National Energy Regulator of South Africa (NERSA): briefing on Electricity Pricing Policy

Meeting report

National Energy Regulator of South Africa (NERSA) briefing
Mr Smunda Mokoena, Chief Executive Officer: NERSA, briefed the Committee on the concepts and methods that govern the determination of electricity pricing in South Africa. He provided a short overview of the background to electricity price regulation, how the current NERSA structure and mandate had evolved from the original National Energy Regulator and the legislative requirements arising from the Electricity Regulation Act (the Act).

Mr Thembani Bukula, Full-Time Member: Regulator of Electricity: NERSA explained the rationale behind the change from the Rate of Return Methodology (ROR) to the Multi Year Price Determination (MYPD) method as this formed the basis of electricity price determination. Price determinations specifications were provided in the major areas of Municipal Tariffs Eskom Retail Tariff Structural Adjustments (ERTSA) and Negotiated Pricing Agreements (NPA). The measures for protecting the poor and the resulting provisions for Free Basic Electricity (FBE) were premised on the fact that the poor could not afford to be connected and therefore could not have access to FBE. With this in mind, provision was also made for free connections, and a "life line tariff" in the energy pricing policy. They also suggested further options to be implemented for protecting the poor. The Department of Energy electricity pricing policy was approved in December 2008 and provided excellent guidance and was gradually being phased in by NERSA. It consisted of 60 policy statements, which confirmed existing practices, removed uncertainty and introduced new requirements. NERSA's conclusions noted that, although lower price increases in the past had allowed electricity consumers to enjoy considerable savings, the current high price increases had a major impact on the poorest in South Africa. On Eskom's current financial position, they noted Eskom's declining reserve position, increased power usage, inadequate coal supply infrastructure and the delay in finalising Eskom's funding model. Additionally, managing Eskom’s cost risks by passing them on through higher tariffs created price uncertainty for distributors and consumers.

Discussion
Mr J Schmidt (DA) stated that one could not separate NERSA issues from Eskom and asked for the Committee's indulgence on his questions regarding Eskom. He remarked on his firm belief that Eskom was not run cost-effectively. It was NERSA's function to see that people were provided with electricity at the best cost possible. According to Eskom's financial statements, they were owed R 2,883 billion. It was clear that they needed R 3 billion for their building programme. This meant that Eskom could obtain the required funding if they simply collected on their bad debt. A planned nuclear power station was 80% funded but Eskom was unwilling to proceed because they could not raise the additional 20%. Eskom had also overspent on other projects.

Mr Bukula replied that the MYPD set targets for the reduction of the R 2,883 billion bad debt. It was currently moving in the target direction (from 7% to 2%) He asked members to remember that they only had one piece of legislation to apply and the Act stated that if a NERSA tribunal found that an allegation made against a regulated entity/licencee was correct, it may serve a notice on the licencee to comply with the licence conditions or the provisions of the Act (National Energy Regulator Act, 2004). They had given Eskom this notice and Eskom had provided NERSA with their plan for reducing this debt. Though it had been decreasing steadily, it was still high.

Mr Schmidt stated that the MYPD re-opener trigger of a 3% review level and 10% re-open level looked like NERSA was protecting Eskom at the expense of the consumer. The triggers NERSA had proposed appeared to be aimed at protecting Eskom and not the consumer.

Mr Bukula responded that there had been no dissent regarding the triggers they had set during the public participation processes. They would therefore stick to these triggers until such time that they no longer worked.

Mr Schmidt took issue with Eskom's practice of building up stockpiles through short-term contracts. The world standard for coal stockpiles was 20 days. Eskom adhered to a stockpile standard of 41 days.

Mr Bukula responded that while the rules stated that stockpiles of 20 days should be held, Eskom held stockpiles of 42 days at their own costs. NERSA’s MYPD allowance only extended to the 20 day standard. What Eskom chose to do to mitigate their risk was at their own cost. This was classified as a balance sheet item and was not recorded on the income statement and therefore affected the value of Eskom without directly affecting the consumer in the form of higher tariffs.

