Comments on
INDEPENDENT SYSTEM AND MARKET OPERATOR BILL
(As introduced in the National Assembly (proposed section 75); explanatory summary of
Bill published in Government Gazette No. 34289 of 13 May 2011)
For more details on this document, contact
§ Manisha Gulati, Energy Economist – [email protected]
§ Saliem Fakir, Head- Living Planet Unit – [email protected]
Our key observations
§ The creation of ISMO is focussed on addressing the immediate challenge of under-investment in
new generation by the private sector. In the absence of a comprehensive policy decision on the
extent of reforms and the intended structure of the electricity market, the timing of the ISMO
needs to be deliberated upon. Moreover, the ISMO would result in limited benefits.
§ Private sector investment hinges on a host of factors. Unless the current policy and regulatory
framework is overhauled, private sector investment would still not be forthcoming.
§ The Bill does not provide confidence in a smooth transition to ISMO. The transition also needs to
be carefully phased and managed given the risks involved.
§ The independence and governance of the ISMO need to be improved. The ISMO must be allowed
to make its own procedures and regulations for its efficient and effective functioning. It should be
explicitly granted adequate discretion to evolve the market rules and market structure, within the
broad mandate of government policy and the specific rules of the regulator. The governance
system of the ISMO must incorporate stakeholder involvement through consultations.
§ Capitalization and creditworthiness of the ISMO, as currently proposed is weak and needs to be
enhanced.
Our detailed comments
The proposal to introduce an Independent System and Market Operator (ISMO) in South Africa,
though pending for long, introduces some difficult but fascinating issues of market design and
regulation in the electricity sector in the country. To be specific, the creation of an ISMO warrants an
overall policy decision on the structure of the electricity industry in South Africa. There is lack of
clarity on the extent of reforms to be pursued in the electricity industry and the final structure of the
electricity industry envisaged in the country. What is known is that the government wishes to
facilitate private investment in the generation business. But, IPPs constitute only a small step in the
overall reforms and structure of the electricity industry. Moreover, it is not clear if Eskom would be
vertically unbundled to separate the transmission function or if the distribution business will finally
be reformed and reorganized. Finally, the extent of wholesale and retail competition is unknown.
The industry structure will have a significant impact on the need, role of and functions to be
performed by the ISMO. Therefore, WWF believes that a comprehensive policy decision on the
extent of reforms and the structure of the electricity industry is crucial before the creation of the
ISMO and deliberation on its institutional design and functions. Nevertheless, WWF would like to
comment on the creation and functions of the ISMO as proposed under the INDEPENDENT SYSTEM
AND MARKET OPERATOR BILL.
WWF believes that before evaluating the proposed ISMO as laid down by this Bill, it is important to
understand the role of an ISMO in the electricity sector, and the various institutional models that are
possible for the creation of an ISMO. At the same time, it is necessary to understand the extent of
reforms or competition that exists in markets where ISMOs have been created and the experience
with such ISMOs. Such an understanding is critical not only for evaluating the proposed ISMO in
South Africa but also for facilitating discussions on the overall context for the creation of an ISMO in
South Africa.
What is a system and market operator?
A system operator (SO) is a centralized institution, which is responsible for ensuring the safe and
reliable operation of the overall power system. The main duty of an SO includes operation, or at
least, coordinating the operation of the transmission system. The SO thus serves primarily technical
purposes and may or may not be involved in any directly market-related functions. In contrast to an
SO, a market operator (MO) is a centralized institution, which operates an organized market for the
commercial exchange of energy or other products between market participants. The typical
functions of an SO and MO are highlighted in Table 1.
Table 1: Generic functions of market operator and system operator
System Operator
Market Operator
§ Operate the system, ensure reliability and § Operate and/or facilitate the market
security
§ Registration of market participants
§ Real-time dispatch to balance supply and § Receiving
bids/offers
from
market
demand
participants
§ Managing ancillary services to maintain § Market clearing
system reliability
§ Settlement and invoicing
§ Manage congestion
Source: KEMA 2007
1
International experience indicates that in practice, diverse approaches have been adopted across
countries; with the responsibilities for system and market operation being distributed to one or
more institutions. In particular, there may exist several market operators in the same market. In the
US, market operation and system operation are usually integrated and are the responsibility of what
is called an Independent System Operator (ISO). However, different models can be found in different
states/regions. On the other hand, in Europe, the energy market is under a distinct market operator,
whereas the procurement of ancillary and balancing services or the allocation of transport capacities
are mostly –performed by a system operator (see Table 2). The market operator is often named
‘Power Exchange’. In UK, the role of system operations is fulfilled by the ‘pool’. What is, however,
common across these markets is that they have all enforced a measure of vertical and horizontal
disaggregation together with competition at the wholesale level, and at least to some extent the
retail level.
