Local Content Requirements In South Africa

South Africa has seen a similar trend as the scenario described above, whereby the economy has been growing and placing increased pressure on the electricity supply. To increase electrical supply in the country, renewable energy has been recognised as an essential part of a mix of energy carriers that offer a positive impact on environmental and human well-being (as compared to fossil fuel). The South African government announced that it was to procure renewable energy from independent power producers (IPPs), according to the requirements of the Integrated Resources Plan (IRP) 2010 – promulgated under the Electricity Regulation Act, 2006 (Act No. 4 of 2006). The IRP 2010 document committed government to having 17.8 GW of renewable energy installed by 2030 (Department of Energy 2011a:6).

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In an effort to meet the targets presented in the IRP 2010 document, the Minister of Energy released a determination in 2011, stating that a total of 3725 MW would be procured by 2016 through one or more tendering processes. The energy to be procured from renewable sources would include wind, concentrated solar power (CSP), solar photovoltaic (PV), biogas, biomass, landfill gas, small hydro and small (under 5 MW) projects (Department of Energy 2011b:118-119). Then, in December 2012 an announcement of an additional 3200 MW of renewable energy to be purchased through the Renewable Energy Independent Power Producer Procurement Programme (REIPPPP) was made by the DOE, pushing the programme’s expected completion date from 2016 to 2021 [Department of Trade and Industry (DTI) 2015:xi]. The DOE made further allocations of 1000 MW in round 4 of the REIPPPP, plus another 200 MW was allocated to CSP projects. In addition, a request for further proposals was put forward by the Minister of Energy for 1800 MW, which would be allocated to bidders previously unsuccessful but able to revise their tenders and re-submit. The minister went further to announce that an additional 6300 MW was applied for through the National Energy Regulator of South Africa (NERSA), in accordance with provisions in the IRP 2010-2030 (DOE 2014b, 2015; Engineering News Article 2014a).

The REIPPPP also included a portion of projects termed ‘small scale’ that was designed to include those between 1 MW and 5 MW. During the first small scale window application period, 102 projects were submitted with the potential for generating 450 MW. However, only 78 projects were successful, totalling 345 MW (Engineering News Article 2014b). The implications of such a large tender were significant to countries such as South Africa. At the time of writing this paper, four rounds of the REIPPPP had been concluded: 92 projects were approved with a combined nameplate capacity of 5243 MW. This resulted in an investment value of R193 billion (bn) (Engineering News Article 2015). The DOE noted that of this investment value, R53.4bn was from foreign sources that increased South Africa’s inward foreign direct investment (FDI) in 2015 by just more than double with the other total FDI for the same period being R22.6bn (DOE 2016:27).

The DTI created an industrial policy that complies with the South African laws but sets certain prerequisites for the use of policy tools such as local content. The DOE identified key features of the REIPPPP that they felt would be catalytic for achieving economic development objectives, whilst aligning with the DTI policies. These are as follows:

  • develop projects that lead to new opportunities for local communities
  • create job opportunities in certain technologies and especially in construction
  • opportunity for procurement to be structured by government, emphasising certain economic development objectives
  • formation of new companies combining emerging black enterprises with experienced, well-resourced companies (in terms of equity share and project management)
  • promotion of Broad Based Black Economic Empowerment (BBBEE) potential via subcontracting and procurement to include large, medium and small enterprises, bringing benefit to target groups of people
  • involvement of black equity and management skills through the extended time-frame IPPs would operate in (DOE 2011:92-93).

Based on the objectives above, the DOE developed a table of socio-economic outputs that had to be met, or exceeded, in order for tenderers to become a ‘preferred bidder’ in the REIPPPP. The tender adjudication was based on the 70-30 principle where 70% would be evaluated on price and 30% would make up the socio-economic criteria. From the latter, there was a further breakdown (see Table 1 in which certain points were obtainable based on the objectives provided in the bulleted points above).

Each renewable energy project required a minimum of 40% participation by a South African entity, a minimum ownership by black South Africans of 12% (with the target set at 20%) and a minimum ownership of a local community of 2.5%, where the community lived within a 50-km radius of the project (Baker & Wlokas 2014:10). Local content requirements (LCRs) featured in the economic development criteria and the government used this specific tool in an attempt to commit to industrial development. The National Development Plan (NDP) and the New Growth Plan (NGP) utilise local content as a policy tool to stimulate development and to try and maximise benefits for the immediate economy; this programme from the DOE was aimed at doing the same (DOE 2011). The term local content has been defined by the South African Bureau of Standards (SABS) as:

that portion of goods, works and services that have been generated and produced in South Africa. Companies that import raw material and convert this raw material in South Africa also contribute to local content to the extent that the South African value-add processes and additional inputs count as local content. (GIZ 2013a:27)

The calculation of local content is illustrated in Box 1.

