) still retain their exclusive
service regions, but are able to buy power from competing generators. In addition,
although customers are in general still unable to choose between preferred suppliers,
large energy consumers – consuming in excess of a specified volume of power – are
able to contract with generators directly. By enabling large electricity consumers to
purchase power from alternative power producers, and by providing a greater number of
potential customers for IPPs, the wholesale model makes the electricity market more
competitive relative to the current single-buyer model. In addition, allowing large energy
consumers to enter into long-term purchasing agreements with IPPs directly will facilitate
the financing of new generation capacity. (Kessides, 2004)


5. Electricity sector reform


In South Africa, significant investments in generation are needed. However, the current
structure of the electricity sector is not suited to attracting the long-term capital needed
for adequate and reliable electricity supply.

The establishment of a wholesale electricity market (wholesale competition) is often
advocated to introduce competition into power generation. According to the World Bank
Research Report, most reform programmes are designed to move from monopoly
structures to wholesale and retail competition, with wholesale and retail competition
representing the standard prescription (Kessides, 2004). The wholesale electricity
market is organised as either a power exchange or power pool. Between 2001 and
2004, much work had been done to design such a power exchange (Eberhard, 2008c).
However, in February 2005, Eskom announced that government would not continue with
the planned establishment of an independent South African power exchange (Phasiwe,
2005). At present, the South African energy sector lacks sufficient competition among
power generation for the establishment of a wholesale electricity market. Specifically, the
number of independent generators is too small to support a competitive market.
Problems of market power are still prevalent in the sector and will remain for some time
unless government regulation addresses this concern.




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Government must urgently take steps to reduce the Eskom monopoly and encourage
greater competition in the electricity sector. These measures will help to facilitate the
entry of independent power producers into the market.


Specifically, we propose:


   5.1         Unbundling generation from transmission


As a first step in encouraging private sector involvement, the potentially competitive
activity of generation must be unbundled from the natural monopoly of transmission. In
addition, conditions must be created that enable a regulated third party to obtain equal
access to the transmission system. IPPs are more likely to enter the sector if Eskom (as
the dominant power player) does not own the national grid.


The World Bank notes that this unbundling of transmission from generation is one of the
most important steps in electricity restructuring and reform (Kessides, 2004).


Thus we propose:


         Transmission be unbundled from generation by establishing a separate
         state-owned electricity transmission company




The foundation for this reform has already been laid down in the 1998 White Paper and
subsequent government policy documents.


In the 1998 White Paper, the government acknowledged that both the restructuring of
Eskom and the provision of open access to the transmission lines were necessary
preparatory steps to facilitate competition in the electricity supply industry. As such, the
long term approach would entail Eskom being restructured into separate generation and
transmission companies. (Department of Minerals and Energy, 1998)


In August 2000, the Department of Public Enterprises published “A Policy Framework:
an Accelerated Agenda towards the Restructuring of State Owned Enterprises.” This


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policy framework indicated that, although transmission would remain state owned, it
would likely be transformed into a separate independent company. (Eberhard, 2002)


Furthermore, in May 2001, proposals for the reform of the electricity supply industry
were approved by Cabinet. The proposals made provision for the establishment of a
separate state-owned transmission company that would operate independently from
generation. (Eberhard, 2005)


As Cabinet has already agreed to this in principle - in 2001 - now is the time to proceed
in this regard. This will create a platform for competition in and entry into the electricity
sector.


   5.2     Facilitating greater private sector participation


The current structure of the electricity sector – in terms of the single-buyer model - is not
suited to attracting the long-term capital needed for the significant investments in
generation that are needed. As such, the state must address the lack of private sector
involvement and competition in the sector.


It has already been indicated that, at present, the number of independent generators is
too small to support a competitive market. Problems of market power (read: Eskom
monopoly) are still prevalent in the sector and will remain for some time unless
government regulation addresses this concern. In order for the electricity market to be
competitive, a number of unaffiliated suppliers must operate within the market – as
opposed to a single supplier dominating the market as Eskom does today.


While provision is made for IPPs to generate up to 30 percent of South Africa’s total
electricity output, the power generated must be sold to Eskom and not to any other
users. This monopoly power is one of the fundamental reasons why we are faced with
such a severe shortage of electricity generating capacity.


Eskom’s monopoly as the sole purchaser of electricity in South Africa must be
dismantled, and all obstacles for IPPs to generate and sell electricity to large electricity
consumers must be removed.



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As stated in Section 2, South Africa’s current tariff dispensation is one of the largest
constraints to attracting IPPs. Frost and Sullivan further emphasised that if tariffs remain
low, they will continue to limit the prospects for IPP. Should Eskom’s proposed 60
percent tariff hike be approved - the investment climate would be more favourable for
IPPs. However, even if the tariff hike is approved, Minister of Minerals and Energy,
Buyelwa Sonjica, stated that South Africa will still have the cheapest electricity in the
world. (Business Report, 2008)


As such, the DA proposes:


   Eskom’s designation as the sole purchaser of electricity in terms of the
   Electricity Regulation Act of 2006 be revoked and all obstacles for IPPs to
   generate and sell electricity to large electricity consumers must be removed.


This will enable private producers to either feed power back into the national grid or,
alternatively, sell generated capacity directly to large consumers.


