THE VIABILITY OF THE ESTABLISHMENT OF THE NATIONAL RED / 7th RED

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THE VIABILITY OF THE ESTABLISHMENT OF THE NATIONAL RED / 7th RED

PRESENTATION TO THE PARLIAMENTARY PORTFOLIO COMMITTEE ON MINERALS AND ENERGY

ByThe NERSA Secretariat

23 June 2006

Smunda Mokoena – Chief Executive Officer

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DISCLAIMER• Due to the short notice the Regulator did not have the opportunity to

consider its response and as a result, this presentation is that of the Secretariat only.

• The Energy Regulator requests the opportunity to make its submission to this Committee later, once it has formulated its position and more importantly, to extensively comment on the Seven-RED-Model, as soon as more information is available.

• Due to the unavailability of information underpinning the National / Seven-RED-Model, this presentation is a preliminary view of the NERSA Secretariat;

• This submission is consistent with previous NER decisions.• We are aware of the Cabinet decision of 14 September 2005.

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OVERVIEW OF SUBMISSION

• PURPOSE OF PRESENTATION• CONTEXT OF COMMENTS

– EDI restructuring effort– Models evaluated– Basis for modelling– Maximum number of financially viable REDs– Modelling criteria– Financial objectives

• THE SIX RED (BLUEPRINT) MODEL• THE NATIONAL RED MODEL• MITIGATING CONDITIONS FOR NATIONAL RED MODEL• CONCLUSION• REQUEST TO PPC

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PURPOSE OF SUBMISSION

– To provide comments on the proposed structure of the distribution industry, particularly the National RED (RED 7)

– To ensure that the objectives for restructuring are met in reforming the EDI.

– To give the PPC an overview of the development and effort in the restructuring process.

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EDI Restructuring EffortNELF1993/4

EWG1995/6

ERIC1997/8

EDIRC1998/01

EDIH2003 - Present

24 consultative workshopsDetailed modeling

International consultantsConsolidate into 1 to 17

NELF led to establishment

of the NER.NER to restructure through licensing

International ConsultantsDetailed Modeling

EDI Blueprint6 REDs

Financially IndependentMandatory participation

5 DistributorsRestructuring Task Force

CabinetMax. number of

Financially viable REDs

NER PARTICIPATION IN GOVERNMENT COMMITTEES

MSF2005/6

Farm InnConsultations

2002/3

Reticulation issueVoluntary participationRevised BoundariesNon viable entities

Inter RED subsidies

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Structure Models Evaluated

GTD

Customers

GT

D

Customers

1. Vertically integrated 2. National Distributor 3. Regional Distributors (Recommended)

4. Eskom and some LGs (New Model) 5. Splitting wires and tradingGTD

Customers LGCustomers

LGCustomers

LGCustomers

LGCustomers

LGCustomers

G W

T TT T

Customer Choice

GT

RED

Customers

RED

Customers

RED

Customers

RED

Customers

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EWG Recommendations adopted by Cabinet in 1998

1. That the industry be consolidated into – the maximum number of financially healthy independent regional

distributors – to strengthen the weakest distributors, – facilitate a standardisation of tariffs, – facilitate the electrification programme and to – increase the efficiency of the industry – so it can continue to be an engine for growth and prosperity.

2. That the industry– move to cost-reflective tariffs and – that transparent taxes be established for

• electrification and • other municipal services

– to ensure the industry is able to meet its obligations long-term.

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EWG1995/6

ERIC1997/8

EDIRC1998/01

EDIH2003 - Present






EDI Blueprint6 REDs






MSF2005/6


2002/3


Inter RED subsidies

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“Maximum number of financially viable REDs”• Any number of REDs can be viable if they

charge their full cost to consumers and the consumers are able to pay.

• The challenge is to find a position where tariffs reflect cost and are aligned between distributors.

• Within a RED, the cost to supply customer categories are pooled to have equitable tariffs.

Proposed number of distributors• EWG process, between 1 to 17• ERIC process, optimum 5• EDIRC process, recommended 6• New proposal

– 6 Metro REDs (Urban) PLUS 1 National RED (Municipalities and Rural)

– National RED not financially independent;– REDs not balanced;– No supporting report– No evidence of detailed modeling.

Ind

ust

ry v

iabi

lity

Number of Distributors

1 5 10 15 20 25 30

Viable

Not Viable

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EDI Blueprint Modeling Criteria• Size – loss of economies of scale in creating businesses that are

unmanageably large;• Balance between REDs

– Urban / rural customers: each must have a significant urban load centre;– Load mix: domestic load is a key cost driver and should be balanced across

REDs;– Assets employed: Broad equivalence in the assets employed;– Load density (MWh per km line) should be balanced;– Load factor: balanced within a small range, above 70% LF;– Income per household balanced across REDs

• Financial independence– Avoid long term financial transfers between REDs;

• Implementation cost– Observe network configuration;– Observe facility requirements: Control centers; work management centers; stores

and depots;– Observe significant geographical boundaries: physical and political.

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Financial requirements• Need strong robust REDs

– Fund ongoing operation;– Fund required new capital expenditure;– Service debt;– Earn reasonable return on equity at prices which reflect efficient supply

costs.• Blueprint Recommendations

– Reliance of any one RED on financial transfers from other, financially stronger REDs should be avoided, except for the possibility of limited financial support during the establishment phase.

– A system in which some REDs are financially strong and others weak would be a critical mistake, and against the long-term interests of final customers.

– Any scheme of inter-RED financial transfers would quickly come under pressure, and be the cause of difficulty and tension from the outset.

– A desire by the stronger REDs to avoid/minimise the cash transfer is inevitable, the effect of which would be to place the weaker RED under financial strain – to the ultimate detriment of the final customer.

