Portfolio Committee on Minerals and Energy Public Hearing on RED1 Progress, the current situation and the Way Forward

1
Portfolio Committee on Minerals and Energy Public
Hearing on RED1 Progress, the current situation
and the Way Forward

• Presentation to Minerals and Energy Portfolio
  Committee, Parliament, Cape Town
• Wednesday, 14 February 2007

2
Overview of presentation

• History of Restructuring
• Objectives of Restructuring
• RED1 Establishment
• RED1 Governance
• RED1 Strategic Goals and Strategies
• RED1 Supply Area Pre 25 October 2006
• RED1 Transition Agreements
• RED1 Planning for Transfer

3
Overview of presentation cont.

• RED1 Stakeholder Engagement
• RED1 Stakeholder Engagement The City of Cape
  Town position
• Recent developments The City of Cape Towns
  position
• Recent developments Cabinets 25 October
  decision Issues arising from recent developments
  RED1s income
• Issues arising from recent developments Special
  Combined Company and Board Meeting
• Challenges, Successes, Values and Lessons Learnt
• Conclusion
• Way Forward

4
History of Restructuring
5
History of Restructuring

• Background
• National Government decided in May 2001 to
  restructure the Electricity Distribution Industry
  (EDI) into six Regional Electricity Distributors
  (REDs)
• President Mbeki announced in 2004 that the first
  RED would be established on 1 July 2005.
• RED 1 was elected the first RED to be
  established, with the City of Cape Town as core
• RED 1 has now been operating for just over 18
  months.

6
Objectives of Restructuring
Energy White Paper Objectives EDI Restructuring Blueprint Objectives
Ensure electrification targets are met Achievement of governments electrification programme Universal access to electricity for all South Africans
Provide low-cost electricity Sustainable electricity supply to low-income consumers, regardless of location, at affordable prices
Facilitate better price equality Sustainable electricity supply to low-income consumers, regardless of location, at affordable prices
Improve the financial health of the industry Future REDs to operate on a sustained, financially viable basis as independent businesses
Foster proper co-ordination of operations and investment capital Future REDs to operate on a sustained, financially viable basis as independent businesses
Improve quality of service and supply Acceptable and sustainable levels of supply security and quality
Attract and retain competent employees Future REDs to provide secure employment to their employees, provide skills development and training consistent with a high technology, modern distribution business Transition to be done within the context of a comprehensive human resources strategy and an agreed social plan
Planned and managed transition
7
RED 1 Establishment
8
RED 1 Establishment

• Sponsors Committee, as project governance, and
  RED Committee, as project implementer,
  established by EDI Holdings, CCT and Eskom
• City of Cape Town (CCT) followed required
  legislative prescription prior to choosing the
  RED as the vehicle of electricity service
  provision
• Municipal Systems Act (MSA) Sections 78 and 80
• Municipal Finance Management Act (MFMA) Section
  84
• Registered by EDI Holdings as company 02
  November 2004
• Established as a Municipal Entity by City of Cape
  Town 31 May 2005
• Commenced Operations 01 July 2005
• First phase - transfer of CCT electricity
  business and Eskom business within the Cape Town
  metro area
• Further phases were to follow pending final
  decision by Cabinet on EDIR end-state
• Licensed by NERSA

9
RED 1 Establishment (continues)

• Various agreements concluded
• Service Delivery Agreement (SDA) between CCT and
  RED 1
• Operating and Transitional Plan for Transfer
  Agreements (OTPTAs) with both the Citys
  Electricity Directorate and Eskom
• RED 1 Board appointed
• Business Plan and Budget Approved (RED1 Board and
  City)
• Transfer of CCT Electricity Department and Eskom
  Metro Portion planned for-
• March 2006 June 2006
• November 2006 December 2006
• June 2007
• Date for transfer consistently moved by City

10
RED 1 Governance
11
RED 1 Governance

• Seven independent non-executive Board Members
• P Nzimande (Interim Chair) M Kalawe N Walaza L
  Mayekiso J John Prof A
• Eberhardt (resigned 08/2006)
• Four Board Committees
• Finance and Procurement
• Strategy and Operations
• Audit and Risk
• Human Capital and Remuneration
• Company Secretariat appointed
• Internal Audit functions sourced from Citys
  Internal Audit Unit
• External Audit Auditor General of SA
• Executive Management appointed
• CEO, COO and CFO