1
KEMA International B.V., Issue Paper - Market Operator (Regulatory Oversight), prepared for the ERRA
Licensing and Competition Committee, December 2007
Table 2: System and market operation functions in different markets
PJM US
Spain
Scandinavia
Belgium
Energy
Ancillary services
Balancing
SO/MO
SO/MO
Transport capacity
SO/MO
Similar examples
New
US
MO
MO (D-1)
SO
(realtime)
MO
York Italy
Great
Britain
MO
SO
SA/SO
MO
SO
SO
MO
SO
SO
MO
AO (forward) SO
MO (spot)
France,
Austria
Netherlands
Legend: MO – Market Operator; SO – System Operator; AO – Auction office (SO-owned); SA – Settlement Administrator
Source: KEMA 2007
It may be useful to note that though the system and market operation functions are vested in
different entities in many markets, this separation has been criticized on grounds of ‘separation
fallacy’. This view rests on the theory that the functions of the system operator and market operator
cannot be separated because congestion management, balancing, ancillary services and
transmission usage cannot be effectively handled2.
Models for system operators
Several models for ISOs have emerged over the years. These models have been given different
names by different thinkers3 but they all hinge on the extent of transmission system unbundling. The
main models are as follows:
§ System Operator: Under this model, the system operator is functionally separate along with
transmission operation and planning operating within a single vertically integrated utility. It is
not, however, a separate entity in terms of the ownership of any assets. The first generation US
ISOs in the 1990s followed this model.
§ Vertically Integrated model: This model foresees the appointment of an independent system
operator whereas the vertically integrated company retains the ownership of the network on the
condition that it is actually managed by a completely independent company or body. The ISO is
responsible for operating, maintaining and developing the transmission system and investment.
Conversely, the asset owner has no responsibility and no prerogatives with regard to investment
planning, which basically reduces its function to a financial investor. The asset owner is under the
obligation to finance the investments decided by the ISO and approved by the regulatory
authority. Articles 13/ 14 f. of the EU-Directives provide for the ISO model
§ Independent System Operator: Under this model, the system operator does not own the
transmission assets but is ownership unbundled from the rest of the system. Examples of this
model are the PJM, ISO-New England, AESO in Alberta, and the National Grid in Scotland.
§ Independent Transmission System Operator (ITSO): This model involves full ownership separation
of the network and system operation from generation, distribution, wholesale and retail sales.
Examples of this model are the National Grid in England and Wales, Red Electrica in Spain, and
TenneT in the Netherlands
Reviews of the role and functioning of SOs in the energy sector indicates that SOs which are formed
on the ITSO model (i.e. which combine ownership and investment in the transmission network
2
3
Hogan, Electricity market design and structure: Avoiding the separation fallacy, 2002.
Michael Politt and Paul Joskow for example
together with operation and management of the SO) perform better than SOs that are along the ISO
model4.
What is the need for independent system and market operators?
The concept of an ISO gained ground in 1996 with the United States’ Federal Energy Regulatory
Commission’s (FERC) initiatives towards supporting competition in the wholesale electricity market
by requiring public utilities to provide open access and non-discriminatory transmission services.
FERC recognized that it could do little to change the prevailing pattern of ownership of grid assets,
and was therefore limited to focussing on the control of those assets.
More generally, thereafter, the concept of creating independent system operators can be found in
the liberalization of the electricity sector. The liberalization process involves the creation of
competitive generation and retail markets. This gives rise to both complex operations with the
existence of multiple buyers and sellers as well as market power concerns. The latter involves
vertical market power due to ownership across the electricity value chain and horizontal market
power due to transmission constraints. These, in turn, give rise to issues of gird reliability and safety,
scheduling and dispatching various load and generation facilities, incentives for building transmission
capacity, fairness and transparency, reducing market power, and monitoring market manipulations.
