US embassy cable - 05PRETORIA3233

UNCLAS SECTION 01 OF 03 PRETORIA 003233 
 
SIPDIS 
 
Sensitive 
 
STATE PLEASE PASS USAID 
STATE PLEASE PASS USGS 
USDOC FOR 4510/ITA/MAC/AME/OA/DIEMOND 
DOE FOR THOMAS SPERL 
 
E.O.   12958: N/A 
TAGS: EPET, ENRG, EINV, EIND, ETRD, ECON, SF 
SUBJECT: SOUTH AFRICA: REGIONAL ELECTRICITY DISTRIBUTOR 
ESTABLISHED, BUT FRAUGHT WITH QUESTIONS 
 
 
Summary 
------- 
1. (U) On July 4, the government launched the country's 
first regional electricity distributor (RED) - known as 
RED ONE.  For the moment, RED ONE encompasses only Cape 
Town and a few nearby municipalities in the Western Cape, 
but the plan is for up to 40 municipalities to 
voluntarily join.  RED ONE is part of a much broader plan 
to create six regional distributors that will be able to 
provide local electricity service more efficiently than 
187 municipalities do now.  However, serious legal, 
commercial, and operational hurdles must be resolved 
before the REDS plan can be implemented.   The government 
is determined that restructuring take place, and has 
promised to apply greater political pressure and amend 
municipal law, if need be.  The Electricity Regulation 
Bill, due in Parliament at the end of August, may be the 
first opportunity to resolve some of the legal and 
operational issues.  End Summary. 
 
BIG RED 
------- 
2. (U) On July 4, Minister of Minerals and Energy Lindiwe 
Hendricks launched in Cape Town what the government 
billed as the first regional electricity distributor (RED 
ONE).  Actual operations began on July 1.  The timing of 
the launch met the July 1 deadline that President Mbeki 
put forward in his opening speech to Parliament last 
February.  RED ONE is the first step of a plan to create 
six regional distributors by 2007 to manage the supply of 
electricity to end users throughout the country. 
 
3. (U) At the launch, Phindile Nzimande, CEO of 
Electricity Distribution Industry Holdings, Inc. (EDI, a 
government corporation established to facilitation the 
creation of regional distributors) said that 
restructuring along regional lines should raise the 
efficiency, quality, and affordability of electricity for 
everyone in South Africa.  As larger entities, the REDs 
should be able to reach economies of scale, be better 
able to build and maintain infrastructure, and harmonize 
the 150 plus tariffs that are currently charged across 
the country. 
 
4. (U) RED ONE will be managed by a Chief Executive 
Officer and a Chief Operating Officer who will report to 
a 15-person board.  Appointed as first CEO is former Cape 
Town Council member Saleem Mowzer.  Appointed as first 
COO is former Eskom Western Region General Manager Peter 
Sechemane.  Phindile Nzimande was appointed Chairperson 
of the Board.  As CEO of EDI, she also reports directly 
to Minister of Minerals and Energy Lindiwe Hendricks. 
Six other board members have also been named. 
 
OR LITTLE RED? 
-------------- 
5. (SBU) Despite the hoopla of the launch, the truth is 
that nothing much has changed from an operational point 
of view.  RED ONE comprises only the Cape Town 
Metropolitan area, already an active municipal 
electricity distributor before it became RED ONE.  What 
has changed, however, is that, legally, the Cape Town 
Municipality now functions as a RED.  Some forty other 
municipalities throughout the Western Cape Province and 
the western section of the Northern Cape Province may now 
voluntarily join RED ONE.  For this to start happening, 
however, quite a few issues still need to be resolved. 
Still under negotiation is compensation for and transfer 
of assets and liabilities to RED ONE, shareholding in RED 
ONE, revenue sharing by participating municipalities, as 
well as various governance and competition issues. 
Moreover, there is still a debate over what type of legal 
entity RED ONE should be, i.e., a public enterprise or a 
municipality. 
 
6. (SBU) Tom Skinner, Eskom's Project Manager for 
Distribution Restructuring, believes that RED ONE 
negotiations with Eskom will take at least six to 
eighteen months to complete, and that incorporation of 
all regional municipalities will take at least three to 
five years to complete.  In the meantime, Eskom has 
agreed to supply RED ONE with electricity for 18 months 
in lieu of its commitment to the Cape Town Metropolitan 
area. 
 