Mr Schmidt remarked that Eskom had recorded a loss of R 3,7 billion in the previous financial year. If they were run cost-effectively, they would have made a profit. He got the impression that NERSA believed everything they were told by Eskom without conducting their own investigations. All the examples he had mentioned pointed to the fact that Eskom was not cost effective. Broadly NERSA needed to investigate whether Eskom was cost-effective.

Mr Schmidt remarked that the bad debt had grown by R100 million in the last financial year.

Mr Bukula responded that this amount was classified as non-technical losses.

Mr Schmidt stated that Eskom had built schools and spent on other projects that were not their core business. This was wonderful but it was not Eskom's duty.
Eskom's duty was to produce electricity for the country and NERSA needed to get them back into line to do what they were supposed to do. In the end the consumer had to pay for their inefficiency.

Mr Bukula responded that Eskom might have their own social investment obligations as the reason for the spending on schools and other non-core projects.

Mr Schmidt felt that there was a serious problem with the pricing structure as the benefits of this structure accrued only to the big commercial customers.

Mr Schmidt noted that maintenance spending was never monitored at municipal level. From experience, he could state that municipalities did not apply to NERSA for price increases and did not spend their electricity revenue on maintenance. Within the same district, municipalities charged five different tariffs to five different towns. This was unregulated.

Mr Bukula responded that he would like the names of the municipalities who had not applied for tariff increases. They recognised this as a failure and would endeavour to ensure that municipalities did not implement unapproved tariffs in future.

Mr Schmidt stated that eight of the ten power stations had collieries connected to them. All of these were under-producing. The same coal that collieries had difficulty delivering to Eskom was offered on the open market at market related prices. Eskom was not being managed cost-effectively. Regulating this was NERSA's job and he did not feel that they were achieving the aim of delivering electricity to the people at the best price possible.

Mr Bukula responded that NERSA interacted with collieries and visited power stations. He noted that there were efficiency issues and they did acknowledge that the system of short-term contracts was not ideal. Power stations should have long-term contracts. Under current conditions power stations had to operate at much higher levels than the supply from their linked collieries. This forced power stations to purchase coal on the short term market. NERSA was conducting its own investigation into primary energy (basic energy generation inputs such as coal), as this was the primary cost driver. Furthermore NERSA had disciplined Eskom in the past based on findings from their own investigations. If they made similar findings in this investigation, they would act in the same manner.

Mr Mokoena added that where issues were outside their jurisdiction, they informed the policy makers. They had done so regarding the way that coal prices were set. As coal was a strategic input for electricity regulation and had market related aspects, it was an issue outside their competency. Perhaps the strategy behind coal pricing should be reviewed.

Mr L Greyling (ID) stated that Mr Schmidt's estimates were very conservative and that a figure closer to R 1,2 trillion was going to be needed for power stations over the next 25 years. Who was going to fund this? He asked if the funding would be obtained from the consumers through increased tariffs, whether the funding would come directly out of the fiscus or whether other methods would be employed to provide this funding. Confusion about this caused many problems.

Mr Bukula replied that it was correct that R 3 billion was needed for capital expansion. This was additional to the R343 billion already needed for capital expansion this year. When evaluating the figures, it was important to note that NERSA's function was to strike a balance between the needs of all stakeholders. Eskom and the other regulated entities were also stakeholders and NERSA was responsible for ensuring that regulated entities were sustainable and efficient. The funding model was under discussion by the policy makers. If government was unable to provide funding and Eskom was unable to borrow the necessary funding, it had to be derived from tariffs. Whatever method was chosen to fund the building of new power stations, it would ultimately affect the consumer.

Mr Greyling noted that the reason Eskom had given for not signing power generation agreements with these Independent Power Producers (IPPs) was that Eskom could not commit to this transaction until their funding model was approved. IPPs did not have any certainty going forward and this case also applied to renewable energy feeding tariffs. These were very progressive measures but if Eskom continued by not concluding these agreements, progress would not be made. He asked what institutional obligations would apply to Eskom to sign these types of agreements in future.

