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Cablegate: Eskom Reduces Tariff Hike Request, Looks for Private

VZCZCXRO7823
RR RUEHBZ RUEHDU RUEHGI RUEHJO RUEHMA RUEHMR RUEHPA RUEHRN RUEHTRO
DE RUEHSA #2498/01 3381452
ZNR UUUUU ZZH
R 041452Z DEC 09
FM AMEMBASSY PRETORIA
TO RUEHC/SECSTATE WASHDC 0477
INFO RUCPDC/DEPT OF COMMERCE WASHINGTON DC
RHEBAAA/DEPT OF ENERGY WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCNSAD/SOUTHERN AF DEVELOPMENT COMMUNITY COLLECTIVE
RUEHZO/AFRICAN UNION COLLECTIVE

UNCLAS SECTION 01 OF 03 PRETORIA 002498

SIPDIS
SENSITIVE

STATE PLEASE PASS USGS
DEPT FOR AF/S, ISN, EEB/ESC and CBA, and OES/EGC
DOC FOR ITA/DIEMOND
DOE FOR T.SPERL, G.PERSON, A.BIENAWSKI, M.SCOTT, L.PARKER
TREASURY FOR D.PETERS, P.STEWART

E.O. 12958: N/A
TAGS: ENRG EPET EMIN EINV ETRD ECON SENV PGOV SF
SUBJECT: ESKOM REDUCES TARIFF HIKE REQUEST, LOOKS FOR PRIVATE
CAPITAL, AND JOUSTS WITH GOVERNMENT

REF: A) Pretoria 2315; B) Pretoria 2166 and previous

This message is sensitive but unclassified, not for Internet
distribution.

1. (SBU) SUMMARY: State power utility Eskom backtracked on its
controversial 45 percent tariff hikes for each of three years, at
the last moment revising its application to the regulator down to 35
percent per year. At the same time it announced a number of new
strategic initiatives, a desire for private investment, and delays
in some projects. Many stakeholders deemed the revised rates still
too high and inflationary. Separately, the SAG released some
details of its newly Cabinet-approved Integrated Resource Plan, with
timeframes for some projects differing from Eskom-announced plans.
The Energy Minister highlighted security of supply for pursuit of
nuclear and other projects despite budget woes. USAID Southern
Africa is currently exploring the possibility of providing
assistance to the SAG under its Africa Infrastructure Program. End
Summary.

----------------------------
Never Mind 45% - We Want 35%
----------------------------

2. (SBU) Eskom, South Africa's state-owned power utility, made a
number of significant announcements on December 1. Eskom submitted
a last minute revised tariff application to the National Energy
Regulator of South Africa (Nersa), reducing its requested rate
increases to 35 percent from 45 percent per year over the next three
years. To budget for lower tariff increases, the utility announced
that its second proposed coal-fired power station - Kusile - will be
phased in one year later than originally planned, and that a private
equity partner will be sought for as much as 30 percent of the 4,800
MW power plant, initially scheduled to start coming on line in 2013.
In addition, Eskom is recommending that South Africa postpone its
already-delayed nuclear power program, new gas-fired peaking plants,
and a wind project at Sere.

---------------
Strategic Shift
---------------

3. (SBU) Acting Executive chairperson Mpho Makwana characterized
the decisions as marking a "significant strategic shift" for Eskom,
mainly referring to the quest for private investment in some
projects. The local investigative paper Mail & Guardian depicted
Makwana as a new super hero "Mister Electricity" providing new
"energy" sorely needed at the utility. Eskom forecast a budget
shortfall of $1.9 billion over the next three years, less than the
$4.0 billion originally projected. Eskom announced that it will
reduce the shortfall, despite the slower rate increases, through
project-level private equity partnerships, project deferrals, and
power conservation and demand management initiatives. Makwana
warned that the revised funding plan was based on finely balanced
assumptions on economic growth and the cost of primary energy. An
Eskom spokesperson asserted there was no short-term threat to
security of supply, but admitted the system would remain vulnerable
from 2011 through 2012 when the first turbine of the Medupi
coal-fired power plant comes on line. She said strong demand-side
initiatives were essential to help mitigate any vulnerability. A
power analyst at Frost & Sullivan still predicts power outages from
Qpower analyst at Frost & Sullivan still predicts power outages from
mid-2010 to 2012.