12
RED 1 Business Plan
13
Mission, Vision Values

• Mission
• "To enhance the lives of our people and drive our
  economy by providing affordable electricity and
  related services in an efficient, reliable, safe
  and sustainable manner"
• Vision
• "To lead the South African journey towards the
  provision of world class consolidated electricity
  distribution and related services"
• Values
• To effect sound corporate governance
• To excel in customer relations
• To lead decisively but with humility and
  resilience
• To encourage and value learning, initiative and
  creativity
• To be committed to the transformation of our
  society
• To embrace diversity, recognise strengths and
  develop potential and skills

14
Strategic Goals
Goal 1 Reliability of Supply at Affordable Cost
Goal 2 Protection of Lower Income Earners
Goal 3 Developing Human Capital
Goal 4 Sustained Financial Viability
Goal 5 Planned Managed Transition
Goal 6 Branded Customer Service

• Operational Strategy and Budget to drive
  achievement of goals

15
RED 1 Operational Strategies

• Strategic Operational Plan
• Business Re-engineering
• Network refurbishment and growth
• Maintenance plans
• Rationalised tariff for CCT customers
• FBE Agreements signed with both CCT and Eskom
• 2010 Energy requirements
• Operational Accountability and Monitoring System
• Quality of supply measurement
• Business process monitoring
• Integrated Recovery Plan (Outages)
• 90 day plan
• Demand Side Management Campaign
• NERSA Audits - March 2006
• State of the network and assets
• Power outages

16
RED 1 Other Business Strategies

• Human Capital Strategy
• Compensation Framework
• Harmonised Conditions of Service
• HR policies
• Employment Equity Plan
• Performance Management
• Due diligence on CCT staff
• No Eskom due diligence to be undertaken until
  suspensive conditions met
• Systems Strategy
• Blueprint developed
• Implementation approved by RED 1 Board and CCT
• Benefit For first time CCT Electricity
  Department fully ring-fenced
• - Finance
• - Human Resources
• - IT
• - Legal
• - Business Operations

17
RED1 Supply Area Prior to 25 Oct 06

• Initial area of supply is the area of
  jurisdiction of the City of Cape Town
• Final area of supply to include abutting
  municipalities?
• MOU with Drakenstein

18
Transactional Nature of RED1

• SDA signed between the RED CCT
• Operating agreements (OTPTA) in place between the
  RED1, City of Cape Town and Eskom whilst
  finalising transfer of business arrangements
• License issued by NERSA

19
RED 1 Transaction Agreements
CCT
All Agreements and Nersa Licences expired on 31
December 2006
SDA
RED 1(Municipal Entity of CCT) Control over CCT
geographic area and all customers
NERSA Licence
OTPTA
OTPTA
CCT Electricity Department
Eskom Distribution Portion within Metro Area of
jurisdiction
20
Transaction agreement linkages

• All agreements were subject to resolutive
  conditions
• Conditional to ensure transfer of businesses
• Agreements were inter-linked
• Agreements expired 31 December 2006

21
SDA OTPTA LICENCE Conditions

• OTPTA Conditions
• (31 Dec 06)
• NT Asset Transfer Framework
• Electricity Act approval
• Competition Act approval
• Regulatory provisions for staff transfer
• Eskom Suspensive Conditions (to be resolved by
  DME)

• Licence Conditions
• (31 Dec 06)
• City Transfer (City OTPTA)
• Eskom Transfer (Eskom OTPTA)
• SDAs with other municipalities

• SDA Conditions
• (31 Dec 06)
• OTPTA Conditions
• RED1 Tariff Harmonization Plan
• FBE agreements

Fulfilling conditions is dependent on number of
parties NT, DME, DPE,DPLG, SALGA CCT, RED1, Eskom
22
Planning for Transfer
23
RED1 preparations for transfer

• Draft Asset Transfer Framework developed
• Principles for Wires and Retail transfer
  developed
• RED1 SAP solution and systems strategy
• Human Capital Strategy
• Regulatory provisions for staff transfer
• Transfer, Placement migration strategy
• New Conditions of Service developed
• Retirement Fund arrangements
• Engagements with regulatory and other state
  agencies
• Nersa
• National Treasury, DME, DPE, DPLG, etc
• Stakeholder engagements