Mr Bukula responded that NERSA was entitled to facilitate an agreement to buy and sell power between a generator and a purchaser. They had done this in the case of South African independent power producer, Independent Power Southern Africa (Ipsa), through a Power Purchase Agreement (PPA) with Eskom. At the time Eskom needed the additional power but the downturn in the production due to the recession meant that Eskom no longer needed this additional power. Furthermore, Eskom had not applied for funding to purchase additional power and until the funding model was concluded, Eskom would not have a clear picture of how to approach PPAs. The Department of Energy had issued regulations on 5 August 2009 regarding IPPs and this had shed light on the practical and institutional arrangements around IPPs.

Mr Greyling stated that the best solution to all aspects of the energy crisis was the promotion of energy efficiency. There did not seem to be much movement on this. He asked NERSA to elaborate on energy efficiency in South Africa and asked them to look at the funding models in conjunction with how Eskom financed Demand Side Management (DSM). The bigger issue was determining how much Eskom lived up to its obligation regarding energy efficiency.

Mr Bukula agreed that energy efficiency was the quickest and cheapest way to address energy shortages. NERSA had given Eskom R1,2 billion over the past 3 years and they had to report on their Demand Side Management (DSM) initiatives (such as installation of Energy Efficient light bulbs) and NERSA had the records to account for the R1,2 billion. DSM was supported and NERSA did monitor developments.

Mr Greyling asked if NERSA had looked at encouraging people to change their energy usage patterns.

Mr Bukula stated that South Africa did not use differentiated tariffs across the board. Most big businesses used differentiated tariffs but they were not available to consumers.

Ms N Mathibela (ANC) noted concern about the poor being disadvantaged. She asked how Free Basic Electricity (FBE) could be provided to people if municipalities could not afford to implement this.

Mr Bukula responded that there was a range of reasons that FBE was not able to be implemented. One problem was the vast distances people had to travel to get their FBE coupons. Over the last three years, the use of FBE had increased by approximately 15%, showing that there had been improvement. Municipalities did involve NERSA in this process and NERSA had increased the FBE allowances as usage had increased. In dealing with municipalities, NERSA recommended solutions and it was up to the municipalities to implement.

Ms Mathibela referred to the challenges NERSA had experienced in terms of municipalities reporting to NERSA. She asked what could be done if municipalities failed to comply.

Ms S Radebe (ANC) remarked that NERSA did not seem to be in control of Eskom and asked for a more detailed account of the arrangements in place regarding NERSA's authority over Eskom.

Mr Mokoena responded that the Committee should fully appreciate the environment in which NERSA functioned. NERSA had several stakeholders to consider: policy makers and law makers (Department of Energy and Parliament) who crafted the policies they implemented, regulated entities, customers/end users and investors. Being the regulator was an unenviable job because of the conflicting needs of end-users and regulated entities. This was specifically seen in the need to protect end-users and the need to ensure that the regulated entity was viable and sustainable in the long-term. NERSA's independence was a focus point of the 2008 National Economic Development and Labour Council (Nedlac) Summit and they interrogated the applications made by Eskom thoroughly and ensured public participation in these processes. Once they made their determinations, the reasons were posted and the public was free to question the decision. No one had done that. The answer to the questions on NERSA's role and powers was that their role was clearly defined in legislation. In the case of a defaulting licencee, NERSA was entitled to impose a fine. People should have confidence in the work of NERSA because of the transparency of their processes and their focus on public participation. Members should bear in mind that they played a specific role within the broader framework in South Africa and NERSA aimed to be consistent and transparent.

Mr Radebe recounted the series of tariff increases. He asked if NERSA had considered the MYPD rules when these tariff increases were awarded.

Mr Bukula responded that where illegal tariffs were charged, the NERSA process was to issue a notice stating that the situation should be rectified. In most cases, the budget for that year had already been approved and if the municipality failed to respond in the following financial year, the tariff increase would be cut in the following financial year.