------------------------------------
Not so Fast - Government does Policy
------------------------------------

4. (SBU) On December 3, Energy Minister Dipuo Peters released some
details of the SAG inaugural integrated resources plan (IRP1), which
had been approved by President Zuma's Cabinet December 2. It
appeared that the SAG was reasserting its preeminence on strategy in
announcing this long-anticipated planning document, which presented
some misalignment with Eskom's announcements in conjunction with the
revised tariff request in the same week. According to Minister
Peters, the IRP1 is premised on no delay in Kusile or the other
projects that Eskom proposed delaying to make its numbers work.
Minister Peters said the SADOE believed that all the projects are
necessary to "keep the lights on." She added, "We cannot stop
planning [for security of supply] simply because there is no money.
In my view you have to plan and then look for the money based on the

PRETORIA 00002498 002 OF 003


plan." SADOE acting Deputy Director General (DDG) Ompi Aphane, who
has overseen drafting of the IRP1, indicated that Nersa will use the
IRP1 to make its determination on the capital project aspect of
Eskom's application. Aphane said the SAG would begin broad
stakeholder consultations in January to formulate a second stage
IRP2. Aphane also announced that an Independent System Operator
(ISO), separated from Eskom in a phased procedure, would be created.


---------------------------------
Negative Reactions to Tariff Hike
---------------------------------

5. (SBU) Meanwhile, business, labor, and politicians were almost
uniformly critical in their reaction to Eskom's revised 35 percent
tariff hike request. Business Unity SA (BUSA) said, "We view the
revised proposal as still being on the upper side. It could have
unintended outcomes on the economy." The Agricultural Business
Chamber said, "The revised price hike is very high - probably too
high." Labor federations, other business groups, the ruling
African National Congress party and opposition parties all took
issue with the requested hikes.

-----------------
Inflation Worries
-----------------

6. (SBU) Economists agreed that the scale of South Africa's
impending electricity tariff increases are the biggest single threat
to the country's inflation outlook. Eskom has hiked its power
prices 91 percent since 2005. Many commentators have opined that
the requested tariff hikes will be inflationary, but it is not clear
how much sophisticated analysis of direct and indirect costs have
been modeled. ABSA Capital said the revised 35 percent increase in
electricity tariffs would directly contribute 0.6 percentage points
to the inflation rate over a full financial year. A Barnard Jacobs
Mellet analyst told Deputy Economic Counselor that with a 35 percent
nominal tariff increase, he would expect inflation to remain within
the 3-6 percent target band for most of 2010 and 2011. Nonetheless,
Eskom had told the analyst that the 35 percent increase is in real
terms, which would represent about a 41 percent rise in nominal
terms. Reserve Bank Advisor Brian Kahn said publicly that tariff
increases of 30 percent would probably see inflation remaining just
below the 6 percent inflation target ceiling. Therefore, any higher
increase could prevent the country from attaining sustainably lower
levels of inflation in the medium term. The Reserve Bank assumed a
25 percent tariff increase in its latest economic projections.

--------------------------------------------- -
Private Project Capital, but not Privatization
--------------------------------------------- -

7. (SBU) Most commentators were positive about Eskom's decision to
seek private project capital, but skeptics noted the failure to set
up any independent power producers (IPPs) in the past. Government
policy has long targeted up to 30 percent provision of power by
IPPs, but it has been unable to set up a transparent environment to
attract investors. For example, the then-Department of Minerals and
Energy tender for peaking power plants failed to negotiate a
contract with preferred bidder U.S. firm AES, which eventually
Qcontract with preferred bidder U.S. firm AES, which eventually
dropped contract negotiations, or with runner-up Suez of France.
The newly-approved Integrated Resource Plan has been promised to
provide the framework and policy for engaging IPPs and developing
nuclear and renewable energy. According to aspects of the IRP1
released, there is only 1,100 MW set aside for renewable energy,
cogeneration, and conventional IPP power between 2010 and 2013.
SADOE said the IRP2 planning for post 2014 would quantify power
arising from IPPs as "likely to be far more material".