The creation of a system and market operator found its basis in liberalized electricity markets to
address these very concerns. Thus, a system and market operator can be found in countries
traditionally associated with being at the forefront of electricity market reform, as well as in those
jurisdictions that require ensuring (or signalling) non-discriminatory access to the grid.
The South Africa context for the creation of ISMO
The electricity industry in South Africa is vertically integrated with Eskom performing the generation,
transmission and distribution functions. However, the energy utility has been unable to keep pace
with growing energy demand, leading to severe electricity shortages in the past few years. One of
the steps taken by the Government to address this situation is to solicit private sector participation
in the form of Independent Power Producers in the sector. The Integrated Resource Plan makes a
provision for IPPs to generate up to 30 percent of South Africa’s total electricity output. However,
the power generated by IPPs must be sold only to Eskom and not to any other users. At the same
time, Eskom will continue to build additional generation capacity and improve the maintenance of
its power stations.
Eskom has not been able to close many contracts with IPPs. There are concerns that one of the main
reasons for IPPs being reluctant to invest is Eskom’s dominant position in generation combined with
its ownership of transmission assets and system operation function which would enable Eskom to
dispatch its own power stations before those of IPPs. The creation of an independent system
operator finds its basis in this situation with the belief that the separation of the system operation
function from Eskom would give assurance to IPPs of fair competition between generation
companies requiring access to the monopoly transmission system. More specifically, it would assure
them that the ownership of transmission assets by Eskom, would not lead to anti-competitive
behaviour by Eskom by way of influencing the transmission system to hinder the entry of IPPs, or to
facilitate its own generation projects. At the same time, the market operations functions would be
vested with the ISO, thereby leading to the creation of an independent system and market operator
or ISMO.
4
(i) Jon Stern, System Operators: Lessons From Us And Eu Energy Industry Experience And Mplications For The
England And Wales Water Industry, CCRP, City University and (ii) Paul L. Joskow, Independent System
Operators (VI + Access Rules vs. ISO vs. ITSO), Presentation dated September 28, 2007, Massachusetts Institute
of Technology
To sum up, unlike power sector reforms in other countries, reforms such as creation of ISMO in
South Africa is not driven by objectives of improving efficiency through competition. Instead, the
creation of the ISMO is focussed on addressing the immediate challenge of under-investment in new
generation by both public and private sectors. This underinvestment has led to a very low reserve
margin, and uncertainty around the sustainability of the sector.
While there is no doubt that the existence of an independent system operator (and market
operator) does encourage private sector investment, WWF believes that the creation of an ISMO
will only partially address the immediate challenge facing the country viz. the private sector’s
reluctance to invest in the sector. WWF is also concerned that the creation of ISMO without
pursuing larger reforms in the sector would be premature and may lead to piece-meal reforms in
the sector, in turn resulting in unnecessary oversights and mistakes. Before embarking on the
reasons, WWF would like to reiterate that the debate is not about the concept of an ISMO, but the
timing and practicality of an ISMO. The reasons for this are as follows:
§ To begin with, fundamentally, separating the system and market operation function from Eskom
in the form of an independent company does not change the nature of electricity governance of
the electricity supply industry.
§ There are no clear signals as to the nature of the future power market in the country. In the
absence of such a policy decision or vision, private sector will be understandably reluctant to
invest in the sector.
§ The establishment of a wholesale electricity market56 (wholesale competition) is often advocated
to introduce competition into power generation. However, it is unclear whether the electricity
industry in the country would move towards wholesale competition. Clarity on this aspect is
crucial because the extent of reforms and final industry structure may impact on the Buyer or
Market Operator function that the ISO must perform. At the same time, the South African energy
sector lacks sufficient competition among power generation for the establishment of a wholesale
electricity market. Specifically, the number of independent generators is too small to support a
competitive market.
§ Effective separation of transmission system operators from generation is important for effective
wholesale competition
§ The current contracts being signed by Eskom with IPPs are in the nature of take-or-pay contracts.
In such a situation, Eskom would have to pay for the power generated by the IPP even if it does
not off-take that power. Therefore, as the owner of the transmission system and the procurer of
power, Eskom does not stand to gain by denying access to the transmission network to IPPs.
Alternatively, IPPs don’t stand to lose in the absence of ‘independent’ system operations.
