Hoogenhout Reacts To IPPR On REDs

I HAVE recently commented on Namibia’s Electricity Supply Industry (ESI) in general and in particular on the formation of the Regional Electricity Distributors (REDs).

What has sparked my further comments, as stated below, is the very recent release of the IPPR Briefing Paper No. 41, July 2007 : ‘One Step Forward – Two Steps Backward?’ by Matthias Grossman.As I realise that there must probably be some reader fatigue as regards my written opinions, I therefore sincerely hope that this is the last time that I shall be commenting.However, the main conclusions drawn by Mr Grossmann cannot be allowed to stand unchallenged, especially as it comes under the auspices of the IPPR.In the synopsis of the paper it is stated: “Restructuring the electricity sector and especially the sector of local distribution is a necessary step towards increasing efficiency in the long run.The example of Northern Electricity demonstrates that such a restructuring can lead to considerable gains in efficiency.In the short run, however, the restructuring of the local distribution systems incurs considerable costs.”Mr Grossmann analyses Northern Electricity and the transformation into NORED and draws some conclusions.He touches on generation costs, whilst looking at (final distribution) tariffs, also looks at the role of the local authority surcharge and then makes some recommendations as to the way forward.I shall discuss some of the above one by one.I do not have the White Paper on Energy Policy of 1998 before me, but I do recollect that the structure of energy tariffs must generally be based upon economic principles and on the Long Run Marginal Cost (LRMC) of electricity.I shall not define the concept here as the definition is rather difficult for the layman to understand.Mr Grossmann touches upon this, especially in generation aspects, although not calling it by its name, and comes to the conclusion that considerable costs will be incurred in the short run.I agree.The Electricity Control Board (ECB) was established under the directives and auspices of the 1998 White paper.Probably its own strongest directive in the White Paper is the LRMC concept.The LRMC and SRMC (Short Run…) concepts are widely accepted as being the principle and methodology to establish exactly what the ECB preaches as being the objective of distribution restructuring, ie., cost-reflective tariffs.When one looks at the Internet, one finds numerous examples of such studies made in the ESI throughout the world.They are done in the full glare of public light and are published for anyone to read and criticise.It is my contention that the ECB has woefully failed in this respect of its mandated duties in Namibia as I am not aware of one such LRMC study undertaken or published.It is, for me, unthinkable that geographic groups of distribution customers can be forced or pressurised into REDs when they have not the vaguest idea what lies in store for them.How can a person be forced into jumping in a pool if you have not yet established how deep the pool is and what swimming capabilities that person has? Before the issue of NORED is raised, let me categorically state that before NORED was established, a financial analysis was made, the company structure (together with salaries) was formulated, provision was made for equipment, depreciation on assets, maintenance and replacement of assets in the long run, etc., etc., in accordance with generally accepted accounting principles.Only then a tariff structure was formulated which was known and approved by its Board and communicated to the customers.On what basis the ECB approved this tariff structure is not known, but a licence, initially for one year only, was issued.Surely the ECB should take a more proactive lead in the formulation of REDs? A discussion is presented in the IPPR paper of Northern Electricity (NE), on what it achieved and how and why NORED took over.I fully agree with virtually everything as presented by Mr Grossmann.The ECB was, at that stage, extremely reluctant for NORED to take over from NE, but had, in the end, no option as it is not mandated to go into a contract directly with a distributor, but only to issue a licence.What I absolutely do not agree with is the position taken that “if it works for NORED, it will work for the other proposed REDs.”NORED differs from the other REDs in that: There was no local authority surcharge before the establishment of NORED The bulk of the revenue is from pre-payment meters – very little provision for bad debt.The communal area of NORED is densely populated.And, very importantly, rural distribution networks connecting commercial farms and small settlements is virtually non-existent.The proposed SORED is the exact opposite.It has a huge geographic area, sparse population, small towns and settlements and a large distribution network consisting of 33 kV, 22 kV, and SWER lines.For this RED to make accounting provision for normal operating and maintenance, depreciation, capital development fund, replacement of infrastructure after x-years, provision for natural disasters (and they certainly occur in that area), insurance, etc., will certainly result in a tariff unaffordable for many, resulting in a smaller revenue stream than at present.The position of NamPower must also be borne in mind, as far as rural distribution is concerned.NamPower has in position technically competent staff in most towns together with first resort workshops and ready use stores, essentially to be able to serve the transmission network.Of course, transmission failures are normally not very frequent, but when they do occur, they are extremely urgent.In order to keep its staff occupied, they spend most of their time operating and maintaining the rural distribution networks.The question arises then: Does the proposed RED duplicate this? In order to run transmission only, I do no foresee drastic reductions in NamPower resources.What then, is cost-effective? I do not want to go deeper into this than the above statements.It was, and still is, incumbent upon the ECB to have conducted or now conduct a LRMC study in all five proposed REDs.This is a subject on its own, but I will add that I fully concur with the graphs shown by Mr Grossmann and his projections of costs.What I would like to add is that the ECB kept generation prices too low for too long.