24
Retirement Fund arrangements for RED1 employees

• RED1 Pension Fund registered
• All City of Cape Town and Eskom staff to join
  Pension Fund on date to transfer
• Defined Contribution Fund
• Rules allow for other 6 REDS to be participating
  employers
• Fund is suitable for either ME or PE RED (no rule
  changes needed)
• Rule amendment to make the fund dormant given
  RED1 uncertainty
• Municipal Category (a) tax status needs Income
  Tax Act amendment employer, not fund issue
• RED1 Pension Fund to be deregistered if entity
  wound-up

25
Wires Assets to be Transferred to RED1

• Total value of assets to be transferred - RAll
  distribution network assets 132 kV and below to
  be transferred
• Dedicated, and
• Non-dedicated lines
• All fibre optic networks used for operation of
  RED1 infrastructure
• Systems data (including SCADA) supporting these
  networks
• Technical service depots within RED1 boundaries
• Staff currently employed in supporting these
  networks
• Stock pro rata relative to assets transferred
• Mechanical plant, fleet and technical support
  elements pro-rata basis

26
Finalizing the transfer

• RED 1 Due Diligence
• Asset Schedule
• Staff Liability Schedule
• Contracts to be ceded
• No Eskom due diligence until Eskom suspensive
  conditions met
• National Treasury Asset Transfer approval (still
  not finalised and approved)
• Eskom Suspensive Conditions (no longer valid
  given 25 October 2006 cabinet decision)
• All conditions precedent in all transaction
  agreements to be met before transfer

27
Stakeholder Engagements
28
Stakeholder Engagements

• Parliament
• National Departments
• Provincial Government
• City of Cape Town
• Abutting Municipalities
• SALGA
• Metropolitan Forum
• Eskom
• NERSA
• Business
• Organised Labour
• Customers
• Eskom
• CCT

29
Recent developments The City of Cape Towns
position 1 August 2006

• Background the City of Cape Towns August 2006
  preconditions to transfer included
• That Cabinet must approve the 61 model
• Promulgation of asset transfer framework in terms
  of the MFMA
• As an implicit precondition, that RED1s status
  as a municipal entity must not change
• Staff consultation and consent by each member of
  staff

30
Recent developments The City of Cape Towns
position 2 September 2006

• Agreement with City, in September 2006, that,
• Transaction agreements be extended
• RED1 apply for licence extension
• EDIR licence condition dates be extended
• Extension contemplated from 31 Dec 2006 to 1 July
  2008
• Planned City transfer - 1 July 2007

31
Recent developments Cabinets 25 October
decision

• Key points
• End-state structure for the restructured EDI is
  the six wall-to-wall RED model
• REDs should be public entities, not municipal
  entities
• Nersa should have regulatory jurisdiction over
  the whole of the Electricity Supply Industry
  (including municipal supply areas)

32
Recent developments The City of Cape Towns
Council position 3 - 08 November 2006

• City change of mandate
• City Mayco resolutions of 08 November 2006
• City requests licence to be transferred back to
  it
• SDA and OTPTA be allowed to lapse
• City to engage with EDIH about future of RED1
• Senior Counsel opinionto be sought
• Mayco mandate confirmed by Council on 7 December
  2006

33
Recent developments The City of Cape Towns
Council position 4 04 December 2006

• The Citys position
• As contracting party The Council meeting on 07
  December 2006 resolved to allow the agreements
  between RED1 and the City to lapse
• As service authority The City applied to Nersa
  to have the distribution licence transferred from
  RED1 back to the City and opposed RED1s
  application for an extension of the licence
• Nersa Public hearings held on 07 December 2006
• On 14 December 2006 NERSA awarded licence to the
  City for period of 6 months
• As shareholder The City will need to decide
  what to do with RED1 as a company

34
Recent developments The City of Cape Towns
position

• Citys key objective is to run the Electricity
  Service as a department of the City Council.
• This will take the EDIR 10 years back
• The future of RED1
• Agreements with the City lapsed on 31 December
  2006
• Licence issued to City on 14 December 2006 City
  as the sole shareholder to wind up RED1
• City may use RED1 as a vehicle for its own
  corporatisation strategy (divorced from the
  nationally-driven EDIR project)
• City may offer its shares in RED1 to EDI Holdings
  as a potential buyer
• The RED1 Board must approve the transfer in terms
  of article 26 of the Companys Act
• EDI Holdings must consider commercial risks of
  taking over RED1