§ In the current environment where the supply of electricity is constrained and the shortage is
expected to continue in the next few years, it is difficult to foresee a situation where Eskom
would deny access to IPPs to the transmission network and indirectly, refuse to off-take that
power. Simply put, as the system operator, Eskom would be keen to draw on any power that IPPs
could offer.
§ Eskom is empowered only to sign short or medium contracts with private or municipal producers.
Anything beyond that must be within the framework of the IRP and is subject to decisions by
government. In such a scenario, Eskom’s ability to deny access to IPPs and refusal to off-take
power is questionable.
5
Under wholesale competition, distributors are able to buy electricity from competing generators and use the
transmission network to deliver it to their service areas.
6
For a discussion on electricity market structures, see (i) Ioannis Kessides, Reforming infrastructure:
privatization, regulation and competition, World Bank Policy Research Report, 2004 and (ii) Anton Eberhard.
Competition and Regulation in the Electricity Supply Industry in South Africa. Paper at the TIPS 2001 Annual
Forum. 2001
§ It is currently believed that investors fear that they are in the hands of one single buyer, whose
behaviour in dispatching the system and in planning future expansions is not perceived as
absolutely neutral or professional. Therefore, eliminating the dispatch risk seems to be the right
thing to do. It however, needs to be debated whether the creation of an ISMO to eliminate such
dispatch risk in the absence of separation of the transmission function from Eskom will be
effective.
§ Finally, decisions regarding the IPPs to be chosen and granted PPAs involve a plethora of agencies
viz. the Department of Energy, the National Treasury, the Department of Environmental Affairs,
Eskom, the Department of Economic Development and the Department of Trade and Industry.
Unless policies and processes at all these ends are comprehensively addressed, the ISMO is
unlikely to result in increased private sector participation.
Model proposed for ISMO in SA
A review of literature on system and market operators does not indicate a firm consensus on the
‘best way’ to implement an ISO. But there is consensus on the fact that the institutionalisation of the
system operator and related functions should respond to the local context. It would be appropriate
to say that in the South African context, this would include the broader electricity market structure
and government’s intended evolution of that structure. In the absence of such an overall picture, the
model proposed by the government need to be evaluated in a stand-alone context.
The model proposed is essentially one of the vertically integrated model where there is a system
operator that is ownership unbundled from the rest of the system and the vertically integrated
company retains the ownership of the network. At the same time, the market operations functions
would be vested with the ISO, thereby leading to the creation of an independent system and market
operator or ISMO. Given the single-buyer model7 for the electricity sector in the country, the
function of power procurement is proposed to be vested into the ISMO. This is, understandably,
once again aimed to address the conflicts of interest between Eskom’s various roles as a generator,
planner, system operator and procurer of new capacity.
In the absence of a clear policy statement on government’s intended structure for the electricity
market, the model for ISMO can only be evaluated in the context of a single buyer market structure.
And under such a structure, the model proposed to be adopted seems the best course of action.
Vesting the system and market operator functions in one agency will avoid the ‘separation fallacy’.
Key issues related of creation of ISMO in South Africa
Having discussed the need for ISMO and the suitability of the proposed model, WWF would now like
to comment on aspects of the ISMO Bill that WWF believes are critical for the effective functioning
of the ISMO. These comments have been grouped under the following categories:
§ Transition to ISMO
§ Independence
§ Governance
§ Funding
§ Functions of ISMO
§ Implications for energy market
Transition to ISMO
The most important question related to the creation of the ISMO is the transition to this new entity.
Currently, Eskom has ring-fenced the System and Market Operator (SMO) unit and is finalizing the
implementation plan to establish the SMO as a subsidiary of Eskom. This is being done as part of the
7
Under such a model, an entity procures electricity from competing generators, but retains a monopoly on
transmission and sells electricity to distributors and large consumers.
transition to ISMO8. The SMO unit comprises the functions of systems operation, energy planning
and market development, grid planning, business strategy and planning, and a single buyer office
which will buy from IPPs.
The issue of transition to ISMO (viz. populating and operationalizing ISMO) needs to be better dealt
with and clarified. The Bill does not adequately address how the transition from the current
concentrated system to the creation of a new agency is to take place. The time lines are also unclear.
The existence of an ISMO implies that the system operator carries the risk of the power system.
