Eskom Tariff Increase Application: briefing by Eskom and NERSA

Meeting report

Opening Statement
The Chairperson stated that Eskom would brief Members on the application that was made to the National Energy Regulator of South Africa (NERSA) who would also be giving a briefing. The last time Eskom submitted an application to NERSA, NERSA had stated that there were a few recommendations that Eskom had to fulfill for the application process to be successful. The Committee wanted to see if these recommendations had been implemented. Members also wanted to play an active role in ensuring that recommendations were fulfilled. She wanted Eskom to talk to issues surrounding the application. The Committee wanted to know what the processes were that would be followed during the time that NERSA considered the application. There was a big issue concerning consultations with the public and some municipalities. 

Briefing by Eskom
Mr Jacob Moroga, Chief Executive Officer: Eskom, thanked the Committee for allowing Eskom to brief them on the pricing application for the Multi-Year Price Determination 2 (MYPD2). Previously, the pricing application had been an annual application. Through discussions and by looking at international trends, it was decided that it was more appropriate for the application to span over a number of years. A longer term price application was more appropriate. The first MYPD started in 2006. The application was made in 2005 and covered the years 2006, 2007 and 2008. In 2008, Eskom wanted to submit a three-year application that would cover 2009/10, 2010/11 and 2011/2012. In 2008 when Eskom was about to submit the MYPD, they assessed the funding that was required. One of the big drivers in terms of costs was that Eskom had embarked on a “Big Build Programme”. Secondly, there was a constraint on the power system, which also resulted in costs being incurred. The funding requirements had become substantive; especially for the new build programme. After consultation with necessary stakeholders, Eskom decided that that they would submit a 1-year interim application. This would give them the space that would allow them to talk about the funding model for the next three years.

Eskom submitted the interim pricing application and was granted a 31.3% tariff increase by NERSA. This was put in to effect on the 31 July 2009. The interim application covered Eskom’s operational costs; it did not cover its capital costs. The interim application was based on NERSA’s indication that prices would rise between 20 and 25% over the next two years. The interim amount was based on this price increase plus inflation. Eskom asked for a 34% increase but was given a 31.3% increase, as NERSA’s rate of inflation differed to Eskom’s.

The interim period covered from 1 July 2009 to 31 March 2010. A new determination by NERSA would be needed from 1 April 2010. This determination would be implemented by 1 April 2010 for Eskom customers and from 1 July for municipal customers. The MYPD2 application would cover the years 2010-2012.

One of the key issues underlying the application was that Eskom was currently undertaking a “big build” programme. The last programme happened in the 1970s and 1980s, and was funded by the Capital Development Fund. In this fund, part of the tariffs were taken and put into a reserve. This would help finance the programme. The next wave of capital investment had to be built. However, current electricity prices were cheap and too low, and this did not allow Eskom to accumulate sufficient revenue to cover the funding requirements needed for the build programme. Eskom wanted to increase tariffs to the level where they could be used to build new infrastructure. Eskom was committed to a capital expansion programme. Three power stations were currently being built. Two would be ready in 2012 and the other would be ready in 2013.

The basis of the funding model was to make choices about the various elements that incorporated funding. These elements were:
Tariffs – revenue received from customers
Equity – revenue received from shareholders
Borrowings – money from lenders and investors

All three had to balance in order for Eskom to respond to operational and capital costs. With borrowins, Eskom looked to the market to assess how much they could get. One of the biggest challengers was that South Africa’s tariffs were the lowest in the world and did not respond to the funding requirement for capital. Tariffs had to be raised in order for the new Eskom infrastructure to be built. The amount received from equity and borrowings had to be supported by the tariffs.

Eskom had submitted the pricing application by the 30 September 2009. They also conferred with the South African Local Government Association (SALGA), as this was a mandatory process and they had to ensure that, before NERSA processed the application, municipalities had four days in which to comment. These comments had to be integrated in to the pricing application. The application was then submitted to NERSA, SALGA and National Treasury. Eskom had to wait for SALGA to conclude consultations. This included consultations with all the municipalities by SALGA. Once comments are received, the application would be adjusted. Once NERSA received all the comments and the final application, there would be a public participation process where people could make submissions. NERSA’s determination would happen by the end of February 2010, as tariff increases needed to be instituted by April and July.

Since the end of last year there was an Electricity Pricing Policy (EPP) that was approved by Cabinet, which played a major role in Eskom crafting the pricing application. The application took into account the capital and operational requirements needed by Eskom. The application also looked extensively at what could be done to protect the poor from increasing electricity costs. A big element of this was the Free Basic Electricity (FBE) allocation and the increase thereof. 