35
Issues arising from recent developments RED1s
income 1

• Past income
• There are management fees owing to RED1 by the
  City of Cape Town
• RED1 (or its liquidator, if it is wound-up) has
  the power to recover payment of those fees
• Likely outcome is that the City will have to
  provide security for RED1s debts as part of a
  voluntary winding-up process, rather than pay
  funds over to RED1
• RED1s Board has still not been paid since their
  term of office commenced 18 months ago on 01 July
  2006
• RED1 Staff salaries have not been paid since
  January 2007 (even through staff have valid
  contracts)
• City thus in breach of employment contracts
• Potential constructive dismissal claims by RED1
  staff

36
Issues arising from recent developments RED1s
income 2

• Future income
• with the SDA and OTPTA lapsing on 31 December
  2006, RED1 will not be paid a management fee
  beyond that date (all outstanding claims prior to
  31 December 2006 are still owed to RED1 by the
  City)
• These amount to R5.2m as verified independently
  by the Citys own Internal Audit Unit
• RED1 continues to have obligations beyond that
  date (eg in respect of creditors, salaries and
  rental)
• If RED1 is wound-up through a voluntary
  winding-up, then its shareholder will be required
  to put up security for continuing obligations for
  a 12 month period

37
Issues arising from recent developments Special
Combined Company and Board Meeting

• The Executive Mayor requested the RED1 Board to
  convene a Special Combined Company and Board
  meeting on 25 January 2007 to obtain
• Directors statement on the affairs of RED1
• Impact of Cabinets decision on EDI
  restructuring
• Way forward for RED1
• The RED1 Board presented an
• Overview of RED1s establishment and its
  activities over the past 18 months
• Steps taken to effect the transfer of assets and
  staff
• Recent developments
• Current financial position of RED1
• Future of RED1
• The RED1 Board requested the City to review its
  decision to wind up RED1
• The City negotiate with national government,
  through EDI Holdings an alternative solution
  within the broader EDI Restructuring context.

38
Issues arising from recent developments Combined
Special Board and Company Meeting 25 January
2007

• The RED1 Special Combined Company and Board
  meeting resolved that
• The City-
• pay RED1 the amount owing to RED1 ito the OTPTA
  over the past 18 months pending an independent
  verification exercise by the Citys Internal
  Audit Unit
• continues to process all payments on behalf of
  RED1, including staff salaries and outstanding
  creditors
• inform RED1 by no later than 28 February 2007 as
  to the outcome of the discussions between EDI
  Holdings and the City regarding the future of
  RED1
• discussions between the City and EDI Holdings
  have deadlocked therefore no longer an option
• option is now to wind-up RED1

39
Issues arising from recent developments Combined
Special Board and Company Meeting 25 January
2007

• In light of the above, RED1 to-
• Commence retrenchment consultations with staff
• Terminate all contractual obligations of RED1
• The RED1 Board submit a further report to the CCT
  on options to the City in deciding on the future
  of RED1
• The options are-
• (1) Transfer of shares to EDI Holdings on terms
  to be agreed
• (2) (a) Voluntary winding-up in solvent
  circumstances
• (b) Voluntary winding-up in insolvent
  circumstances
• (3) Winding up by court order in solvent
  circumstances
• (4) City retains RED1 as a shell company

40
Current position of RED1

• RED1 has no ongoing source of income
• RED1 has no operational basis for continuing
• Staff salaries for January 2007 have still not
  been paid despite an undertaking from the
  Executive Mayor on 23 January 2007 that the
  salaries be paid and any other amount owed to
  RED1 be paid over once verified
• Both these directives from the Executive Mayor
  and the City manager have been ignored
• The only option now is to wind up RED1
• This can be done on a solvent basis if the City
  pays RED1 the money it owes the company or
  insolvent basis if the City does not pay what is
  owing
• RED1 has requested an urgent meeting with the
  City to resolve the impasse on non-payment of
  salaries and outstanding creditors

41
Challenges, Successes and Lessons to date
42
Challenges

• RED 1 has in many respects been the pioneer of
  the EDIR process as the Presidential pilot
• RED 1 created with enabling legislation not in
  existence
• RED 1 has worked within a stringent regulatory
  legislative regime.
• MSA MFMA Electricity Regulation Act Companies
  Act King 2.
• City of Cape Town learning curve to work with a
  company as municipal service provider
• Eskom Suspensive Conditions not being met (no
  longer relevant in light of Cabinets decision on
  the EDI Restructuring) and the OTPTA having
  lapsed on 31/12 2006