8. (SBU) Neither the SAG nor Eskom has broached privatization of
Eskom itself. Some economists have suggested that Eskom be broken up
and listed, but discussion of privatization of Eskom and parastatals
generates knee-jerk negative howls from many sectors of the South
African scene. One of the sources of Eskom's challenges is that
government's attempts to involve independent power producers were
not successful, for a number of reasons, and many stakeholders
became disillusioned. Delays in capacity investment during that
period allowed demand to overtake supply, discrediting the potential
of private power in the eyes of many. Eskom and other South African
parastatals have boards that ultimately defer to the single powerful
"shareholder" - the government. As one commentator noted, "the

PRETORIA 00002498 003 OF 003


government wields power without responsibility; the boards have
responsibility without power."

----------------------------
Nuclear and Renewable Energy
----------------------------

9. (SBU) Energy Minister Dipuo Peters has reaffirmed the SAG's
commitment to nuclear and renewable energy in public comments.
Speaking at a recent nuclear conference, she said that the SAG had
taken the lead in formulating the process for selecting a technology
partner for providing up to 20,000 MW of conventional nuclear power
plants. (The Eskom turn-key tender was cancelled in December,
2008.) The SAG is still expected to announce the way forward by
March 2010. The Minister said the first new nuclear power plant
would be up and running by 2020. Westinghouse remains well
positioned to be a technology supplier, given its global track
record in technology transfer. The SAG is still determining its
level of support to the new fourth generation Pebble Bed Modular
Reactor, which is still many years away from commercialization for
power and industrial process heat.

10. (SBU) With regard to renewable energy, Minister Peters
reaffirmed at the nuclear conference that the SAG aimed to install
10,000 gigawatt-hours of renewable energy capacity by 2013,
introduce one million solar water heaters by 2014, advance demand
side management (DSM), and introduce new energy efficiency
initiatives. She also cited the importance of climate change
negotiations and South Africa's Long Term Mitigation Scenarios.
While the regulator has established viable renewable energy feed-in
tariffs (REFIT), thus far South Africa has had only very modest
success in implementing renewable energy projects, largely due to
uncertainty about Eskom purchase agreements for independent
producers and other aspects of SAG policy.

--------
COMMENTS
--------

11. (SBU) Tariff tussles and management turmoil at Eskom are likely
to continue to slow strategic planning at the utility and in
government to establish a fruitful framework for engaging the
private sector and diversifying the energy mix, not to mention
mitigating carbon emissions. The boardroom struggle at Eskom that
led to the departure of the CEO and Chairman (Ref A) resulted from
ambiguity and meddling from the highest levels of government. This
kind of institutional uncertainty could continue to discourage
private investment.

12. (SBU) Continued negative reactions to proposed tariffs may
force Eskom to further pare its rate increase proposals, perhaps to
25 percent per year. This is a tricky balance, to allow tariffs to
reach a more normal market basis to improve Eskom's balance sheet
and attract private investment while keeping the impact reasonable
on inflation, the economy, and consumers. South Africa's
electricity pricing is complicated by municipalities and
residential/industrial/concessionary considerations, but even after
two years of significant increases, current prices are among the
world's very lowest. Three years of significant increases would
move them much closer to international parity. Prices that would
allow private investors more profitability could make a difference
Qallow private investors more profitability could make a difference
in attracting outside capital, as well as encouraging conservation
and improved efficiency. Without private capital, demand may again
outpace supply, resulting in new capacity shortfalls and new threat
of load-shedding.

12. (SBU) U.S. ASSISTANCE, OPPORTUNITIES FOR U.S. PRIVATE SECTOR:
U.S. investors will continue to look seriously at the South African
market, but will be looking for clarity on tariffs, regulatory, and
policy frameworks. USTDA is looking at opportunities to provide
feasibility studies and or technical visits to facilitate U.S.
exports or investment related to power projects. USAID Southern
Africa is currently exploring the possibility of providing
assistance under its Africa Infrastructure Program to the SAG. The
current situation strengthens the case for such assistance. The USG
also aims to launch a bilateral strategic energy dialogue and
implement a recently-signed nuclear energy R&D agreement.

Gips

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