(They are in good company as NERSA, the Regulator of South Africa has done exactly the same, with the same impending result).The concept of LRMC is often associated with generation only.The ECB has boasted in the past that they have kept tariffs low and have saved the electricity consumers much money.Now the chicken is coming home to roost.Generation prices have to rise with a vengeance, probably considerably higher than if timely increases were allowed.LRMC, LRMC, LRMC! For the layman, there is a very real example which most housewives feel every day.For the last two to three years milk prices in southern Africa were pushed down at farmer’s level (Source of production, equal to generation of electricity, electrically speaking) and now there are shortages throughout the region and prices are jumping skywards at an alarming rate.At least NamPower has taken a very good proactive step by issuing stocks.This is to accumulate capital for (mostly) new generation.Pity it was not done even sooner, but NamPower still needs to be congratulated – first for Namibia.I think that Mr Grossmann has covered most of the relevant aspects of local authority surcharges, and enough has previously been said about the matter, also by myself.I am happy with the recommendations and would only like to comment on one.”The ECB should be strengthened as the independent regulator.”The ECB has a daunting task.It must be something like an all-knowing god who only makes the right decisions.This is far easier said than done and, as I have pointed out in previous reports, there are some regulators in the world in the foremost countries which have made terrible, costly mistakes.In general I agree with the recommendation but would like to add the word “competent” after “independent”.The question is: How? And the immediate question thereafter is: At what cost? In large economies, the cost of the regulator is negligible when expressed in c/kWh.Not so in Namibia and strengthening will add to this cost.I am not going to try and come up with a magic solution, but the above-mentioned aspects need to be accommodated.NORED is both geographically, structurally and financially totally different to the proposed SORED, as mentioned above.CENORED is in all aspects more or less in the centre of the two extremes in all aspects.It has some strong towns, and it has quite an extensive rural network.CENORED has also been in existence for a number of years.Would it not be prudent to do a cost recovery, cost reflective, LRMC, call it what you will, study including all the provisions required for a conservative utility in accordance with generally accepted accounting principles under the Company’s Act? It will need to be conducted in the open with the results available for the public.Surely, this will assist all decision makers in their task for the future? There is no sense in publishing a Bill or passing legislation before the necessary home work has been done.P I Hoogenhout Via e-mail41, July 2007 : ‘One Step Forward – Two Steps Backward?’ by Matthias Grossman.As I realise that there must probably be some reader fatigue as regards my written opinions, I therefore sincerely hope that this is the last time that I shall be commenting.However, the main conclusions drawn by Mr Grossmann cannot be allowed to stand unchallenged, especially as it comes under the auspices of the IPPR.In the synopsis of the paper it is stated: “Restructuring the electricity sector and especially the sector of local distribution is a necessary step towards increasing efficiency in the long run.The example of Northern Electricity demonstrates that such a restructuring can lead to considerable gains in efficiency.In the short run, however, the restructuring of the local distribution systems incurs considerable costs.”Mr Grossmann analyses Northern Electricity and the transformation into NORED and draws some conclusions.He touches on generation costs, whilst looking at (final distribution) tariffs, also looks at the role of the local authority surcharge and then makes some recommendations as to the way forward.I shall discuss some of the above one by one.I do not have the White Paper on Energy Policy of 1998 before me, but I do recollect that the structure of energy tariffs must generally be based upon economic principles and on the Long Run Marginal Cost (LRMC) of electricity.I shall not define the concept here as the definition is rather difficult for the layman to understand.Mr Grossmann touches upon this, especially in generation aspects, although not calling it by its name, and comes to the conclusion that considerable costs will be incurred in the short run.I agree.The Electricity Control Board (ECB) was established under the directives and auspices of the 1998 White paper.Probably its own strongest directive in the White Paper is the LRMC concept.The LRMC and SRMC (Short Run…) concepts are widely accepted as being the principle and methodology to establish exactly what the ECB preaches as being the objective of distribution restructuring, ie., cost-reflective tariffs.When one looks at the Internet, one finds numerous examples of such studies made in the ESI throughout the world.They are done in the full glare of public light and are published for anyone to read and criticise.It is my contention that the ECB has woefully failed in this respect of its mandated duties in Namibia as I am not aware of one such LRMC study undertaken or published.It is, for me, unthinkable that geographic groups of distribution customers can be forced or pressurised into REDs when they have not the vaguest idea what lies in store for them.How can a person be forced into jumping in a pool if you have not yet established how deep the pool is and what swimming capabilities that person has? Before the issue of NORED is raised, let me categorically state that before NORED was established, a financial