The Roadmap for Eskom 2019 and its impact on the IPP industry

by Jason van der Poel, Alexandra Felekis, Mzukisi Kota & Mongezi Dladla at Webber Wentzel

Mzukisi Kota WWWW-0729-01 LR.jpg

On Tuesday 29 October 2019, the South African Minister of Public Enterprises, Pravin Gordhan, released, and held a media briefing on, a special paper entitled "Roadmap for Eskom in a Reformed Electricity Supply Industry, 2019" (the Roadmap). The Roadmap highlights the issues that Eskom is currently facing and then sets out the government's plan to address them.  Eskom is currently vertically integrated.  The aim is for Eskom's transmission business to be fully functionally separated into a newly formed subsidiary of Eskom Holdings SOC Limited by 31 December 2021 and for the legal separation of the utility into three companies - generation, transmission and distribution - by 30 December 2022. Webber Wentzel set out below a summary of the Roadmap and their thoughts on some key takeaways flowing therefrom for independent power producers (IPPs), lenders and other stakeholders.

Background

Eskom is facing financial, governance and leadership, operational, structural and climate change challenges. The Roadmap makes it clear that Eskom, in its current form, has failed. The Roadmap, in a high-level manner, outlines the process that will be followed in the restructuring of Eskom as well as the actionable steps to mitigate the electricity supply risks, and to put Eskom and the electricity supply industry on a new path of sustainability.  Among other things, the Roadmap seeks to:

  • address steps to restore Eskom's finances, including government support;
  • identify measures to reduce Eskom's cost structure; and
  • commit to a just transition, safeguarding the livelihood of workers and communities in observing South Africa's climate change commitments.

The New Business Model

Eskom Holdings will hold three subsidiaries, namely, Eskom Generation (Generation Entity), Eskom Transmission (Transmission Entity) and Eskom Distribution (Distribution Entity). The aim is to improve the power utility through greater transparency and accountability and to allow government more effectively to address generation, transmission and distribution challenges separately. Webber Wentzel note that the Generation Entity, the Transmission Entity and the Distribution Entity will not become separate state-owned enterprises and will not have any strategic equity partners from the private sector as had been mooted by some stakeholders.

In the immediate future, the creation of the Transmission Entity is a priority as it is the keystone in Eskom's reform. This entity will be wholly owned by Eskom Holdings and "its core functions will be to act as an unbiased electricity market broker, to promote capital investment within the industry and to catalyse energy efficiency and cost sustainability".

In order for it to achieve its objectives, this separate Transmission Entity will need to meet certain conditions that are set out in the Roadmap, including to:

  • provide access to the grid on a non‐discriminatory basis to the Generation Entity and IPPs;
  • dispatch electricity from the existing asset base of generators and following clear least‐cost principles and penalise generators that do not perform as contractually agreed; and
  • provide full transparency about the performance of the power system to all market participants and the general public.

Governance and Leadership

One of the main drivers for the restructuring of Eskom is the necessity to improve the governance of Eskom. The restructuring of Eskom therefore aims to introduce a robust and transparent corporate governance at Eskom. Each of the subsidiaries having their own boards with separate mandates is intended to increase leadership's accountability for each of the functions. It will also be simpler for the boards to identify and address governance and operational issues within their functions.

The Roadmap provides that the board of Eskom Holdings will be reinforced with individuals with the appropriate skills set and that a new CEO for Eskom Holdings will be appointed "soon".

Thoughts on the Impact of the restructuring of Eskom on the IPP industry

Is a change in law required and how long will this all take?

The aim is for Eskom's transmission business to be fully functionally separated into a newly formed subsidiary of Eskom Holdings by 31 December 2021 and for the legal separation of the utility into three companies - generation, transmission and distribution - by 30 December 2022. We note that this restructuring of Eskom as is currently envisaged in the Roadmap does not in and of itself necessitate a change in legislation. Currently, Eskom is regulated by, among other things, the Eskom Conversion Act (ECA) and its Memorandum of Incorporation. Under these instruments, Eskom has the power, among other things, to incorporate subsidiaries, subject to other relevant regulatory statutes such as the Public Finance Management Act and the Labour Relations Act. Accordingly, the mere formation of the operational divisions into subsidiaries would not, in the ordinary course, require legislative changes. Setting up new corporate entities with independent boards will, however, be a time-consuming task.

From a legislative perspective, what is of greater concern is how Eskom's debt will be allocated as a result of the restructuring. Neither the Roadmap nor the Minister of Finance's Medium Term Budget Speech 2019 provides any detailed guidance on how Eskom's existing debt will be managed or restructured. The ECA provides that Eskom's debt and interest, unless otherwise agreed between Eskom and the lender, must be a first charge against all revenues and assets of Eskom. The successful implementation of the Roadmap will thus require substantial buy-in from Eskom's lenders. The Roadmap recognises this and specifically acknowledges that engagement with Eskom's lenders is required.

In future however, and if the plan is to separate these subsidiaries from the Eskom group and establish them as independent state owned entities, then there will likely be a need for the appropriate legislation to be enacted.

