Governance, Regulatory and Institutional Issues in the Electricity Sector

1. Governance, Regulatory and Institutional Issues in the Electricity Sector Seminar Parliamentary Portfolio Committee on Energy Devon Valley Hotel, Stellenbosch Presented by Mark Pickering Meridian Economics 29 March, 2011

2. Is Electricity Governance working well enough?

3. Governance PerformanceGeneration planning - Policy milestones 1998 Energy White Paper • Government will require the use of integrated resource planning methodologies in evaluating further electricity supply investments and the decommissioning of older power stations (7.1.5.6) • The entry of multiple players into the generation market will be encouraged. (7.1.5.8) • Government will initiate a comprehensive study on future market structures for the South African electricity supply industry (7.1.6) • In the long term Eskom will have to be restructured into separate generation and transmission companies (7.1.6.1)

4. Governance PerformanceGeneration planning - Policy milestones 2004 Investment decision on Medupi (4800 MW coal), followed by Kusile decision (4,800 MW coal) in 2005 2009 • Nuclear procurement halted • In January and February Minister of Energy issues notice of intent to pass regulations in terms of the Electricity Regulation Act to regulate electricity supply planning and the procurement of new generation capacity • 5 August. Electricity regulations on new generation capacity. Regulation provides for the development of an integrated resource plan (IRP) to regulate the licensing of new generation capacity and the recovery of costs arising from independent power producers. • 31 December. Minister gazettes IRP1 “Determination regarding the integrated resource plan and new generation capacity” (3 pages) • 11 years after the Energy White Paper commitment

5. System PerformanceCapacity additions 1970-2028, actual and planned What happened? (Source: Eskom, 2010. Presentation to Parliament)

6. System PerformanceDemand-Supply Balance 2000 to 2007 Target: 15-19% 2008 load shedding (Source: Chettiar, Lakmeeharan & Koch. 2009)

7. System PerformanceDemand-Supply Balance 2010 to 2030 The draft Integrated Resource Plan (IRP) aims to keep the reliable reserve margin close to or above 15% from 2013 onwards. Decisions need to be made in 2011 on new-build in order to ensure security of supply in 2018. How will these decisions be made? (Source: Eskom, March 2011. Presentation to Parliament Based on final IRP)

8. System PerformanceOperations • Results of Eskom turbine over-speed test, 9 Feb, 2011 • 600MW turbine destroyed • Estimate R3bn and 18 months to replace • Are operations as safe and effective as they should be?

9. System PerformanceDistribution backlog • The maintenance and refurbishment distribution backlog continues to grow. • Will throwing money at the problem fix it? The government is considering an adjustment of the tariff to help fund the R27bn cost of replacing and repairing ageing distribution infrastructure. Poorly maintained and old distribution networks are one of the causes of electricity blackouts and have slowed down the roll-out of electrification as it is not possible to add new connections to them. Some electricity cables in Johannesburg date back to the 1930s.

10. System PerformanceEskom capital programme

11. System PerformanceEskom capital programme Medupi Ingula Kusile (Source: Eskom, March 2011. Presentation to Parliament) All three projects will take a decade or more from start of construction to final COD. How much more time is required beforehand for planning, permitting and financing?

12. System PerformanceEskom’s new Build Programme • Significant delays • Are delays reasonable? • Were they avoidable? • What economic cost to the country? (Source: www.eskom.co.za (new build programme) DOE, Nov 2010. Medium Term Risk Mitigation Programme)

13. Governance PerformanceStatus of IPP procurement processes After 13 years of pro-IPP policy statements we have yet to sign a significant Power Purchase Agreement

14. System PerformanceSummary • South Africa’s generation planning system clearly failed in the period 1990-2005 • Was there even a system? • Eskom’s new build programme has made progress, but has experienced significant delays • Very large scale projects that take a decade to build • Procurement issues • Human resource challenges • Shareholder failure to finalise the funding model until late 2010 • No significant IPP participation in the system • What do we learn from this?

15. What does the generation expansion plan require?

16. IRP2010Long lead times for power generators & related infrastructure Firm commitment necessary now Final commitment in IRP 2012 • A substantial portion of the IRP requires investment decisions by non-Eskom parties in 2011 and 2012: • Coal IPPs • Regional hydro and transmission • Gas import infrastructure • Renewables • Potentially even nuclear? • How will these decisions be made? Built, owned & operated by IPPs Commitment necessary due to required high-voltage infrastructure, which has long lead time Commitment necessary due to required gas infrastructure, which has long lead time Possibly required grid upgrade has long lead time and thus makes commitment to power capacity necessary (Source: DOE, March 2011)

17. IRP201Comment • IRP2010 represents an outstanding improvement on IRP2009 • Government has asserted its authority over Eskom • Consultation was broad and inclusive, and appears to have impacted on policy choices • Data transparency has improved, but still some way to go • Implementation is a much bigger challenge than planning • Who will implement the plan? • Eskom cannot possibly do it alone (financially and otherwise) • How will IPPs be attracted into the sector? • Regulatory framework remains unclear • Draft NewGenRegs published, but still to be finalised, and almost certainly inadequate • Feasibility studies still to be undertaken to determine allocation between State and Private generators • Significant uncertainty on the nature and role of the ISMO

18. How will the IRP be implemented?What institutional reforms are proposed?

19. Institutional ReformThe “standard model” for ESI reform Vertically-integrated, publicly-owned monopoly Commercialisation and corporatisation Independent regulation Unbundling to separate potentially competitive elements from non-competitive elements Private sector participation Introduction of competition IPPs for the market or wholesale competition in the market eventually customer choice and retail competition Done Not done (Source: Eberhard, 2010. UCT GSB)