Given this huge challenge to be faced and executed by the ISMO, WWF suggests that a phased
approach to the transition from Eskom to a new entity should be adopted, where functions are not
all transferred at the same time. The transition to ISMO is a sort of restructuring in the electricity
market. There are bound to be problems in the beginning. A phased approach will ensure that the
transition is monitored and any challenges responded to appropriately. This is important from the
perspective of the effective operation of the electricity industry.
An issue that immediately merits attention in the context of the transition is the creation of a new
company to perform the functions of ISMO. Given that Eskom is currently in the process of finalizing
the plan to establish SMO as a subsidiary following the Minister’s directive, it is unclear why the
ISMO bill proposes the creation of a new company for the purpose of establishing the ISMO. A
logical route should be to strengthen and break the umbilical cord of the proposed subsidiary
company with Eskom and develop it as the proposed ISMO. Another area of apparent conflict is the
2011 Newgen regulations which empowers the Minister to determine who will procure new capacity
and the Buyer. However, the ISMO Bill makes the ISMO the sole procurer and buyer. Such conflicts
would have to be addressed in the transition phase.
Independence
A key concern for the operation of energy markets is how the ISMO would be governed, i.e. who
controls and directs ISMO’s activities. This, in essence, raises the issue of independence of the ISMO
and its governance. True independence of the ISMO would require that the ISMO is independent of
market participants. This has, in fact, been included by the Federal Energy Regulatory Commission
(FERC), as one of the eleven principles for ISOs: An ISO and its employees should have no financial
interest in the economic performance of any power market participant9.
A good measure or criteria of an ISMO’s independence can also be found in the FERC’s final order on
the formation of independent system operator (ISO), later also known as a regional transmission
organisation (or RTO)10. FERC proposes that to achieve independence, an ISO must satisfy three
criteria. First, the ISO, its employees, and any non-stakeholder directors must not have any financial
interests in any market participants. Second, the ISO must have a decision-making process that is
independent of control by any market participant or class of participants. Third, the ISO must have
exclusive and independent authority to file changes to its tariff with the regulator. An evaluation of
the ISMO Bill along these criteria is as follows:
8
Select Committee on Labour and Public Enterprises 7 March 2012, Presentation on DPE’s Strategic Plan
2012/13 – 2016/17
9
Federal Energy Regulatory Commission. Promoting Wholesale Competition Through Open Access Nondiscriminatory Transmission Services by Public Utilities & Recovery of Stranded Costs by Public Utilities and
Transmitting Utilities. Docket No. RM95-8-000 and Docket No. RM94-7-001, Order No. 888. Washington, DC.
April 24, 1996.
10
Federal Energy Regulatory Commission. Regional Transmission Organizations. Docket No. RM99-2-000;
Order No. 2000. Washington, DC. December 20, 1999.
Independence of ISMO
The independence of the ISMO can be evaluated at two levels. The first is the legal status of the
ISMO and the second is the independence of the ISMO’s Board. In terms of the legal status, the Bill
proposes the creation of the ISMO as a public corporation with the Government being the sole
shareholder. The governance structure of the ISMO should ideally depend on the Government’s final
view of the structure of the electricity industry. In the absence of such a view and given that the
Government’s immediate concern is facilitation of private investment in the generation segment, it
may be safe to assume that the motive for the creation of the ISMO lies in enhancing private
investment in generation. From this perspective, WWF supports the absence of market participants
from the ISMO. This would ensure that dominant market entities do not use the ISMO to further their
own market power or interests. Eskom is likely to remain the dominant entity for several years even
with the entry of IPPs. The inclusion of market participants in the ISMO would therefore imply that
Eskom would dominate the Board of ISMO.
As far as the ISMO’s Board is concerned, the Bill provides for the appointment of non-executive
members to the Board that has no direct or indirect interest in conflict with the business of ISMO
(Clause 15 of the Bill). This assures the independence of the non-executive members. However, the
provisions for the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), who are also
are members of the Board, are not clear. Clause 20 (3) of the Bill provides the CEO and CFO cannot
be disqualified on grounds of having direct or indirect interest in conflict with the business of ISMO.
On the other hand, Clause 22(3) provides for the CEO and CFO to be disqualified from being
members of the board if they have direct or indirect interest in conflict with the business of ISMO.
These Clauses are contradictory and need to be reviewed. Given that the CEO and CFO will be
responsible for the day to day operations and management of the ISMO, it is important that they
have no direct or indirect interest in conflict with the business of ISMO. It would also be useful to
define indirect interest.