Discussion
The Chairperson commented that the pricing application was submitted for two reasons. The first was because operational costs had to be covered. Secondly, more funds were needed for capital expansion. This was also influenced by the EPP that was adopted by Parliament.

Dr S Pillay (ANC) noted that Eskom said its application to NERSA was submitted on time and NERSA had confirmed this. It was worrying that the media had falsely reported that applications were not going to be handed in on time. This was a problem, as the Committee struggled with what to do when false reports were made. Should the Committee send a message out to the public so that people did not panic? It was irresponsible for the media to report something that was not true. The Committee had a set schedule of meetings. This was disrupted by the media falsely reporting about Eskom’s pricing application, which had caused the need to hold this meeting. This meeting was being held to focus on issues that were not even true.

Mr S Van Dyk (DA) stated that Eskom had to admit that it was due to their own negligence in the past in not increasing tariffs that had resulted in the present controversy. The large increases in tariffs were “killing consumers” these days. The Governor of the South African Reserve Bank (SARB) had stated that the increase could be covered by a once-off tax. He hoped that NERSA and Eskom would not consider this option as only a small amount of taxpayers would have to carry this burden. He noted that Eskom said that the tariff increase was necessary in order to cover current and capital expenditure. He wondered why this was, as tariffs only used to cover current expenditure in the past. He wondered if it was because Eskom could not manage to get enough money from the government. He asked if the tariff price differences were taking into account the different consumers in the country. Were all consumers bound to the same price increases? He noted that coal suppliers profit after tax increased by 134% this past year. He asked if this meant that coal suppliers were now “making a killing” in profit and that consumers were the victims now that Eskom was in trouble.

Mr Moroga replied that, ideally, tariffs had to deal with operational costs as well as any additional associated costs. Additional costs also included capital costs. Capital costs were either funded through equity or borrowings. In order for an institution to borrow money, they needed to be able to demonstrate that they would be able to repay the money. This payment factored was into operational costs. In terms of the power stations that were being built, Eskom wanted all the capital to come from long term funding such as equity and borrowings. As the capital requirements increased, interest costs increased as well. This had to be factored into Operational Expenditure (OPEX). The tariff increase had to support Eskom’s ability to have a balance sheet that could withstand borrowings. NERSA also asked Eskom to look into what capacity was required over the next ten years and what the costs of this would be.

In terms of differences in tariffs for different consumers, there were two kinds of customers. There were consumers who were subject to standard tariffs, which increased every year. The second types of consumers were subject to special pricing agreements. There was a small section in the industrial sector subject to special agreements such as the aluminium industry. On average, industrial customers subsidised the rest of the customer base when one looked at costs to suppliers.

Mr Moroga stated that he could not comment on the profitability of coal suppliers; however, Eskom was an important player in the coal industry. 

The Deputy Minister for Public Enterprises, Mr Enoch Godongwana, pointed out that there were some questions that Eskom could not answer, as the issues were beyond their control. Eskom would not be able to respond to the question concerning a once-off tax that could cover the tariff increase. Eskom did not have control over taxation powers. The Deputy Minister could not respond to the question either, as the funding model was still up for discussion.

The Chairperson said that Committee would call the Ministry in a month to check how far they were with the funding model.

Deputy Minister Godongwana replied that the funding model would be completed by 4 November 2009.

Mr P Van Dalen (DA) noted that when there were salary increases and price increases, businesses looked at the international market. However, when one looked at service delivery, it was convenient to look at South Africa as a third world country. He wondered why Eskom looked at international trends when it wanted to increase prices and salaries, as “lights” in international countries did not “go off all the time”. Eskom’s prices were increasing all the time but the service was not getting any better.

Mr M Oriani-Ambrosini (IFP) said that Eskom was not talking about a tariff increase per se; they were talking about a capital funding plan. This was an important issue that would be with Parliament for years to come. He stated that he had written to the Minister of Public Enterprises months ago. The letter stated that he had received a request from a major electricity supplier in Europe. They wanted to talk about the possibility of funding the capital investment programme by breaking the monopoly of power generation. Competing companies generated labour. He did not receive any reply from the Minister or Eskom, which was extraordinary. He wanted to know if this option was being looked at as a way of funding rather than looking at taxpayers. Eskom may not like this option, but this was a decision the country could make. He heard that even though South Africans would feel the effects of a tariff increase, foreign countries that Eskom supplied would not be affected. He thought it was untenable to ask the South African people to subsidise the supply of electricity to foreign countries.

The Chairperson warned Mr Oriani-Ambrosini that any correspondence had to be made through her, as the Chairperson of the Committee. She could have assisted him or provided him with answers.

Mr Oriani-Ambrosini said that he thought the Committee Secretary was the “postbox” through which the Committee handed requests to the Chairperson. He asked if she wanted Members to correspond with her directly.