Mr Radebe noted that Majuba and Arnot power stations were the same distance for collieries and asked what the reasons were for reaching coal supply agreements outside the Majuba region. He asked if NERSA had personally investigated on site at Majuba power station. He also mentioned the possibility of using a rail line to transport coal to Majuba power station.

Mr Bukula replied that NERSA had conducted site visits at Majuba and Arnot. They had also evaluated the financial records and seen what their coal supply arrangements were. It was a known fact that Majuba power station was built in an area where there was no coal and coal had to be transported from other sources. Arnot had a linked colliery. To the best of his knowledge, the rail line to Majuba had not been built yet. He welcomed information to the contrary.

Mr Radebe referred to the slide regarding the municipal tariffs and failure by municipalities to submit applications for tariff increases. He asked if NERSA had checked on the reasons for this. He recalled that the municipal IDP process started in October. The municipal budget process started in March of every year and this budget had to be approved by April or May of the financial year. He asked if NERSA had interacted with municipalities to determine when these things were agreed upon.

Mr Bukula responded that NERSA conducted checks to the best of its ability. They continued to improve on these processes.

Mr Radebe noted that rural communities pad the higher tariffs while tariffs for businesses were much lower. He asked if the poor were being made to cross subsidise business. He felt that there was no synergy in this situation.

Mr Bukula responded that this was because urban infrastructure was built many years ago and had been fully paid for and had fully depreciated over that period. New infrastructure in rural areas still had to be paid for. The Act required NERSA to ensure that their licencee recovered the full cost of the investment with a reasonable return. The price was determined as a reflection of this cost.

Mr Mokoena responded that this was comparing apples with oranges. Commercial users often received their electricity directly from the transmission phase. They therefore did not incur the costs attached to the distribution phase. Some commercial users were even able to supply municipalities. Rural communities were at the end of the supply chain and got their electricity with the cost of distribution attached. Commercial users could also benefit from economies of scale and this meant that the real price of the electricity they use goes down as production volume increases.

Mr Greyling asked if rural communities would have to bear the costs of the Department of Energy's electrification programme. Approximately R4 billion was allocated to this programme and this should be sufficient to cover the costs of electrifying rural areas.

Mr Bukula responded that the R 4 billion would cover the cost of the capital outlay. The return on the capital must be then covered and this was the part that increases prices/tariffs.

Mr Greyling asked if the R4 billion spent on the project then needed to be recouped through higher tariffs for rural consumers. This sounded ludicrous as the intention was to provide rural communities with electricity and cover those costs by using fiscus.

Mr Bukula responded that once the initial capital amount was spent, the infrastructure had to be maintained and this would be financed through increased tariffs.

Mr Greyling asked how maintenance costs applied to the capital spending issue. These appeared to be two separate issues.

Mr Bukula replied that maintenance costs were covered by the return on the capital investment and the return was generated by increased tariffs.

The Chairperson called a point of order stating that the presenters should continue answering other outstanding questions.

Mr Radebe felt that the Regional Electricity Distributors (REDs) should start immediately and that this would limit the loss of revenue as REDs would improve the efficiency of collection.

Mr J Selau (ANC) recalled that the electricity had been described as comprising three components, namely: generation, transmission and distribution. He pointed out that an important component at the end of that process was the revenue collection and this area seemed to be less regulated. He asked the role NERSA played in this.

Mr Bukula replied that NERSA encouraged municipalities to have by-laws to allow them to disconnect any service when residents failed to pay. This could be used as a credit control measure by municipalities to ensure that they collected more revenue. NERSA encouraged this but actually enforcing it was outside of their mandate.

Mr Selau noted that NERSA had implied that South Africa had never had a blackout. He asked for clarity on the statement that South Africa had never had a blackout of more than five system minutes.