Decision making process
The governance structure of the ISMO has been designed to ensure that no individual or set of the
market participants is allowed to control the ISMO’s operating procedure. All decisions of the ISMO
are to be made by the Board.
While the Bill assures the ISMO’s independence from market participants, it does not provide
assurance of independence from the Government. The Bill empowers the Minister to make
regulations regarding any matter relating to the functioning of the Board that is necessary to ensure
efficiency and effectiveness in the performance of its functions. It also provides for the ISMO Board
to appoint committees with the concurrence of the Minister. These provisions would effectively
allow the Minister to control the ISMO’s operations. The Bill must allow the ISMO to make its own
procedures and regulations for its efficient and effective functioning.
Representations before the regulator
The Bill provides for the ISMO to develop and implement energy supply tariffs for all sales to its
Customers subject to NERSA’s approval. While the Bill does not specifically state that the ISMO
would have independent authority to make filing before the regulator for the determination and
levy of such charges, it is implicit that the ISMO would be allowed to file for changes to its tariffs
before NERSA. If this is not the case, it is a matter worth considering.
Governance
While the Bill assures the ISMO’s independence from market participants, it proposes a standard
public entity governance model for the ISMO wherein the ISMO would go about its work in an
isolated fashion. In practice, however, system/market operators must work closely with
stakeholders. The governance system of the ISMO must therefore guarantee stakeholder
involvement through advisory bodies, obligation to consult stakeholders, obligation to report (as
opposed to just an annual report and financial statements), and opportunity for recourse. The Board
of the ISMO should be mandated to establish appropriate stakeholder consultation mechanisms.
Another governance issue relates to the discretion of the ISMO Board. The government will define
policy. NERSA will continue to develop and apply detailed regulations to support this policy. It is
unclear to what extent may the ISO board experiment with market rules or take measures to evolve
the market. Would this remain the government’s prerogative or would the regulator play a role.
WWF suggests that given that the ISMO would be the most capable entity to undertake such tasks,
the Board of the ISMO should be explicitly granted adequate discretion to evolve the market rules
and market structure, within the broad mandate of government policy and the specific rules of the
regulator. This should however undergo the appropriate stakeholder consultation mechanisms
referred to above.
Funding of ISMO
The Bill provides for the ISMO to be self-funded on the basis of the tariffs, fees and charges levied on
its customers. It allows the ISMO to arrange finances to meet its capital and operational
requirements and raise capital on the basis of its own revenues and assets. Finally, it provides for the
ISMO to obtain loans from the Government. High Court intervention to
order that any prices of electricity supplied or to be supplied be increased to meet the deficit is
provided only in the event that interest due in respect of any securities remains unpaid for three
months.
WWF has identified three challenges with the above provisions. First, given the functions to be
performed by the ISMO, it would not have a huge asset base. Its balance sheet will be rather small
and raising capital on the basis of such a small balance sheet may be difficult. Second, the small
balance sheet of the ISMO does not provide confidence in its ability to bear the risks associated with
power procurement. The financial creditworthiness of ISMO depends on the ability of its customers
to pay the regulated bulk supply tariffs. Given its small balance sheet, the possibility of payment
default by its customers would affect the ISMO’s creditworthiness. Thus, there is a need to ensure
that the ISMO would be able to withstand any potential payment defaults by its customers. Loans
from the Government may allow the ISMO to meet short term financing requirements. They may
not be the available to ISMO to address payment defaults from customers. Even if they are available
for this purpose, government loans are not the prudent way to address such defaults. Finally, ISMO,
being the procurer of power from IPPs, contracts with IPPs would not materialize unless there is
strong payment security from ISMO or the Power Purchase Agreement is bankable. This is unlikely to
be the case given the ISMO’s balance sheet.
For the above reasons, it is important to ensure that ISMO is adequately capitalized at the outset. It
may also be worthwhile to consider some form of government guarantee during the initial phase.