A Constitutional Matter? 
------------------------ 
7. (U) The reason for all of the delay and extended 
negotiations is that the establishment of regional 
electricity distributors (REDs) flies in the face of the 
South African Constitution, which delegates the delivery 
of electricity to municipal government.  Section 156 
states that only municipalities have the authority to 
administer "electricity and gas reticulation, and street 
lighting."  Reticulation is defined as the distribution 
of electricity at 380 volts or less.  This means that, 
short of amending the constitution, authorities have just 
two options for establishing a RED: i.e., build a RED on 
top of an existing municipal entity; or declare a RED to 
be a municipal entity.  One way or the other, it is for 
the municipalities to decide whether to join. 
 
The Municipal Problem 
--------------------- 
8. (SBU) Currently, some 187 municipalities out of a 
total 284 distribute electricity at 380 volts or less to 
their own and sometimes neighboring municipalities. 
Government estimates indicate that 50% of these 
municipalities would probably not be economically viable 
if revenues from their electricity services were 
withdrawn.  Because of this, many municipalities have 
been very reluctant to accept the idea of relinquishing 
their electricity distribution services to a RED, despite 
of government assurances of compensation.  Even the 
National Treasury worries that municipalities without 
electricity revenues would saddle the national government 
with bankrupt municipalities. 
 
9. (SBU) In the meantime, municipalities seem to be 
making a mess of electricity distribution.  Knowing that 
regional electricity distributors were coming, many 
municipalities have failed to maintain their distribution 
networks or replace skilled technicians.  Deteriorating 
infrastructure and capability has led to increasing power 
failures, even in larger municipalities like 
Johannesburg.  Moreover, municipalities have often set 
local tariffs according to financial need rather than to 
facilitate growth and development.  The result has been 
that there is a huge differential in prices and service 
levels among municipalities, with the poorest 
municipalities charging the highest prices. 
 
Municipal and Public Finance Law 
-------------------------------- 
10. (SBU) As government authorities are discovering, 
creating REDs based on municipal law creates a number of 
problems of its own.  Municipal law stipulates that 1) 
municipalities must control 51% of the shares in any 
joint venture formed, 2) may not make foreign loans 3) 
must adhere to a cap on salaries for senior staff, and 4) 
must follow certain procedures to obtain approval for 
capital expenditures.  Both EDI CEO Nzimande and ESKOM's 
Skinner pointed out to us that municipal law could 
hamstring future RED operations, because it does not 
allow for the REDs to make quick decisions, hire highly 
skilled staff, or easily acquire advanced equipment. 
They want to find a way to incorporate the REDs as state 
owned enterprises so that they may more freely operate as 
independent, competing public corporations, unencumbered 
by the legal and fiscal constraints normally imposed on 
local government. 
 
11. (SBU) As it stands now, municipalities have the 
constitutional right to opt out of the REDs scheme.  They 
can continue to distribute electricity even after a 
regional electricity distributor is established.  Eskom 
would still be legally bound to supply electricity to 
them.  This makes the whole scheme voluntary, and 
strengthens the negotiating hand of the municipalities. 
 
12. (SBU) According to EDI's Nzimande, government will 
continue to solicit the voluntary incorporation of 
municipalities in REDs, using economic and commercial 
benefits to persuade them to join.  She said that 
government was determined that restructuring take place, 
and would resort to political persuasion (the ruling ANC 
party controls most municipal councils today) and even 
amendments to the municipal law, if need be.  No one is 
talking about amending the Constitution at this time, 
since regional electricity distribution does not warrant 
the opening of Pandora's Box on other constitutional 
questions. 
 
Next Steps 
---------- 
13. (SBU) The Government knows that it has to finalize a 
number of operational and commercial issues before it can 
implement its RED scheme.  These include: the ringfencing 
from a municipal budget point view of municipal services 
from electricity distribution, compensation to 
municipalities for the loss of electricity revenues, 
compensation to Eskom and municipalities for the transfer 
of assets to the REDs, RED ownership and how to share RED 
revenues among owners, Eskom's role (Eskom currently 
supplies directly to some 150 large users such as the 
mines and plants), the National Energy Regulator's (NER) 
role in determining tariffs, and how to manage 
competition between the REDs and Eskom.  The Electricity 
Regulation Bill, due in Parliament at the end of August, 
may be the first legislative opportunity to resolve some 
of these issues. 
 
FRAZER