Table of Contents

1.Introduction

COSATU, together with our affiliates in the electricity sector NUMSA NUM and SAMWU, welcome the opportunity to make this input to the workshop of the Minerals and Energy Portfolio Committee on Electricity restructuring.

The current proposals for restructuring the electricity industry are idiosyncratic: they meddle with the parts of the sector that work well by international standards, while leaving fundamental problems unsolved. In consequence, they promise soaring costs to households, a slowdown in electrification, and may undermine investment in the industry. COSATU’s main concerns around current proposals for restructuring of electricity are:

They involve substantial changes in pricing and supply systems that are not justified by developmental needs, and indeed seem likely to impose substantial price increases on consumers. This would undermine government’s programme of socio-economic transformation. There is no clear process for discussing the restructuring proposals, which has caused major uncertainties for both industrial and household consumers, as well as for workers in electricity. Even as government and labour are negotiating electricity restructuring under the NFA, the National Electricity Regulator (NER) is moving ahead to implement its own proposals.

• Overall, the proposals seem driven by an ideological commitment to establishing a market for electricity – a model that has proven a failure in a number of countries. This treats electricity as a commodity rather than as a basic need. Furthermore, it does not even seem to be based on hard evidence but rather on a faith in the efficacy of markets.

In this paper, we first review the importance of electricity for development in South Africa, and COSATU’s proposals for restructuring. We then examine some proposals from State agencies.

2. Electricity and development

COSATU’s vision for the electricity sector derives from our history, which saw access to energy shaped by class, race and gender. The apartheid state centred electricity provision on the mines and refineries, which are extraordinarily capital and energy intensive, and on white communities. It provided little electricity in black townships, and virtually none in the rural areas of the "homelands."

This history is reflected in the fact that in 1994, fewer than 40 per cent of households - and probably only around a quarter of African families - had access to electricity. By 1999, according to the October Household Survey, the overall percentage had risen to 69 per cent. Still, as the following table shows, electricity reached less than half of African households in the rural areas. Moreover, many of the new connections only permitted lighting, not cooking. Together with the cost of appliances, this explains the much higher use of electricity for light than for heat.

Main Sources of Energy for Households, 1999

Source: Calculated from, Statistics South Africa, October Household Survey 1999, Table 6. Statistics South Africa website (www.statssa.gov.za)

The implications of the continued lack of electricity in many households is graphically reflected in the Statistics South Africa study on child labour. In 1999, almost one in ten South African children spent eight hours a week or more collecting wood and water.

Historically, electrification in South Africa was made possible by robust government intervention. In particular, the state financed the initial investment in connections and generation. It then structured tariffs so that:

• Mining and refining, which use huge amounts of energy, received relatively cheap electricity.
• Other industry overall paid a higher mark-up, which subsidised household consumption and electrification.

In this context the democratic movement argued that we need a strategy for electricity that would link growth and redistribution. That means electricity must both improve living standards and contribute to employment and productivity. Specifically, it should:

• Support home-based production through higher levels of electrification,
• Reduce the burden of household labour, which falls heavily on women and children,
• Raise living standards in general and improve the conditions for study at home,
• Continue to provide cost-effective electricity for industry, if possible biasing production toward labour-intensive activities, and
• Develop a regional grid that will support development throughout Southern Africa.

To achieve these aims, our strategy for electrification must ensure that all households have access to electricity at a level that can support the use of basic equipment, including stoves as well as productive machinery such as sewing machines and welding equipment.

2.1 Ensuring affordable electricity

Genuine access must ensure that electricity is affordable for poor households. In 2000, the UNDP estimated that close to half of all South Africans -18 million people - lived in households earning under R350 per adult per month. It classed 61 per cent of Africans (compared to 1 per cent of whites) as poor. Some 72 per cent of the poor lived in the rural areas, where electrification is lowest.

