Economic Regulation of the Regional Electricity Distributors: Critical Challenges

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1 Economic Regulation of the Regional Electricity Distributors: Critical Challenges EDI Restructuring for Developmental Local Government: Development Bank of South Africa: 28 October 2005 Prof Anton Eberhard Management program in infrastructure reform and regulation University of Cape Town

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3 The electricity system in South Africa Ultimate goal reliable and cost-effective electricity services provided by efficient, financially sustainable utilities Characteristics Integrated system: Gx, Tx & Dx Nearly all publicly owned Monopoly supply; no competition Need for regulation to protect consumer Effective regulation requires price control over entire electricity value chain

4 Will consumers receive reliable and cost-effective power? Historically NER has passed on billions of rands of savings to consumers through regulating Eskom and municipality electricity tariffs e.g. in 2004 Eskom applied for 8.5% increase but only 2.5% allowed May no longer be possible Electricity Regulation Bill may strip power of NER to regulate prices for 98% of consumers University of of Cape Town - -Graduate School of of Business Growing leaders in in emergent markets

5 Essence of new Bill Municipalities no longer required to seek licence from NER for electricity reticulation The licence is the legal mechanism empowering the NER to set and/or approve prices (Chapter III) Municipalities will now set and approve tariffs within national norms and standards prescribed by the Minister (Chapter IV) Municipalities also given control over service providers such as Eskom and REDs operating within municipal boundaries

6 Why are these radical changes being proposed? Constitution.. a municipality has executive authority in respect of, and has the right to administer.electricity reticulation 156(1)(a); Schedule 4B A decade of debate about what this actually means Bill chooses an interpretation that maximises powers of municipalities Reticulation defined as distribution and supply (trading) of electricity to the community (domestic, commercial and light industrial customers) within its area of jurisdiction

7 Electricity Regulation Bill is fundamentally flawed 1. Misunderstanding of how economic regulation works 2. Regulatory powers divided (duplicated) between NER and Minister 3. Municipalities face conflicting governance and regulatory roles 4. Proposed compliance and enforcement procedures are unworkable Consequences 1. Effective economic regulation not possible 2. Consumers not adequately protected in terms of receiving a reliable and cost-effective service

8 (1a) Problem with regulating via national norms and standards Might be appropriate for technical areas such as quality of supply But they are useless for establishing cost effective tariffs levels for customers supplied by specific utilities Can only be applied in a general sense and are weak and ineffective instrument for driving down costs and protecting consumers They are no substitute for standard economic regulatory methodologies such as rate-of-return or price-cap regulation

9 (1b) Economic regulation involves.. Cost-minimisation and efficiency Cost-reflective tariffs - financial sustainability of utility Adequate return on investment: utilities encouraged to invest in maintenance and expanded services Social equity / fairness: electrification and tariffs are affordable by poor

10 (1c) Effective economic regulation requires professional regulator Requires understanding of operational costs, the asset base, investment plans, cost-of-capital and revenue requirement of individual utilities and involves setting realistic and effective incentives for efficiency improvements Rate-of-return or price or revenue caps We should employ international best-practice Individual utilities need to be regulated Entire value chain needs to be regulated

11 (2) Regulatory powers should not be divided between NER and Minister NER has progressively built professional capacity which constitutes a valuable national resource Involvement by Minister in prescribing norms and standards confuses regulatory roles and responsibilities and compromises the independence of the regulator Will the Minister issue timely, relevant, enforceable norms and standards? Will they be consistent with the regulatory methodology of the NER?

12 (3) Municipalities should not face conflicting regulatory roles Local councillors represent constituencies that desire free or minimal cost electricity Municipalities own and operate electricity assets and desire to maximise returns and extract surpluses And now they are also requested to play a neutral role in tariff-setting and approvals i.e. balance financial viability of utility while ensuring consumer protection Is it realistic to expect municipalities to balance these conflicting goals? Evidence suggests that they don t get it right assets have been run down, quality of supply is deteriorating

13 So what should be done? Most elegant solution is to remove one word from the Constitution - electricity i.e. it will then be beyond dispute that municipalities have no exclusive right to set and approve electricity tariffs and the NER will be able to regulate the entire value chain

14 What should be done (2): Define executive authority over, and the right to administer electricity reticulation as being limited to municipalities being responsible for ensuring that local electrification planning is integrated with other development planning (such as housing and water) The NER can thus regulate the entire electricity value chain This is consistent with the Constitution: 155 (7) The national government.has the legislative and executive authority to see to the effective performance by municipalities of their functions in respect of matters listed in Schedules 4 & 5, by regulating the exercise by municipalities of their executive authority referred to in Section 156 (1). Developmental local government

15 What should be done (3) Clarify the role of municipalities in relation to electricity distribution Local electrification planning (yes) Asset ownership (shareholding in the REDs) Operations (transfer to REDs) Economic regulation- tariff setting & approval (no) Clarify municipal governance over REDs Essentially that of a shareholder arms length Shareholder agreement and SDA with REDs (yes) No day-to-day operational involvement No control over tariffs and prices Clarify in Electricity Regulation Bill (re-write Chapter IV) and in Electricity Distribution Restructuring Bill and exemptions from aspects of MSA and MFMA

16 Electricity regulators* in Africa *Regulators generally outside Ministry but may, or may not, have final tariff-setting authority

17 African Forum of Utility Regulators AFUR recommends that the following key principles form part of an initial framework for utility regulation in Africa: Minimum regulation necessary to achieve policy and sector objectives; Adherence to transparent decision-making and due process requirements; Independent or autonomous regulation where possible; Accountability towards government, investors and end-users Non-discrimination when not in conflict with policy prerogatives of government; Protection of investors against physical and regulatory expropriation; and Promotion of competition by limiting anti-competitive behaviour. A Framework for Utility Regulation in Africa 2003

18 Conclusion Professional and effective economic regulation of the entire electricity value chain (including municipal distribution and REDs) is essential to maintain and advance reliable and cost-effective electricity services for all South Africans We need to align ourselves more with international best-practice (municipalities have no pre-ordained, exclusive right to control electricity distribution) Electricity sector stakeholders need to restore sense to the policy debate and to legislative developments (this already happening)

19 The Management Programme in Infrastructure Reform & Regulation (MIR) is an emerging centre of excellence and expertise in Africa. It is committed to enhancing knowledge and capacity to manage the reform and regulation of the electricity, gas, telecommunications, water and transport industries in support of sustainable development. Prof Anton Eberhard Research, training courses, consultancy University of Cape Town

20 Multiple responsibilities of regulators Economic regulation of natural monopoly components Facilitation of new investment Quality of supply Dispute resolution Market information Policy advice Advancing public benefits