Mr Bukula replied that one system minute was equal to a blackout encompassing all of South Africa. An interruption in just one area was only equivalent to a fraction of a system minute (the smaller the area and length of the blackout, the smaller the fraction). The cumulative blackouts in South Africa over 10 years had been calculated and this did not add up to more than five system minutes. He had not intended it to sound like South Africa had not had blackouts. There had been load shedding and blackouts. A system minute was a technical measure of the reliability of an electricity transmission system. It was one of the criteria that investors used to determine the availability and reliability of electricity supply in a country.

Mr Selau asked if this meant that South Africa had not had a total blackout in the last ten years.

Mr Bukula responded that this was correct. The usual definition of blackout still applied but a system minute was a technical term.

Mr Selau remarked that South Africa depended heavily on coal powered electricity generation. And asked how the other possibilities, such as gas, nuclear and sustainable energy methods were being developed. Furthermore, he wondered what regulations NERSA had developed to aid these energy alternatives.

Mr Schmidt stated that he was still of the opinion that NERSA was protecting Eskom. NERSA seemed too stuck on the rules. He felt that the Committee needed to apply common sense and the main issue here was that it was the consumer who wound up paying. He had accessed the NERSA Report on the recent approval of electricity tariff increases and he did not see the reasons for this decision reflected in the report. There was a need to protect the end user. If NERSA needed political support, they should inform the Committee on what was needed.

Mr Bukula responded that if Eskom was not efficient, the loss should come out of their bottom line. The consumer should not pay for this. NERSA applied the rules provided for in the legislation.

Mr E Lucas (IFP) pointed to bad planning by Eskom in the past. They had dragged their feet on solar water heating, daylight savings and other energy efficiency initiatives. He felt that Eskom had chosen the easy way out by demanding more money from the consumers. Maintenance on the infrastructure was not implemented and it begged the question of where the money was spent. He felt that much of the infrastructure was already in place to electrify increasing urban communities, referring to existing pylons where the connections could simply be made to electrify the surrounding communities. The Independent Power Producers were discouraged because they had to allow Eskom to resell electricity at a higher price than if they had been able to sell to consumers directly. This was a big handicap. This did not make sense when one considered that South Africa supplied electricity to other countries at a better rate than was applied to South Africa's citizens.

Mr S Motau (DA) stated Eskom had been awarded a 27% tariff increase in 2007, followed by a 31% increase in 2008. The rumour mill had placed the next tariff increase application at 40%. This added up to 100% increase in the price of electricity in three years. This was the reason for the cynicism regarding NERSA. The solution hinged on the finalisation of the funding model. They would then be able to present the people with good reasons for actions taken regarding electricity in South Africa. People needed this kind of certainty. He added that no other company in South Africa would be allowed these kinds of increases and this had been the crux of much of the discussion.

Mr P Dexter (COPE) noted that NERSA seemed unable to control Eskom and asked what consequences were applied to Eskom. He asked what powers could be given to NERSA so that there would be consequences for Eskom. This was where the Committee could help.

Ms L Moss (ANC) asked NERSA to tell the Committee about the challenges they faced and what legislative and policy assistance they needed. She stated that this was an area in which the Committee could contribute to make an impact on people's lives.

Mr Mokoena replied that NERSA did consult strongly with the policy makers on Eskom's applications. They had outlined Eskom's funding options. Eskom needed to submit their application to NERSA before the end of September 2009. NERSA was hopeful that the decision on Eskom’s price increase application would have been finalised by the end of the October 2009. NERSA was not privy to the actual figure yet. He agreed that the funding model should be finalised. It was not correct to say that they did not evaluate the applications thoroughly. NERSA did this fairly, transparently and in the interests of all stakeholders, especially the consumer.
 
The Chairperson reminded members that NERSA could be called to respond to any unanswered questions at a later date. She also suggested an oversight visit to NERSA and asked members to consider this proposal.

[Note: For this meeting, Ms R Tinto was elected as Acting Chairperson as the Chairperson, Ms E Thabethe, was unable to attend due to illness.]

The meeting was adjourned.