Given mass poverty, ensuring affordable electricity requires careful structuring of tariffs. COSATU supported the ANC’s commitment, in its 2000 Local Government Manifesto, to free lifeline tariffs, which would ensure every household a supply of free electricity. This minimum amount should be enough to support both lighting and cooking. It can be offset by higher tariffs on the rich and on industry.

Cross-subsidisation of households by business does entail higher production costs for industry based outside the home. Since industry accounts for about 80 per cent of all electricity use, however, the mark up is relatively small – around 5 per cent – while the benefits for household come to around 50 per cent.

The impact on employment and production of this system is not obvious, and should be studied much more carefully. Energy-intensive industries are typically also capital intensive. Thus, the largest users of electricity - the aluminium refineries - create very few jobs, while requiring huge investments. In theory, they could generate jobs in more labour-intensive downstream industries, but these have been slow to emerge. In contrast, home-based production typically brings lower and more uncertain incomes, but generates much higher levels of employment relative to investment.

The electricity sector is also an important source of employment. However, employee numbers have more than halved from 66 000 in the 1980’s to about 31 000 at present, with labour productivity more than doubling over the same period. This has also been accompanied by extensive outsourcing and sub-contracting.

2.2 Managing regional inequalities

Given the huge regional inequalities shaped by apartheid, electrification also requires cross subsidisation between regions. The following table demonstrates these inequalities. Under the current system, electricity is provided by municipalities, which makes this kind of cross subsidisation difficult. As a result, municipalities in the former homelands face great difficulties in extending electricity, and some are in danger of collapsing. Meanwhile, in richer areas, electricity is used to cross subsidise other services.

Electrification by province, 1996

	Total number of households	% of households without access to basic electricity
Western Cape	983	15%
Gauteng	1,964	20%
Northern Cape	187	29%
Free State	626	43%
Mpumalanga	604	43%
KwaZulu-Natal	1,661	46%
North West	721	56%
Northern Province	982	63%
Eastern Cape	1,332	68%

South Africa	8,338	42%
Western Cape, Gauteng:	2,947	19%
Northern Cape, Free State, KwaZulu Natal, North West, Mpumalanga:	3799	46%
Eastern Cape, Northern Province:	2,314	66%

 

To deal with these inequalities, COSATU has long supported the proposal that the municipal distribution systems be replaced by a national distributor. The national distributor could ensure that both capital and skills are allocated to meet the needs of poorer regions.

2.3 Ensuring supply

South Africa currently has close to the cheapest electricity in the world. This situation arises in part because of Eskom’s operational efficiency, and in part because of large investments in the past, which have obviated new investment for the past 20 years. Most predictions suggest that new investment will only become necessary in seven to ten years.

The question thus becomes how best to increase supply when it becomes necessary. Options which have been proposed by different stakeholders include:

1. Invest in new plants funded by Eskom bonds.
2. Import electricity from neighbouring countries, which have substantial hydroelectricity power.
3. Invite private investors to generate electricity.

The first two options seem preferable. The first option would enable South Africa to take advantage of Eskom’s relatively low financing costs – substantially lower than the rate of return required by private investors. This would entail some increase in the Public Sector Borrowing Requirement (PSBR), but hold costs down, according to some estimates, by 25 per cent relative to private supply.

In addition, importing from our neighbours would help shift consumption to hydroelectric power, which is better for the environment, and provide the basis for expanded regional trade. It seems, however, that while the increase in income to our neighbours would be substantial, they do not generate enough to meet all our projected needs.

We should not turn to nuclear power, which is dangerous and unnecessary. The environmental standards for coal-fired plants should, however, be improved.