Functions of ISMOs
It is proposed that the ISMO will perform the broad roles of planning, power procurement (from
Eskom and IPPs), wholesale tariff aggregation and dispatch. In the current context, the functions of
the ISMO seem appropriate. Integration of these functions into the ISMO, will avoid interorganisational communication problems leading to more effective functioning of the ISMO, besides
using scarce human expertise in a productive manner. But should policy and legislation allow for the
establishment of bilateral PPAs with new IPPs, the market operator function may have no specific
role to play in relation to these agreements – although of course the system operator function
would have to be involved. Therefore, the future structure of the electricity market may result in
changes in the functions of the ISMO.
Implications for energy market
As mentioned earlier, the creation of an ISMO is an initiative towards supporting competition in the
wholesale electricity market. More specifically, the initiative is aimed towards assuring IPPs of fair
competition between generation companies requiring access to the monopoly transmission system.
While this is an immediate objective, there is a need to debate the impact of the ISMO on the overall
energy market in terms of market development, increased competition, efficiency improvement,
and cost reduction.
The creation of an ISMO is often accompanied by wider sectoral reforms and restructuring. This
leads to enhanced wholesale competition. The creation of ISMO imples the existence of a market
that provides accurate price signals for participants to make informed decisions regarding
investment in new power plants to significantly increase supply.
In the South African context, the creation of the ISMO is a piece meal approach to electricity market
reforms. To begin with, it does not break up the basic monopolistic structure of the sector. Second,
the market structure is one where all future generation capacity would be compelled to sell to the
single buyer). Third, the entire issue of ISMO revolves around generation capacity only. The issue of
how demand-side resources compete has been left out. Energy markets cannot be truly developed
unless this aspect is dealt with. Finally, there is no clarity on bilateral power deals and wheeling. The
above aspects imply that the ISMO may only end up creating limited competition for the market
amongst IPPs. It is precisely for this reason that WWF believes that these aspects need to be
deliberated upon in the context of the overall policy for the sector.
While the impact on market development hinges on broader policy issues, the impact on efficiency
improvement needs to be understood in the context of the incentives available to the ISMO. Given
the functions to be performed by the ISMO and the specific exclusion of transmission asset
ownership from the ISMO, it is unclear what effective incentives would be available to the ISMO to
bring about efficiency improvements and cost reduction.
The issue of cost reduction is sensitive. A desirable outcome from ISMO, as is being spoken about, is
lower electricity prices. It has been argued that for Eskom to build all the required new generation
capacity, steep electricity increases will be required. These increases will have negative impact on
the economy. But with IPPs, the ISMO will pay only for the delivered power in terms of the PPA.
Further, there is a belief that IPPs will price PPAs with ISMO at lower risk premium than with Eskom,
due to absence of inherent conflict of interest in contracting process. While the latter may be true to
an extent, there is no way of knowing what electricity costs or charges are likely to be. The price
quoted by IPPs would in practice depend on several factors such as the type of procurement process
(example the extent of competition involved in the process), fuel markets, regulatory tools to create
better incentives for efficient production of power, and even the supply demand imbalance. There is
no guarantee that IPP tariffs would be lower when contracting to the ISMO.
Another aspect that is being ignored here is that whether a generation plant is built by Eskom or by
an IPP, the consumer has to pay for the new capacity. In case of Eskom, this would largely take the
form of capital expenditure that is recovered through the consumer tariff and in case of IPPs it is the
tariff under the PPA. This tariff covers capital expenditure. Therefore, new capacity coming online
would lead to increase in tariffs, other things remaining the same. Perhaps, the degree of increase
may be lower.
Conclusion
To conclude, WWF recognizes that an ISMO is key in facilitating introduction of IPPs because the
ISMO brings about (i) transparency and accountability for a level play field in planning and dispatch;
(ii) transparency in governance; and (iii) no conflicts of interest for the incumbent as both player and
referee. The debate is not about the benefits of the ISMO but about its timing as well as the overall
design of the electricity market structure. The latter is crucial to be able to derive the maximum
benefits from the creation of an ISMO.
WWF recognizes that changing a large structure that has been in existence for many years is
extremely difficult. While it is prudent to adopt caution in making changes, it is important to
understand that further delay is imprudent. The creation of ISMO as piece-meal reforms in the
sector may lead to unnecessary oversights and mistakes. Moreover, its benefits in terms of market
development at this stage may be limited. Having said that, it is important that the proposed
transition to ISMO is carefully phased and managed given the risks are high. The independence and
governance of the ISMO are crucial issues that must not be ignored. More importantly, the
capitalization and creditworthiness of the ISMO should be ensured.