The Transmission Entity will be the Buyer

According to the Roadmap, the last phase of the restructuring will be completed by the end of 2022 with the three functions of generation, transmission and distribution housed in the three different Eskom subsidiaries. During the transitional separation period, the function of procuring new energy will remain with the Department of Mineral Resources and Energy (Department) and the buyer function will reside in the Transmission Entity. The Transmission Entity will buy energy from the generators under power purchase agreements (PPAs) procured by the Department and sell the energy under electricity supply agreements (ESAs) entered into with the Distribution Entity, municipalities or large power users. When the restructuring has been completed, the buyer for purposes of the PPAs entered into with generators (including the IPPs) will be the Transmission Entity and therefore the existing PPAs between Eskom and various IPPs will have to be transferred to the Transmission Entity. This however, should not be of great concern to IPPs and lenders, provided that the sovereign guarantees provided by the Government of South Africa under the implementation agreements are not adversely affected.

Distribution is only discussed briefly in the Roadmap. The Distribution Entity will be authorised to buy from the Transmission Entity, licenced municipal generators and embedded generation. The Roadmap states that further consideration will be given to the structure of the distribution sector as a whole and that the appropriate policy parameters will be formulated in due course. This is a fundamental shift towards an open and competitive market and should be welcomed by the private sector. However, the credit worthiness of the Distribution Entity will be a key challenge that will have to be addressed.

What does the Roadmap mean for the heavily anticipated Renewable Energy IPP Procurement Programme Bid Window 5 expected to commence next year?

Probably not much as the timing for establishment of the three entities is estimated only to be achieved by 30 December 2022. If the next bid window goes ahead next year, Eskom in its current form will still be the buyer. So what is relevant to Bid Window 5? The plan states that 2000MW that will stabilise the system in response to the load-shedding must be procured on an urgent basis. The Department intends to issue a request for information (RFI) that seeks information regarding supply and demand side options available that can be brought online in the shortest possible time at reasonable cost. Arguably the RFI responses will inform which technologies are procured or developed first and in what period of time. It is clear from the recently published 2019 Integrated Resource Plan (IRP 2019), that new solar PV and wind could be feeding electricity into the grid by 2022. At this stage the exact number of MW available to IPPs is an open question as all existing Ministerial Determinations will be revised to give effect to the IRP 2019 and some of these MW may be allocated exclusively to Eskom.

What will Eskom's new Generation Entity mean for IPPs?

Regarding the generation of electricity, the restructured Eskom as envisaged by the Roadmap will have a Generation Entity that is responsible solely for generation. The Roadmap proposes that the current power plant base will be separated into a number of feasible smaller generation units, including renewables, with the intention that over time, the generation market will become more competitive and decentralised.

All Eskom-owned power plants will be housed in this entity and the entity will contract with the Transmission Entity for the right to sell electricity and use the grid in the same way as IPPs would need to. A key concern for IPPs is whether in fact all parties will be treated equally - will the agreements to be entered into between these affiliated entities be on a true arm's length basis or will priority be given on the basis that the majority of the required generation capacity is generated by the Generation Entity’s assets.

As indicated above, the idea of a more open and competitive generation market is reiterated in the Roadmap and therefore a level of competition could exist between the Generation Entity and the IPPs. Eskom will likely seek to broaden its business by diversifying into various sectors of energy production including renewable energy. Should this be the case, the allocations for renewable energy technologies in the IRP 2019 may not be sourced from IPPs exclusively, as may have been assumed by stakeholders. Another key question is whether or not the Generation Entity will be permitted to participate in REIPPPP and compete directly with IPPs. The industry will however have to wait for the Ministerial Determinations in respect of this new generation capacity in order to ascertain whether the renewable energy MW allocations under the IRP 2019 will be sourced from the Generation Entity, IPPs or both.

What does the Eskom split mean for captive power IPPs wanting to wheel electricity?

Currently, the Electricity Regulation Act (ERA) governs the generation and sale of electricity in South Africa. The ERA contemplates access to the system by third parties and expressly obliges a distributor or transmission licensee to grant non-discriminatory access to the system to an IPP provided that: (i) the IPP has obtained the necessary license for the generation and sale of electricity to a third party; and (ii) the conditions of the distributor or transmitter's license are met. In addition to meeting the requirements in the ERA, an IPP will need to meet Eskom's wheeling requirements. To date, rights to wheel electricity on Eskom's transmission or distribution system have been granted sparingly by Eskom.

The Roadmap echoes the ERA and includes non-discriminatory access to the grid as one of the objectives of the split. IPPs would be required to agree on wheeling arrangements with the Transmission Entity. On the premise that the grid will be available for all generators of electricity, rules and procedures for wheeling will have to be put in place to ensure equality amongst all users. A key question will be whether it will be easy to put wheeling arrangements in place for captive power projects looking to sell to private third party off takers or whether priority will be given to power plants supplying the transmission and distribution entities.

Conclusion

Webber Wentzel sees the release of the Roadmap as a positive step in the commencement of a restructuring of South Africa's electricity supply industry to minimise Eskom's reliance on fiscal allocations and to stabilise electricity supply. Although the Roadmap provides some clarity on the way forward for the struggling utility, the process poses many questions that need to be answered to restore investor confidence and drive further private investment in the energy sector. To this end, the market is patiently awaiting greater clarity from the Government of South Africa on the management of Eskom's debt in light of the Roadmap, the appointment of a permanent Eskom CEO and how national stakeholders who oppose Eskom's restructuring will be managed. The questions to be answered in order to restore investor confidence in the South African electricity market will require a high degree of alignment between the Minister of Public Enterprises, the Minster of Mineral Resources and Energy and the Minister of Finance.

Mongezi Dladla.jpg Jason-van-der-Poel.jpg Alex Felekis WWWW-1839-01 LR.jpg
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