2.4 Summary of COSATU’s proposals

Our key proposals around electricity restructuring are as follows:

• Integration of municipal sectors into a national distributor.
• Vertical integration between generation, transmission and distribution, under continued public ownership.
• A stronger regulatory regime.
• Accelerated implementation of the lifeline block tariffs model, with cross-subsidisation as required by region, by sector (industry to households), and by income group.
• Increasing levels of electrification (quantities per household) to adequate amounts of electricity for full household use and basic economic activities.
• Raising finance through Eskom bonds where necessary to fund the increasing of supply.
• Increased focus on renewable sources of energy.
• We propose movement towards a National Energy Summit, which would facilitate an inclusive and comprehensive approach to the restructuring of the energy sector.

3. Proposals from the State

Current proposals for restructuring the electricity sector would mean the industry could no longer drive development. Moreover, they require massive system changes that seem likely to overstrain management capacity, leading to significant unintended consequences. The proposals derive from the Department of Mineral and Energy (DME) and the NER. Their status remains unclear.

The proposals mostly emanate from the consultants Price Waterhouse Coopers. It was reported yesterday that they have been paid R24.2 million for consulting on electricity restructuring.

We are also concerned that the Minister of Public Enterprises yesterday in his parliamentary press briefing made various announcements around electricity restructuring, when in our understanding we are still engaged in negotiations around the very same issues. For example, the announcements around the ringfencing of the distribution business as a separate EDI holdings company, the recommissioning of 10% of Eskom’s capacity with a BEE focus, and the intended sale of up to 20% of Eskom’s generation capacity undermine current engagements around the restructuring process.

The government proposals essentially start with the argument that the problem with electricity in South Africa is the absence of a market, in the sense of multiple buyers and suppliers interacting through the price mechanism. From this standpoint, Eskom must be inefficient simply because it has a monopoly on generation. A national distributor would be a monopsony, and similarly inefficient. Moreover, the cross subsidisation of households by industry means that prices do not reflect market prices, which is necessarily undesirable – if one believes markets are invariably efficient.

It follows from this approach that restructuring should centre, not on ensuring that electricity contributes to economic and social development, but rather on establishing a market. Indeed, the DME has told labour, in negotiations on electricity restructuring, that a key aim is to establish a competitive market. Key steps are to set up several generators and distributors, and ensure that prices reflect cost plus a specified mark up.

The NER is particularly wedded to market-based system. It writes,

"To ensure the success of the [electricity] industry, the NER is of the view that government should promote the following developments, namely-

• The establishment and operation of an effective and efficient rationalised, viable electricity supply industry;
• Eliminating monopolies in the generation and sales/supply sectors;
• Rationalising end-use prices and tariffs;
• Giving customers the right to choose their electricity supplier;
• Creating an electricity market;
• Introducing competition into the industry, especially in the generation sector;
• Addressing the impact of generation, transmission and distribution on the environment;
• Permitting open, non-discriminatory access to the transmission system;
• Levelling of the playing fields between distributors of electricity; and
• Encouraging private sector participation in the industry."

(NER, "The Electricity Supply Industry in South Africa," www.ner.org.za, May 2001)

These proposals simply ignore the inherent market imperfections and structural problems left by apartheid. That is the only way they can assume that the market will provide the most efficient outcome from a social standpoint.

In reality, mass poverty and unemployment mean that:

• Competition will likely only ensure good service for the rich, while the poor face higher costs and worse access, and
• Market prices would end cross-subsidisation of households by industry, which could actually reduce overall employment in the long run.

 

Further "unintended consequences" of the proposals could include disrupting the security of supply, lowering the standard of service, and compromising safety standards (both for workers and communities).

In addition, the large cost of new generation capacity can lead markets to underinvest systematically in the production of electricity. This was the experience in California, which adopted a very similar approach to restructuring electricity. As a result, it has faced blackouts and a distressing economic decline.