The Chairperson stated that she had not seen his request. Members had to submit queries to her via the secretary. She did not want to dwell on the issue in the meeting and preferred to talk to Mr Oriani-Ambrosini after the meeting.

Mr Moroga stated that the idea of bringing new capital into the industry was theoretically correct. However, the issues were that private capital looked for market-related returns. This meant that the prices for electricity had to reflect these returns. Contracts with foreign countries were exposed to price increases implemented by South Africa. The increases in tariffs were reflected in contracts given to other countries.

Mr G Koornhof (ANC) noted that there were a lot of hardships in the country currently. He hoped that Eskom was taking this into consideration. If one looked at tariff increases in municipalities, one would see that the basic tariff plus the VAT on that made up the total amount. He asked if Eskom considered reducing the VAT rate to reduce the burden that consumers faced. He noted that in times of high inflation, the country tried to keep within inflation targets. One of the difficulties that the country had in keeping inflation under control was the increase in administrative processes. This fueled inflation. He asked if Eskom considered how increases in administrative costs would affect tariff increases.

Mr Moroga stated that the VAT matter was a policy issue. He could not comment on this. He understood the impacts of administrative pricing. The underlying rationale for increasing prices was the understanding that Eskom needed to “grow the system”. This required sufficient funding, which meant that Eskom needed to borrow funds, but also have the revenue to balance the financial transaction. If the country did not have enough capacity, its growth could be constrained.

Dr Pillay commented that there was a lot of argument that Eskom was a monopoly and that this prevented competition from entering the market and as a result the price of electricity rose. There was a perception that bringing in independent producers of electricity would decrease the price of electricity. However South Africa was the cheapest producer of electricity in the world. This justified why Eskom should continue to be a monopoly. While Eskom was talking about increasing tariffs, they were also looking at ways to subsidise the poor.

Mr M Mangena (AZAPO) agreed that there was a constant call for the private sector to enter the “electricity arena”. The understanding was that they would break the monopoly and the price of electricity would decrease. However, the private sector would not enter the arena unless the electricity price were substantially higher than what they were currently. He did not see how this would be beneficial to the people of South Africa. Taking into consideration the EPP and the tariff increases being requested, he did not see the private sector being interested.

Deputy Minister Godongwana said that he welcomed the idea of private companies voyaging into energy generation. This would help Eskom by providing the organisation with additional capacity. The idea that private producers would help decrease the price of electricity was incorrect if looked at in the context of South Africa. The price would be pushed upward.

Mr Moroga added that the Deputy Minister had responded to the question accurately and sufficiently. There was no need for him to elaborate.

The Chairperson stated that the point of the application was also to solve the electricity supply problem currently experienced so that there would not be any problems in the future. The increase in the tariffs could not just be justified by saying there was a need to cover operational and capital costs. Eskom also had to say that the tariff incresaes was a solution to the supply problem.

Mr C Gololo (ANC) said that the aluminum smelters were electricity “guzzlers” and that they were exempt from tariff increments because the price of aluminum in the market fluctuated. This was an international trend. He asked if Eskom found that they lost a lot of money because of this. He wanted to know the percentage for reserve margins regarding electricity security.

Mr Moroga answered that the aluminum contracts represented, in terms of capacity, about 5% of the system. It was important that Eskom learn from this and focus more closely on long-term contracts and how they reflected the reality of what was happening in the country presently. Eskom wanted to do this in a way that did not leave an impression that they could not fulfill their commitments. He said that aluminium smelters were not exempt from tariff increases. Eskom had a special agreement with them based on the aluminium produced.

Mr Moroga said that the reserve margin improved largely because demand for electricity decreased due to the global meltdown. However, it was still not where it should be and the new power stations were needed to ensure electricity supply security. Currently, the reserve margin was at 10%, but Eskom needed to be at 15% minimum.

Mr Van Dalen noted that independent power producers (IPPs) needed more money to generate power than Eskom did at the moment. He asked what Eskom was charging at the moment. He also wanted to know what the price per unit was if power was generated by diesel.

Mr Moroga replied that diesel-generated power could reach up to thirty times that of an average coal station. However, diesel power was limited due to high costs.

Mr Oriani-Ambrosini said that the Committee was in need of more source documentation from Eskom. The Committee was always told different things by different people. He wanted clarity that there was no long term contract to any foreign country that obliged Eskom to supply electricity at the lowest rate possible. The Committee could not understand what was being said without spreadsheets and other source documents.

Mr Moroga answered that there were special agreement with foreign customers. He would send the Committee a response with the list of foreign contracts.

