If I recall pip hasn't handled the upgrade of distribute very well for awhile now but I can't see to find an existing ticket for it.
the older issue is that pip can't upgrade distribute in python 3 (related to distribute requiring 2to3)
btw, pip-1.4 (unreleased) has new logic to skip even trying, because the problem prevents upgrades and wheel building for projects like "pyramid" (which formally depend on setuptools)
Marcus