In fact, the general international experience of privatising electricity has often been disastrous. A study by the PSIRU (Bayliss 2001) gives examples from, amongst others, New Zealand, Australia, California, the U.K., Argentina, Brazil, the Dominican Republic, Moldova and Kazakhstan. To take two examples:

• New Zealand had two months of power cuts in 1999 because the private electricity company didn't maintain the underground cables. It simply wasn't cost effective for them to do this.
• California has also experienced protracted power cuts since the deregulation and privatisation of the electricity industry. Since this process started in 1996 prices have risen by up to 300 per cent, the system is completely fragmented, and there have been massive shortages in the generating capacity, resulting in frequent power failures. As a result, production in the state dropped by 10 per cent in 2000.

 

California Governor Gray Davis said in his State of the State address, "We must face reality: California's deregulation scheme is a colossal and dangerous failure. It has not lowered consumer prices. And it has not increased supply. In fact, it has resulted in sky-rocketing prices, price-gouging and an unreliable supply of electricity. In short, an energy nightmare… We have lost control over our own power. We have surrendered the decisions about where electricity is sold - and for how much - to private companies with only one objective: maximising unheard-of-profits."

In contrast, there is extensive international experience of highly successful and efficient publicly owned electricity utilities. For example, EDF in France was previously nationalised and remains under state ownership, is well known for its efficiency as well as its international expansion. The Nordic examples also present case studies of highly successful and sustainable public ownership. Any arguments for public ownership in developed countries are far stronger in developing countries which still face the challenge of increasing electrification, and even more so in a country such as South Africa with its extreme levels of poverty and inequality.

3.1 Creating multiple market participants

The logic that competition is always beneficial apparently lies behind the proposal to privatise 30 per cent of electricity generation. This proposal is also one source of uncertainty: labour has been assured repeatedly by government, even at Ministerial level, that the process will entail only the sale of mothballed plants and the licensing of new generators. Meanwhile, business has apparently been told that the process will involve the sale of Eskom capacity.

The NER proposals to introduce private generation - which derive from a study by PricewaterhouseCoopers (PwC) for the Department of Minerals and Energy - rest largely on the assumption that Eskom, as a monopoly, must be inefficient. The evidence does not support that claim. After all, Eskom has managed to spend around a billion a year for electrification. It supplies amongst the cheapest energy in the world, and maintains adequate services for industry.

Internationally, an academic study of private and public electricity utilities found that private electricity companies do not generally outperform public ones. For generation, the results provided "strong empirical support for the view that, given the technology employed, IOUs [privately-owned plants] and MUNIs [publicly-owned plants] were being operated equally efficiently." In transmission and distribution, the conclusion again was that there was "no significant difference in technical efficiency between the two ownership types."

If Eskom is forced to compete with private producers, it will find it difficult or impossible to deliver on its social obligations. After all, the way to maximise profits is to supply companies and the rich, not to extend electrification. Even if government funds electrification, it will no longer be a part of Eskom’s duties to ensure adequate service and affordability for the poor. The question becomes why we should restructure something which appears to be delivering well.

The decision to tax Eskom this year underlines the risks of the market-oriented approach. Government promised that it would return the taxes raised from Eskom through an electrification fund. Unfortunately, it then agreed with Eskom that the company could report a loss until 2004, and use any surpluses - which would earlier have gone for electrification - to improve its competitive ability in order to withstand private competition. The result? Government could only find R600 million for electrification on the budget; a similar amount will be supplied by foreign donors, This is hardly a desirable or sustainable way to meet a core government commitment.

A further problem lies in the possible NER requirement that Eskom raise its prices in order to ensure the viability of smaller producers. That would mean, paradoxically, that competition would bring higher prices. This danger becomes further apparent from a comment by the NER:

"An important consideration will be whether the tariff arrangements proposed by Eskom adequately reflect the full avoided costs of purchasing electricity from IPPs [independent private producers] and whether they are sufficient to encourage the entrance of new players." (NER, "The Electricity Supply Industry in South Africa," www.ner.org.za, May 2001)

The ideological drive to introduce competition apparently also lies behind the proposal to break Eskom up into three competing groups. The proposal is apparently being implemented, although we still do not know what it actually entails. If it leads to allocation of profits and perks according to performance, it could add to inequalities and reduce Eskom’s ability to intervene strategically to support development efforts. Generally, it seems likely to undermine Eskom’s ability to anticipate and meet changes in demand.

