Competition News, Edition 12, June 2003

Labour

South Africa's organised labour position on the restructuring of the electricity industry can be summarised thus: "If it ain't broke, why fix it?" Eskom is seen as one of the most successful utilities in the country, offering the best prices consumers can find in the world. There is excess capacity to last at least another four years. Moreover, most of the poorer sections of the country are now connected, and government's electrification programme targets continue to be exceeded. According to organised labour, restructuring will compromise Eskom's universal service obligations and cross-subsidisation across customers. Furthermore, the introduction of competitors might trigger price increases in the sector and lead to job losses. Government, in its policy development around the sector, is addressing the issues of universal service and cross-subsidies.

Municipalities

Municipalities are principally concerned that the restructuring initiative might impact negatively on their financial viability. Most of them derive a substantial amount of revenue from electricity sales. Distribution assets, liabilities, staff and systems will have to be transferred to the REDs as consolidation of the distribution sector takes place. This will dry-up the income stream and threaten their financial viability. The transfer of assets will also result in weaker credit ratings for municipalities. In addition, some municipalities use the revenue from electricity sales to cross-subsidise the provision of other services such as water and sanitation. According to the recently published Electricity Distribution Industry Restructuring Bill, REDs will be subject to the multi-jurisdictional ownership of the contributing municipalities. This should allay the municipalities' fears and concerns.

Eskom

Eskom would prefer to maintain the status quo where it is the only player in the market. Government differs with Eskom with regard to the timing and method of introducing competition. Whilst the DME supports immediate restructuring and open competition, followed by full privatisation, Eskom would prefer to view restructuring and partial privatisation as long-term goals. Eskom also sees itself as a champion of government's social upliftment through its electrification programme. The mistaken view is that once competition is introduced, universal service will die a natural death. This is not necessarily the case. Proper and effective regulation should guard against this. In any event, universal service in the future would be the mandate of the REDs, not Eskom. The EDI Restructuring Bill should therefore address the question of compensating Eskom for its distribution assets.

Policy Issues and International Lessons

The proposed market structure will see Eskom retaining no more than 70% of the market, with IPPs and BEE companies owning the remaining 30%. The industry will be oligopolistic with one dominant firm and a few small players.

This structure immediately raises some concerns from a competition policy perspective. Although the current Competition Act does not condemn concentrated market structures per se, oligopolistic industries are notorious for stifling competition. Common anti-competitive practices associated with structures where there is one dominant firm include the abuse of a dominant position, price fixing, market sharing and excessive pricing. Lessons from international experience indicate that getting the structure of the market right is the first and most crucial step in restructuring the ESI. According to Binz and Frankena,⁶ "If legislators do not get market structures 'right' as current restructuring plans are being developed, it is unlikely they will have an opportunity to go back and fix structural problems at a later date." Eskom will still wield the majority of market power, which will insulate it from the threat of competition. The 30% private sector participation is certainly not sufficient to provide an antidote to abuse and does no justice to effective competition. Furthermore, there will be institutional barriers to entry, preventing further entry by IPPs for a certain period of time. If restructuring is to be done, it should be done properly; otherwise changing the status quo of the industry will not fully achieve, the desired outcomes.
In order for the entry of new firms to have an impact on the conduct of the incumbent firm it must be timely, likely and sufficient. It is questionable whether the entry of IPPs, which will take up 30% of the market, will be timely, considering the current performance of shares in the energy markets. Add to that the current regulatory and policy uncertainty surrounding the ESI restructuring process, it must be contemplated that investors will need a little more persuasion to commit their funds to the industry.
The second lesson from jurisdictions where ESI restructuring has succeeded, e.g. in the UK, is the presence of two or more equal-sized competitors and a few small players to start with. Here the market has been opened up gradually. This reinforces the viewpoint that effective competition at the beginning of the process is paramount.
Thirdly, successful restructuring needs to be undertaken against the background of excess generation capacity. This is done in order to contain price increases and enhance consumer welfare. Excess capacity is running out in South Africa. The market system, as envisaged, may still work, but it may not produce the desired benefits of lower prices for consumers. Government has indicated that IPPs and not Eskom should install new generation capacity. Considering the long lead-times needed for such investments, and the lack of interest by private investors at this stage the only plausible option would be to put the generation of new capacity up for tender. This would allow Eskom to participate without having to wait for an emergency request to approach the company as 'supplier of last resort', when there is no investment forthcoming.

A fourth observation from international experience is the presence of gas as a very close substitute for electricity. South Africa has begun the exploration for gas in Mozambique and Namibia. These efforts should be encouraged, as they will strengthen competition. The viability of gas as an alternative source of energy will depend on its cost advantages relative to coal.