analysis was made, the company structure (together with salaries) was formulated, provision was made for equipment, depreciation on assets, maintenance and replacement of assets in the long run, etc., etc., in accordance with generally accepted accounting principles.Only then a tariff structure was formulated which was known and approved by its Board and communicated to the customers.On what basis the ECB approved this tariff structure is not known, but a licence, initially for one year only, was issued.Surely the ECB should take a more proactive lead in the formulation of REDs? A discussion is presented in the IPPR paper of Northern Electricity (NE), on what it achieved and how and why NORED took over.I fully agree with virtually everything as presented by Mr Grossmann.The ECB was, at that stage, extremely reluctant for NORED to take over from NE, but had, in the end, no option as it is not mandated to go into a contract directly with a distributor, but only to issue a licence.What I absolutely do not agree with is the position taken that “if it works for NORED, it will work for the other proposed REDs.”NORED differs from the other REDs in that: There was no local authority surcharge before the establishment of NORED The bulk of the revenue is from pre-payment meters – very little provision for bad debt.The communal area of NORED is densely populated.And, very importantly, rural distribution networks connecting commercial farms and small settlements is virtually non-existent.The proposed SORED is the exact opposite.It has a huge geographic area, sparse population, small towns and settlements and a large distribution network consisting of 33 kV, 22 kV, and SWER lines.For this RED to make accounting provision for normal operating and maintenance, depreciation, capital development fund, replacement of infrastructure after x-years, provision for natural disasters (and they certainly occur in that area), insurance, etc., will certainly result in a tariff unaffordable for many, resulting in a smaller revenue stream than at present.The position of NamPower must also be borne in mind, as far as rural distribution is concerned.NamPower has in position technically competent staff in most towns together with first resort workshops and ready use stores, essentially to be able to serve the transmission network.Of course, transmission failures are normally not very frequent, but when they do occur, they are extremely urgent.In order to keep its staff occupied, they spend most of their time operating and maintaining the rural distribution networks.The question arises then: Does the proposed RED duplicate this? In order to run transmission only, I do no foresee drastic reductions in NamPower resources.What then, is cost-effective? I do not want to go deeper into this than the above statements.It was, and still is, incumbent upon the ECB to have conducted or now conduct a LRMC study in all five proposed REDs.This is a subject on its own, but I will add that I fully concur with the graphs shown by Mr Grossmann and his projections of costs.What I would like to add is that the ECB kept generation prices too low for too long.(They are in good company as NERSA, the Regulator of South Africa has done exactly the same, with the same impending result).The concept of LRMC is often associated with generation only.The ECB has boasted in the past that they have kept tariffs low and have saved the electricity consumers much money.Now the chicken is coming home to roost.Generation prices have to rise with a vengeance, probably considerably higher than if timely increases were allowed.LRMC, LRMC, LRMC! For the layman, there is a very real example which most housewives feel every day.For the last two to three years milk prices in southern Africa were pushed down at farmer’s level (Source of production, equal to generation of electricity, electrically speaking) and now there are shortages throughout the region and prices are jumping skywards at an alarming rate.At least NamPower has taken a very good proactive step by issuing stocks.This is to accumulate capital for (mostly) new generation.Pity it was not done even sooner, but NamPower still needs to be congratulated – first for Namibia.I think that Mr Grossmann has covered most of the relevant aspects of local authority surcharges, and enough has previously been said about the matter, also by myself. I am happy with the recommendations and would only like to comment on one.”The ECB should be strengthened as the independent regulator.”The ECB has a daunting task.It must be something like an all-knowing god who only makes the right decisions.This is far easier said than done and, as I have pointed out in previous reports, there are some regulators in the world in the foremost countries which have made terrible, costly mistakes.In general I agree with the recommendation but would like to add the word “competent” after “independent”.The question is: How? And the immediate question thereafter is: At what cost? In large economies, the cost of the regulator is negligible when expressed in c/kWh.Not so in Namibia and strengthening will add to this cost.I am not going to try and come up with a magic solution, but the above-mentioned aspects need to be accommodated.NORED is both geographically, structurally and financially totally different to the proposed SORED, as mentioned above.CENORED is in all aspects more or less in the centre of the two extremes in all aspects.It has some strong towns, and it has quite an extensive rural network.CENORED has also been in existence for a number of years. Would it not be prudent to do a cost recovery, cost reflective, LRMC, call it what you will, study including all the provisions required for a conservative utility in accordance with generally accepted accounting principles under the Company’s Act? It will need to be conducted in the open with the results available for the public.Surely, this will assist all decision makers in their task for the future? There is no sense in publishing a Bill or passing legislation before the necessary home work has been done.P I Hoogenhout Via e-mail