In Table 2, the levels required from the REIPPPP per technology are summarised. It is important to note that the levels generally increase with each round of bid submissions.

The difference between the threshold levels (above) and the target levels were defined in the REIPPPP tender documentation. Bidders had to achieve the minimum requirement threshold levels to be compliant; they were, however, encouraged to attempt to reach target levels as the intention of the DOE (in alignment with the DTI industrial policies) was to maximise local benefits. The percentages were evaluated on a sliding scale where no points were allocated to bidders achieving threshold level. As higher percentages were achieved, more points were awarded until the maximum points were gained by those bidders able to reach target in their submission.

Local content impact on investment

Certain key drivers are needed to create a climate conducive to encouraging investment in the renewable energy sector and although LCRs create a drawcard for manufacturers to consider establishing in a new economy, there are additional drivers to support this move. Abrahams (2012) argues that the drivers necessary for establishing a renewable energy manufacturing hub in South Africa would include:

  • a sustainable renewable energy market with growth prospects
  • a strong supply-side support that would include established supplier relationships and manufacturer capabilities
  • the presence of skilled labour
  • physical location and infrastructure availability
  • research and development (R&D) presence that is accessible
  • the existence of incentives for manufacturers
  • a supportive government. (p. iv)

The first key driver to be tested in this research would be the market strength and potential growth of the sector. South Africa has committed to a renewable energy programme that holds predetermined levels of energy to be purchased per technology. Therefore, the market for IPPs and manufacturers has been established, and demand has been shown to be present, with potential for future expansion. Because a strong supplier support was listed as a key driver, the existence of local manufacturers and suppliers of renewable energy technologies, components and ancillary items would be conducive to investment attraction.

Domestic skilled labour is required for sector support, as there is currently criticism about the large influx of foreign labour used to erect and develop renewable energy projects in South Africa.

IPPs have, however, indicated through media releases that the required skilled labor is not present in the country, and this represents challenges to IPPs wanting to maximize their local content spend.

There are studies, at the time of writing, which is testing the market in terms of being able to supply suitably qualified labor for work in renewable energy by original equipment manufacturers (OEMs).

Physical location of renewable energy projects is also important since IPPs need to locate in areas with optimal renewable energy resources, and manufacturers need to be close to their customers so as to minimise logistical costs (these can be quite high for the larger and abnormal loads that characterise some technologies, e.g. large wind turbine blades and towers).

Electrical transmission infrastructure is equally important as this is needed to ensure grid connectivity and the ability of the system to evacuate and distribute the power generated on-site.

Manufacturing also relies largely on supportive infrastructure being present. The ability of South Africa’s logistical and electrical infrastructure to support local manufacturers of renewable energy technologies and components was tested during the survey process. The fact of whether local suppliers are able to produce such manufactured goods at the right quality levels and price was also questioned in the survey.

R&D is important to IPPs and manufacturers alike as it can lower costs and improve efficiencies. However, due to technologies already tested and proven internationally, the IPPs in South Africa are generally installing and developing projects with very little R&D investment. R&D is more relevant to the manufacturing of renewable energy components and it is usually found that the country of origin of a particular technology will tend to keep this intellectual property and R&D local, whilst only allowing some manufacturing of the most basic subcomponents to be outsourced.

The existence of incentives for IPPs is important and South Africa currently uses such for investment attraction. However, with the IPPs looking to tender in the REIPPPP, the tender itself could be viewed as an incentive since it is a guaranteed take-off for energy to be produced over a 20-year period.

Lastly, a supportive government is important for manufacturers and IPPs alike. Government can indicate support via the procurement of renewable energy and can set targets and goals that show future demand continuing for the supply of such energy. National projects via South Africa’s National State utility, Eskom, as well as through the DOE – previously done in South Africa – send out positive signals of support.

Ultimately, throughout the conflicting debate on the impact of LCRs it is acknowledged that local content will have an impact on investment attraction, although this has not been determined in the case of the South African renewable energy sector. An increase in investment, especially from FDI, does have a positive association with economic growth and, therefore, benefit to the local economy. From literature and research based on econometric techniques and case studies, Veloso (2001) refers to the impact of FDI where all indicators point to the fact that it contributes to economic growth and reinforces the learning processes of industrialising nations. There was also evidence that there was a spill-over effect from FDI, providing an increase in the economic growth rate (Veloso 2001:21-23). This study, therefore, looks at the relationship between LCR levels and their impact on investment attraction; it is assumed that increased investment through foreign sources will naturally have a positive effect on the local economy.

Specific aspects regarding setting of local content requirements

Setting LCRs is complex and multi-faceted since, on the one hand, LCRs can add value to locally-produced goods and can stimulate R&D and innovation, but on the other hand LCRs can distort international trade and affect the efficient allocation of resources. It has been noted that ‘(g)lobally, LCR for renewable technologies in different forms have been used in rare instances and mainly in developing countries’ (EBRD Blog 2012:1).