BHP Billiton and other large industrial concerns would no longer be reliant on Eskom’s
erratic supply of electricity. These companies would be able to use private power utilities
to build dedicated power plants. If Eskom’s designation as the sole purchaser was
revoked, the power generated from these plants could be sold directly to the end user
instead of Eskom. Although the current electricity rates that large consumers pay would
be lower than those that a new plant could provide, large power consumers would likely
agree to the price concession in a bid to secure an uninterrupted and sufficient power
supply (Eustace Davie, Shed Eskom’s monopoly to solve the electricity crisis, The Free
Market Foundation, January 2008). Large industrial consumers would no longer be
wholly reliant on Eskom’s erratic supply of electricity. These companies would be able to
make use of private suppliers, while Eskom could focus on other end-users, removing a
lot of pressure on their already over-stretched capacity to produce power.


At the same time, IPPs would not have to enter into a protracted negotiation with Eskom
regarding a power purchase agreement, but could negotiate directly with the potential
consumer.




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   5.3     Addressing Eskom’s monopoly


In 2001, then-chief executive Thulani Gcabashe stated that Eskom expected its 95
percent share in power generation to be reduced to not less than 50 percent in the next
few years (Business Day, 2001). However, as previously mentioned, Eskom currently
provides around 95 percent of South Africa’s electricity (Department of Minerals and
Energy, Digest of South African energy statistics, 2006).


Thus, any attempt to deregulate the electricity sector must also address the issue of
market power. In the long-term, government must reduce Eskom’s market share in
generation and allow for a much increased percentage of South Africa’s electricity
requirements to be supplied by IPPs.


In 2000, a Minerals and Energy draft policy paper proposed reducing Eskom’s market
share of generation to 35 percent. Eskom was alarmed at the extent of this reform and
lobbied against it at the highest levels in government. Although now is not the time to
announce a significant decrease in Eskom’s market share in generation, once energy
security has been established, the state must take a long term approach in this regard.


As such, the DA proposes:


   Setting a timetable for the gradual reduction of Eskom’s market share, with the
   objective of reaching a level of a minimum of 35% generated by Eskom by 2015


6. Conclusion


South Africa’s severe electricity shortage is attributable to Eskom’s monopoly. In
addition, although Eskom has taken steps to mitigate the situation, the utility is yet to
suggest a permanent solution. As such, even while in the grip of the crisis, the gradual
liberalisation of electricity generation will provide as rapid a recovery as possible.
Eradicating Eskom’s monopoly is South Africa’s best long-term approach.




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As such, it is of paramount importance that Eskom’s monopoly as the sole purchaser of
electricity in South Africa is done away with and that conditions that encourage
competition and private sector involvement be created.


We have proposed two important steps in this regard: Firstly, unbundling the monopoly
activity of transmission from the potentially competitive generation and creating equal
access to the grid. Secondly, revoking Eskom’s designation as the single-buyer of
electricity and enabling private producers to either feed power back into the national grid,
or alternatively, sell generated capacity directly to large consumers.


In addition, because any attempt to deregulate the electricity sector must also address
the issue of market power, in the long run, government must reduce Eskom’s market
share in generation and allow for a much increased percentage of South Africa’s
electricity requirements to be supplied by IPPs.




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7. Bibliography


Business Day. (2001). The telecoms sector is seen as future revenue generator.
Business Day. 2 April. Available online at: www.businessday.co.za


Business Report. (2008). Sonjica downplays Eskom price hike. Business Report. 1 April.
Available online at: www.busrep.co.za


Davie, E. (2008). Shed Eskom’s monopoly to solve the electricity crisis. The Free Market
Foundation. 24 January. Available online at: www.freemarketfoundation.com


Democratic Alliance. (2008). Keeping the lights on: The DA’s proposals to tackle South
Africa’s electricity crisis. 28 January. Available online at: www.da.org.za


Department of Minerals and Energy. (1998). White Paper on the Energy Policy of the
Republic of South Africa. Available at: www.info.gov.za


Department of Minerals and Energy. (2006a). Digest of South African energy statistics.
Available online at: www.dme.gov.za


Department of Minerals and Energy. (2006b). Electricity Regulation Act. No. 4 of 2006.
Available at: www.info.gov.za


Eberhard, A. (2002). Competition and Regulation in the Electricity Supply Industry in
South Africa. Trade and Industrial Policy Secretariat Working Paper 2


Eberhard, A. (2004). Electricity investment – Vital to get market structure right. Business
Day. September 23


Eberhard, A. (2005). From State to Market and Back Again: South Africa’s Power Sector
Reforms. Economic & Political Weekly. 10 December


Eberhard, A. (2006). Eskom’s broken contract in the Cape. Business Day. 28 February




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Eberhard, A. (2008a). Overseas lessons in coping with power scarcity. Business Day. 24
January


Eberhard, A. (2008b). What is required to shore up Eskom. Sunday Times. 3 February


Eberhard, A. (2008c). Sale shock therapy. Financial Mail. 14 March


Phasiwe, K. (2005). Plans for wholesale power market to be put on hold. Business Day.
28 February. Obtained from Eskom Archived News. Available at: www.eskom.co.za


Kessides, I. (2004). Reforming Infrastructure: Privatization, Regulation, and Competition.
A World Bank Policy Research Report. A co-publication of the World Bank and Oxford
University Press


Le Roux, M. (2008). Private electricity contract cancelled. Business Day. 3 April




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