43
Successes

• Being able to meet the target set by the State
  President in very strenuous circumstances
• Being able to create the start of RED 1 without
  the necessary enabling legislation and within the
  constraints of highly regulatory environment
• Being able to create the first RED in the face of
  these massive challenges.
• RED1 has achieved the following-
• Electrification into Eskom areas in support of
  the Citys electrification objectives and targets
• Biggest-ever capital budget spend (95.4)
• Provision of free basic electricity in Eskom
  areas

44
Successes

• Progress towards the harmonisation of conditions
  of service
• The establishment of the REDS Pension Fund
• The development of a harmonised tariff framework
• The development of change management programmes
  to ensure that the people, systems and culture of
  the entity are service and delivery orientated
• Negotiated national government support and
  funding for crucial projects such as the 2010
  world cup, electrification and green energy
  projects
• Demonstration model for the restructuring process
  which up until 2005 was at a conceptual phase

45
Lessons learnt

• Negotiation between parent entities must be at
  advanced stage before creation of the company,
  thereby enabling much smoother transfer of
  businesses
• Strategy to be aligned between National
  Government Departments as well as with Local
  Government entities and Eskom prior to start of
  restructuring process
• Negotiations with ESKOM at National level (and
  not at Eskom Regional level)
• Creation of an entity such as RED 1 should not be
  done close to either National or Local Government
  elections
• Restructuring time should minimised to contain
  the strain on budgets and staff morale.

46
Lessons learnt 2

• Implement a more effective communication strategy
  to staff and other stakeholders
• Challenge of dual authority between
  municipalities NERSA needs to be resolved
• Clarify mechanisms for municipal regulation via
  SDA
• Municipal control of budget growth, revenue,
  tariffs could undermine the objectives of
  restructuring
• EDIR legislation must be in place if
  restructuring is to succeed

47
Lessons from RED1 as a municipal entity

• Valuable lessons can be learnt from RED1 as a
  Municipal Entity
• The City exercised its sole shareholder status by
  prevailing in the following
• RED1 budget
• Non payment of the RED1 management fee to RED1
  ito the OTPTA (Operating Agreement)
• Not approving the tariff proposals determined by
  the RED1 Board
• Not submitting the Framework for the transfer of
  staff and assets
• Non payment of RED1 staff salaries for January
  2007
• Non payment to RED1 creditors
• Non payment of RED1 Board of Directors fees
• Informing RED1s lessor that the City will take
  over RED1s lease and pay the rental
• Reduction of RED1s office space to 3 offices and
  charging RED1 a rental
• Non processing of RED1s PAYE
• All these activities were done in contravention
  of the MFMA and the Municipal Systems Act

48
Conclusion

• The City of Cape Town has resolved not to
  participate in the EDI Restructuring because-
• It does not support 6 wall-to-wall REDs as Public
  Entities
• The negative financial impact the REDs process
  will have on the Citys Finances, even though a
  surcharge (surpluses) have been guaranteed
• Below is an illustration of the surcharges and
  shared services costs guaranteed to the City of
  Cape Town
• Surpluses guaranteed over the next 3 years-

49
Surcharge and Shared Services Costsguaranteed to
the City of Cape Town
City Surcharge City Shared Services Cost CITY TOTAL Eskom Surcharge Eskom Shared Services Cost ESKOM TOTAL TOTAL
2006/2007 R296 896 666 R133 399 468 R430 296 134 R45 533 840 R2 979 000 R48 512 840
2007/2008 R335 695 000 R144 872 000 R480 567 000
2008/2009 R359 193 650 R152 115 600 R511 309 250

50
The Way Forward

• RED1 has laid a solid foundation for the transfer
  of the City and Eskoms electricity businesses
  into RED1
• The EDI restructuring will only succeed if
  municipalities and Eskom are compelled to
  participate
• EDI restructuring bill must be legislated
  urgently to govern the restructuring process
• The EDIR process will only succeed with a
  constitutional amendment
• In relation to RED1
• RED1 be converted and/or established into a
  public entity amalgamating Eskom and non-Metro
  Municipalities
• Though not optimal, it is financially viable
• National Government, via EDI Holdings continue to
  engage the City of Cape Town to participate in
  the EDIR
• DME together with EDI Holdings and the RED1 Board
  intervene to resolve the current impasse with the
  City of Cape Town

51

• RED1 thanks the Parliamentary Portfolio
  Committee, our National Government, Parliament
  and our strategic partners for the support and
  encouragement over the past 18 months!