One of the main justifications put forward by developing countries in defence of LCRs is that they are relevant when the type of industry is completely new to their economy. They therefore use LCRs in order to stimulate and develop an infant industry, which they intend to establish into a mainstream manufacturer that can compete globally. This argument can be justified, but countries do not always reduce or remove LCRs after a period, in which case this can become a trade barrier. Therefore, countries are not always in a position to be able to select the highest quality of goods at a competitive price because LCRs have a direct influence on the procurement of these goods or services. A new phrase has been coined in this regard – ‘clean energy trade war’ – where countries use LCRs to justify the blocking of free trade in the name of transitioning to more environmentally-friendly means of developing energy (Kuntze & Moerenhout 2013:vi).

When to use local content policy

Local content can achieve many successes in a host economy; however, there are certain pre-conditions that need to be present before implementing such a policy. Kuntze and Moerenhout (2013:1) identified these key conditions. Firstly, there would have to be a ‘stable and sizeable market’ for which financial support should be available. This was seen as crucial, to avoid the crowding out of investment. In addition, the LCRs should not be set too high or be too restrictive and they should have a learning aspect tied into them in order to ensure skills transfer, thereby increasing efficiencies over the long term (Kuntze & Moerenhout 2013:1). The basic pre-conditions for effectively implementing LCRs in a particular economy are summarised in Figure 1.

Local content policy advantages

Kuntze and Moerenhout (2013:6-9) found that LCRs increased the demand for certain products, which in turn increased the demand for staff, brought in new technologies and – because more manufacturing was taking place – the tax base for government increased. Wu and Salzman (2014:422-423) similarly concluded that local content increased the demand for domestically-produced goods, leading to higher levels of employment. Lewis (2013:4) found an interesting spin-off from increased local manufacturing – as global competition increased in response to more market entrants, product costs were driven down and technological innovation increased.

Local content policy disadvantages

Local content requirements can bring about negative consequences such as inflationary pressure on prices, incentivising business to misallocate resources, and impacting on trade relations by using a form of protectionist measure. It was also found that because of local content, companies may employ fewer staff due to the increased expenses caused by the policy and this also restricts the transfer of technologies (Kuntze & Moerenhout 2013:6-9).

The GIZ (2013b:29) found that local content limited the level of natural competition and Nowicki (1997:363) found that it disrupted the production and planning choices of manufacturers, which led to higher prices. In the specific case of South Africa’s renewable energy industry, local content was found to allegedly increase the cost of renewable energy equipment, which may encourage a strategy of reducing the amount of staff allocated to a project and less energy output would be available for the same investment amount. Brazil noted that when implementing LCRs in their wind sector, manufacturers only shifted the low and medium content production to their country, whilst the high technology components of their manufacturing process remained in the country of origin (Rennkamp & Westin 2013).

When analysing the automotive sector which has used LCRs extensively, there are numerous examples of the impact of this tool. Barnes and Black (2013:14-15) found that companies focused mainly on assembly, and not manufacturing, to reach the required levels of local content. Second tier suppliers also used mainly imported goods over locally-manufactured goods and aspects such as advanced work and tooling, as well as technology investment, still took place outside of South Africa (Barnes & Black 2013:14-15). The Philippines found inefficiencies in their performance standards which included LCRs, embargoes on imported vehicles, and tariffs on import and export requirements. It was estimated that – due to the protectionist policy – the cost to the consumer was approximately 40% of the vehicle price. This effect was mostly attributed to the tariff and if LCRs and the export requirements were removed, the result would change by approximately 10% (Veloso 2001:37).

LCRs have been listed as being responsible for both successes and failures of certain projects in the chemicals and computer sectors, depending on the specifics of each project and technology. It was estimated that – because of LCRs – in Brazil, computers cost up to 200% to 300% more than if sourced outside of the country and this has slowed the use of this technology and reduced the pace of upgrading to new systems (Veloso 2001:38).

Negative criticism found by Eberhard, Kolker and Leigland (2014:28-29) of LCRs in the REIPPPP were that:

LCRs were expressed in value terms but the worth of each job in a particular value chain is not measured; LCRs could therefore be refined to focus rather on maximising jobs of high value than simply creating as many positions as possible.

If there is no capacity-building of the local market to supply developers there is an increase in inefficiencies and little skills transfer from the programme, increasing the costs for the foreign operators and developers.

LCRs are oblivious to market conditions and currently there is an oversupply of renewable technologies, which makes local manufacturing profits very difficult to achieve. Well established and mature manufacturers need to observe a very strong and sustainable market in order to justify moving into a new region (Eberhard et al. 2014:28-29).

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