Problems also seem likely to arise from the insistence that we set up regional distributors - REDs - rather than a single national entity. As we understand it, the current government proposal is that a national distributor will be established as a transitional measure for five years. While we welcome the agreement to establish a National Holding Company, we are concerned that it may be dissolved into six REDS on a fixed time scale. Furthermore, the Holding Companies powers to transfer resources between REDS seem very limited, which would undermine its main justification.

Given the huge geographic inequalities left by apartheid, as discussed above, the establishment of regional distributors seems certain to ensure continued poor service in the former homeland areas, in particular. The more rural REDs will face lower incomes, higher costs, and less access to skills. Even the DME’s own evidence suggests that two of the REDs in particular – those covering the Eastern Cape and Northern Province – will not be viable. Government’s proposal to only transfer between REDs in extreme circumstances would not be workable, given the need for ongoing pooling of resources in order to ensure that people in all corners of South Africa benefit from our national electrification programme.

3.2 Ending cross subsidies

The second pillar of the market-oriented proposals is the assumption that market prices are always best for social and economic development. This approach would mean an end to cross subsidies. Typically this argument focuses on ending subsidies of households by formal industry. That would lead to an increase of between 20 and 50 per cent in household electricity tariffs.

The NER’s framework for electricity pricing, the Wholesale Electricity Pricing System (WEPS), is dedicated to ending cross subsidisation. In this system the termination of cross-subsidies follows naturally from the establishment of a market in electricity. Generators would be allowed to circumvent the REDS in order to supply larger customers (those using over 100 GWh a year). The benefits would go to large, energy-intensive industry and the generator; the REDs - and households - would bear the cost.

According to the CEO of the NER,

"The PricewaterhouseCoopers (PwC) study into EDI restructuring assumes the WEPS tariffing [sic] principles will apply when REDs are established. A large component of the predicted price increase in their Draft Blueprint Report is due to this fact, rather than the restructuring process itself. Even if restructuring is not done, the WEPS will be implemented as planned from 2002, resulting in price adjustments. (NER, Electricity Regulator Journal, March 2001, www.ner.org.za, May 2001; emphasis added)

For labour, the WEPS is a major source of uncertainty. We have been assured repeatedly by representatives of the DME, at the highest level, that the WEPS will not be introduced in the near future. Yet Eskom advertisements in the national press on Sunday, September 16, indicated that the WEPS is on the verge of implementation. It appears that the DME may not be fully in control of the NER’s pricing decisions.

To assess the WEPS, we need to consider its implications in the context of our long-run aims – to create employment, ensure greater equality in the ownership of assets and income, raise living standards for the poor and grow the economy. As noted above, from this standpoint, it probably makes sense to continue to levy somewhat higher charges on large energy-intensive industry in order to subsidise broader development through smaller, more labour-intensive producers. Unless located in a strategy to ensure downstream development, cheaper energy for big users will only keep us on the path of capital-intensive, labour-shedding growth.

It has been argued that the WEPS will still allow cross subsidisation of poor households by rich ones. But if the overall cost of electricity to households rises, as predicted by PWC, by between 20 and 50 per cent, the potential for cross-subsidisation will be radically reduced. In this context, the commitment to free lifeline tariffs will be undermined, since higher-income consumers could not manage the additional cost.

3.3 Summary of critique

The free market approach to restructuring electricity runs counter to government’s overall aim of serving the poor. It seems to arise from a commitment to privatisation coupled with a demand that Eskom pay taxes and a reluctance to fund new investment in generation through Eskom bonds. Indeed, the NER seems to see privatisation as integral to government policy:

"Market restructuring in the power sector should be seen in the context of a general policy to reform state-owned enterprises (SOEs). Corporatisation and commercialisation of SOEs, often linked to privatisation, form part of the process of separating the tasks of policy, regulation and commercial activities. This process has been adopted in South Africa, as in a wide range of other countries."