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EWG1995/6

ERIC1997/8

EDIRC1998/01

EDIH2003 - Present






EDI Blueprint6 REDs






MSF2005/6


2002/3


Inter RED subsidies

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THE SIX RED BLUEPRINT MODEL

Process and Analysis• Developed through a very thorough consultation process• Based on extensive independent consultancy support• Rigorous modelling with aim of achieving restructuring objectives• Recommendations were preceded by substantial expenditure to

enable the best possible solution

Outcomes • Restructuring objectives met; • REDs are balanced;• REDs are independently financially viable;• Mandatory participation by both Eskom and the municipalities;

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THE SIX RED BLUEPRINT MODEL (Cont…)

Outcomes Continued• No gross tariff disparities in neighbouring communities; • Cost reflective tariffs and viable supply areas; • Potential for a better credit rating;• More attractive to scarce skills;• Faster decision making;• Best able to incorporate / be responsive to local

stakeholder input and needs;• More likely to foster competitive behaviour leading to

improved levels of service and efficiency

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THE NATIONAL RED MODEL

PROCESS AND ANALYSIS• No public document

• No evidence of a detailed study and analysis

• Not aware that stakeholders, including NER / NERSA were consulted on the change to a National RED / 7th RED

OUTCOMES • REDs, not balanced;• National RED not financially viable;• National RED is substantially larger: long communication lines,

removed from local constituencies;

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THE NATIONAL RED MODEL (Cont…)

OUTCOMES CONTINUED• Potential for large tariff discrepancies with Metro REDs and negative impact

on customers; • Require subsidies from Metro REDs or the Fiscus: tension and reluctance to

subsidise potential inefficient operations;• Reluctance to cash transfers will place the National RED under financial

strain;• Challenge to regulate efficiency of operations - National RED can not be

benchmarked against the Metro REDs;• Single rural entity with central planning and execution – potentially stifles

much needed innovation and learning and inter RED competition.• Voluntary participation in the REDs is likely to result in the industry not

changing substantially from its present status.• Unresolved policy issues.

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MITIGATING CONDITIONS FOR NATIONAL RED MODEL

Issue: Financial viability of the National RED

Concerns• The National RED is not financially viable;• Continued financial support is required to contain tariffs at equitable

levels between the REDs;• Metro REDs will be reluctant to transfer cash to the National RED;• Metro REDs will be reluctant to accept a higher bulk purchase tariff

(wholesale) than the National RED

Condition• Provisions from the fiscus be put in place to fund a National RED.

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Issue: Ownership and Governance of a National RED

Concerns• Uncertainty regarding industry ownership and governance;• Transition arrangements are likely to cause further uncertainty and

delay restructuring to the end state.

Condition• A firm policy position must be taken regarding the ownership and

governance structure of the National RED and implemented from day one.

• Transfer of staff, assets and customers to the REDs on day one.

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Issue: Regulation of the National RED

Concerns• No provision is made for the Regulator (NERSA) to regulate the

National RED • The Regulator is the only entity that can ensure the regulatory

objectives are achieved • Regulatory skills are scares.

Condition• Appropriate legislation be put in place to ensure the National

RED, and the Metro REDs are regulated by NERSA

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Issue: Municipal levies (taxes to replace surpluses)

Concerns• Municipal revenue will be impacted by the restructuring of the EDI.• Uncoordinated taxes could result in irrational and discriminatory

levies on electricity sales.• Customer resistance to input taxes impacting competitiveness.• Discriminatory windfall taxes to municipalities with large users.

Condition• legislation to ensure fair and equitable levies are raised by

municipalities, to replace the existing surpluses generated

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Issue: Tariff rationalisation

Concerns• The National RED will have a different cost structure from the

Metro REDs. • The regulatory principles for rationalisation of tariffs in the industry

can not be applied uniformly;• Cost reflective tariffs will not be uniform between REDs;• Customers will want to move RED boundaries.

Condition• Metro REDs should be allowed to expand their customer base to

adjacent areas in the National RED.

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Issue: Voluntary participation by municipalities

Concern• Voluntary participation of municipal distributors in the National RED

is a major cause for concern in restructuring;• An inflexible stance by stakeholders will continue while unresolved

policy issues can still be influenced in their favour;• An inappropriate industry structure could result;• Using incentives to encourage voluntary participation may lead to

discriminatory treatment of consumers by the National RED.

Conditions• Outstanding policy issues must be urgently resolved to obtain

mandatory municipal participation.

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CONCLUSION

• Not enough time was available for the Energy Regulator to formulate its position;

• We have no details on the National RED;• We have supported EDI restructuring throughout the

existence of the NER; • We have indicated our preference for the six RED

model, based on sound restructuring principles;• Notwithstanding, we recognise that if policy makers wish

to proceed, we will support it .• Subject to the mitigation conditions for the deficiencies of

the National RED model;

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CONCLUSIONS (Cont..)

• Continued delays in the restructuring and policy uncertainty is at the expense of the industry. This is reflected in – Underinvestment in infrastructure; – Lack of appropriate maintenance; – Loss of skills and deterioration of assets;– Excessive transfer of electricity revenues to municipal surpluses.

• Policy finalisation is a matter of critical urgency;– Delays increases restructuring costs;

– Delays may limit potential investors.

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• The NERSA Secretariat respectfully requests that the Parliamentary Portfolio Committee consider the comments and recommendations of the NERSA Secretariat.

• Due to the unavailability of a public document on the National RED, the Regulator, respectfully request an opportunity to comment on such a document, once it is publicly available.

Thank you for your attention

Request to PPC

THE VIABILITY OF THE ESTABLISHMENT OF THE NATIONAL RED / 7th RED

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