20. Institutional ReformEmergence of the “standard model” of reform (Source: Eberhard, 2010. UCT GSB)

21. Algeria (2): Kahraba, Kahrama Morocco (3): Tetouan, JorfLasfar, Tahaddart Tunisia (2): El Biban, Rades II Egypt (3): Sidi Krir, Port Said, Suez Senegal (2): GTI Dakar, Kounoune I IPP* Burkina Faso (1): Hydro Afrique Ethiopia (1): Gojeb* Cote D’Ivoire (2): Vridi Ciprel, Azito Congo (1): Sonda (X) Kenya (4): Westmont, Iberafrica, OrPower4, Tsavo Nigeria (3): AES Nigeria Barge, Okpai, Afam* Ghana (1): Takoradi II Tanzania (4):Tanwat, IPTL, Songas, Mtwara Mauritius (4): Belle Vue, Deep River, FUEL, St Aubin Angola (1):Chicapa* Institutional ReformGreenfield IPPs in Africa 40 IPPs 15 Countries 10,000MW US$8 billion Source: based on WB PPI database as well as author’s compilation. Notes: (X) designates projects were cancelled; * designates projects are under construction; emergency power units not depicted. (Source: Eberhard, 2010. UCT GSB)

22. Institutional ReformMarket breakdown in six Latin American and six African countries Market structure depend on government policy. (Source: Pickering, 2010)

23. Institutional Reform Reality is often different from “standard model” • Power sector reform in most African countries has not followed the standard model • Few countries have fully unbundled their utilities • Private sector participation often limited to IPPs • Wholesale and retail competition often absent • Instead, hybrid power markets have developed • Incumbent state-owned utilities have retained dominant market positions • Independent Power Producers (IPPs) are being introduced on the margin • i.e. both State Owned Enterprise (SOEs) and IPPs are involved in new generation investments (Source: Eberhard, 2010. UCT GSB)

24. Institutional ReformSix key functions need to be performed Planning Allocation Procurement Buyer System Operator Transmission

25. Institutional Reform Historic structure of the ESI Eskom Holdings • Historically: • Vertically integrated utility • Eskom performed all the functions • Very little IPP procurement • The outcome has been: • A supply-side bias • Erratic fluctuations between over and under capacity • An unsustainable reliance on coal Gx IPP Planning Allocation Procurement Buyer System Operator Imp Exp Transmission KSACS D (Regions 1-6) Mun Mun KIC C C C C

26. Institutional Reform Allocation of functions under the 2009 Newgen Regulations Eskom Holdings IPPs Gx System Operator Planning MOE MOE, MOF Allocation Procurement Buyer? System Operator Imp Exp Government has been heavily reliant on Eskom to execute generation Planning and IPP Procurement. This is a very unhealthy situation, which has led to considerable frustration and wasted resources for aspirant IPPs. Transmission KSACS D (Regions 1-6) Mun Mun KIC C C C C

27. Institutional Reform Presidential commitment to an ISO “To ensure reliable power supply, we have established an Inter-Ministerial Committee on Energy, to develop a 20-year integrated resource plan. Among other things, this will look at the participation of independent power producers, and protecting the poor from rising electricity prices. We will establish an independent system operator, separate from Eskom Holdings. Eskom will continue to build additional generation capacity and improve the maintenance of its power stations.” (President Zuma. 2010, 11 February. State of the Nation Address) So, what functions will the ISO perform?

28. Institutional Reform Towards an Independent System Operator (ISO)? Eskom Holdings What functions will the ISO eventually perform? How will these functions migrate out of Eskom over time? How will the ISO be governed? Should Eskom be vertically disaggregated and a Transmission System Operator established? Imp Exp IPPs Eskom Gx ISO/ISMO/TSO Planning Buyer Allocation System Operator Procurement Transmission KSACS D (Regions 1-6) Mun Mun KIC C C C C

29. Eskom Holdings Imp Exp IPPs Imp Exp IPPs Eskom Holdings Imp Exp IPPs Eskom Gx Eskom Gx Eskom Holdings Imp Exp IPPs Eskom Gx Eskom Gx ISO/Grid Co ISO/Grid Co ISO/Grid Co ISO/Grid Co Planning Buyer Planning Buyer Planning Buyer Planning Buyer Allocation Allocation Allocation Allocation Procurement Procurement Procurement Procurement System Operator Transmission System Operator Transmission System Operator Transmission System Operator Transmission RED1 RED2 RED… RED6 KSACS D (Regions 1-6) RED1 RED2 RED… RED6 KSACS D (Regions 1-6) C C C C C C C C Mun Mun Mun Mun KIC C C C C KIC C C C C Limited unbundling, pre-REDs Vertical unbundled, pre-REDs Various ways to do things… Limited unbundling, with REDs Vertically unbundled, with REDs

30. Concluding Comments

31. Conclusion • The performance of South Africa’s power system has deteriorated in some key respects over the last two decades • Generation planning has been particularly poor, leading to dangerously low reserve margins and, in some years, load shedding • Investment decisions have been non-transparent and debateable. Some project choices (Medupi and Kusile) have probably increased the risk of shortages, due to their size, approach to construction and uncertain funding. Smaller projects and an open market may have led to greater security of supply • Despite repeated policy statements favouring IPPs very little has been achieved, and many investors have written us off • In general, the governance of the sector has been unimaginative and reactive, with little willingness to experiment with market forms and frequent failures to complete processes.

32. Conclusion • South Africa is clearly not following the Standard Model for power sector reform, although some elements have been in place for over a decade • South Africa is beginning to recognise the challenge of managing a hybrid system, but has yet to implement institutional reforms to ensure that the functions of Planning, Allocating, Procuring and Buying are performed effectively and independently of Eskom. • South Africa should seriously consider unbundling Eskom and establishing a Transmission System Operator over time.

33. Thank You