(NER, Electricity Regulator Journal, March 2001, www.ner.org.za, May 2001)

The NER’s proposals for restructuring electricity supply and distribution fly in the face of the government’s commitment to a strong developmental state. Even if Eskom itself remains in government hands, it would be fundamentally weakened as a tool for development and industrial strategy. It would provide a windfall for big business at the cost of micro enterprise and the poor, and effectively remove key assets from public control.

The status of these proposals remains very unclear, however. In bilaterals, the DME has assured labour that it would ensure the new distribution system is functioning before it undertakes substantial changes in tariffs. Yet as noted above, in the weekend newspapers Eskom advertisements painted a different picture.

4.The big questions

The current proposals point to two major debates.

First, when does competition lead to efficiency? As the recent DTI discussion document on industrial strategy points out, standard economic theory argues that markets function to serve the rich, not the poor. This may not be a major drawback in industrialised countries; in South Africa, which reportedly has the third worst income distribution in the world, it is devastating.

Some government spokespeople argue that "transparent subsidies" will remedy this defect. They contend that Parliament would then have the power to decide on a yearly basis whether to provide services to the poor. In contrast, they say, cross-subsidisation hides the real cost to society.

This argument ignores:

• The need to ensure stability in the system. As the recent experience with the electrification fund showed, annual budget decisions can lead to wild fluctuations, which in turn destabilise delivery systems. Parliament could equally decide on a stable, self-financing system of cross-subsidisation. That would not reduce Parliament’s sovereignty, since it can always change its decision. It would, however, ensure greater stability for key national priorities.
• The ability of the rich to mobilise against subsidies. Annual payments from the budget are certainly more open to lobbying by opponents than cross subsidisation through the pricing system.

 

Second, what is the relationship between electrification, job creation and economic growth? The RDP essentially argued that the development of household infrastructure formed a central way to stimulate productivity for the poor, provide income-generating opportunities, and ensure more equitable distribution of assets. That strategy would justify substantial government spending on municipal services in general. To succeed, however, it has to be located in the context of other efforts to support micro enterprise and employment generation.

The view inherent in the NER proposals seems to be that only electricity for big business is relevant to economic expansion. Electricity for the poor is simply a way to raise living standards - a discretionary luxury, rather than a necessity, for our development strategy. In this vein, many of the recent connections have only provided sufficient electricity for lighting purposes.

5. Conclusions

COSATU is opposed to the proposed introduction of WEPS and privatisation of generation. It is especially dangerous to push this through before the distribution system is even stabilised and in the absence of an adequate regulatory regime.

In any case, before rushing to restructure, we need research on:

• The impact of mark-up pricing, ending the cross subsidy of households (and home-based production) by industry, on economic growth, job creation, regional inequalities and poverty
• The scope for developing activities downstream from electricity-intensive industries
• The potential for importing electricity from neighbouring countries, and the implications for the regional economy.
• The likely impact of privatising generation, at least in part, on electricity prices in the next 20 years. The long time span is needed to take into account the cost of new capacity.

Only this type of in-depth social cost-benefit analyses can permit a reasoned discourse on electrification. They would let us set sound targets for electrification and electricity pricing, and define the best structures to achieve them. We would be available to participate in a joint process around this.

Finally, uncertainty about the process of restructuring electricity is damaging for labour, business, local government and consumers in general. We urgently need clarification on who is driving restructuring, and how decisions are made. Currently, no stakeholders are sure on the proposed process and timeframes for developing restructuring plans. This has added considerably to the economic and social insecurity faced by both labour and business. To deal with this problem, a more open and well-defined process of consultation should be developed, for instance based on tabling proposals at NEDLAC.

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