Mr Mangena noted that it was only once the Built Programme was completed that there would be electricity supply security. He asked if Eskom could assure this. Eskom had said a number of years previously that they were going to run out of their reserve margin. At that point the government suggested that Eskom not build power stations. This was not Eskom's problem, as it just implemented what the state as the shareholder told them to do. 

The Chairperson said that the government needed to take collective ownership of its mistakes. Government had to agree that it made an error and resolve not to make the same errors this time around. The Committee needed to be very decisive in its leadership. The government could not afford to let anything go wrong with the Build Programme, as mishaps would result in permanent electricity supply shortages. The Build Programme was critical and had to continue. The state had a constitutional obligation to provide the people of South Africa with their basic needs.

Mr Moroga said that it was time for national decisions to be made around these issues. Electricity was a key foundation for the economy. It was time to move forward and make the right investments.

Deputy Minister Godongwana said that he was not as optimistic as Mr Moroga about security of electricity supply in the country. His own assessment was that Eskom's board had to say what they required to run the entity in a sustainable way. If not enough funding was given, the Build Programme would have to be postponed. He noted that there was a problem with coal quality. This needed to be discussed, as it affected power supply.

The Chairperson said that she did not want Eskom in the room while NERSA was briefing the Committee, as NERSA was still in the process of reviewing their application. She thanked Eskom for briefing the Committee on the pricing application. The state and the Committee had to do everything they could to ensure that the Build Programme was not postponed or stopped.

National Energy Regulator of South Africa (NERSA) briefing
Mr Smunda Mokoena, Chief Executive Officer: NERSA, spoke about Eskom’s second Multi Year Price Determination (MYPD) revenue application. He provided background on electricity price regulation processes, which took place annually. In 2005 Eskom had decided to move to a MYPD to cover the period April 2006 to March 2007. This would allow for price stability when Eskom would start providing for massive capital investments in new generation capacity.

Eskom did not apply for the MYPD2 price control in September 2008 and postponed their submission pending the resolution of the funding model with the government. In January 2009 the MYPD2 rules were approved by NERSA following consultations and a public hearing. In May 2009, Eskom applied for a 34% interim tariff increase; however, NERSA had approved a 31.3% increase. Eskom submitted their MYPD2 revenue application by the end of September 2009 to obtain the necessary approvals for implementation in March 2010. Various regulatory methodologies were used to ensure that allowed revenues such as revenue margins from licensed activities, and charges and tariffs complied with the requirements of the Electricity Regulation Act. The Rate of Return (ROR) methodology was applied on an annual basis for regulating Eskom’s revenue from 2003 to 2005. The allowed revenue was the tariff revenue net of charges and negotiated price agreements.

The MYPD was applied to Eskom over a three-year period and provided certainty of price increases. Municipal electricity distributors were provided with an annual price increase guideline based largely on the Eskom price increase. They would submit applications for tariff increases after municipal budgets were approved. Challenges included municipal compliance with timelines for approvals by the Regulator and failure to submit information on financial and operational performance.

Tariffs were a means to recovering the utilities revenue, and therefore needed to be structured in a combination of different charging parameters that would recover revenue. Key issues focused on making tariffs more cost reflective and unbundling tariff components. Eskom also had Negotiated Price Agreements (NPAs) with large industrial users. Current NPA consumption amounted to 7.5% of Eskom sales.

NERSA and Eskom was also involved in initiatives to protect the poor, since addressing affordability was a major issue during periods of high price increases. Some of these initiatives involved facilitating access to electricity through government-subsidised electrification, Free Basic Electricity (FBE) and free connections to low consumption residential customers.  Other options could include increasing the FBE volume, making low consumption domestic tariffs VAT-free and investing in more energy efficient housing.

The MYPD2 application was received from Eskom on 30 September 2009. In October, NERSA would deliberate on Eskom’s confidentiality application. NERSA hoped to publish an application for public participation in November. December would be the closing date for stakeholder and Eskom inputs. A draft decision incorporating stakeholder comments would be drawn up in January 2010 and public hearings on the draft decision would take place in February or early March. Thereafter, NERSA would make a final decision concerning Eskom’s application. 

Discussion
The Chairperson said that the tariff increases were quite worrying. The Committee had pointed out that tariff increases for big users and small users were very different. It seemed that small users were being charged higher tariffs than big users. This was a very serious matter. The Committee would come back to NERSA to discuss this issue in depth. 

Mr Van Dyk said that there was a big difference in tariffs being paid by small users and big users. Small users were paying more because electricity was being distributed through municipalities, which added profit onto the costs before distributing the electricity to the consumers. Eskom's distribution of 40% of the power to big consumers was only subject to normal tariff increases. He wondered if, in NERSA’s consideration of Eskom's application, they had discussed with Eskom the idea of IPPs. There were a lot of IPPs that wanted to enter the market. This could help Eskom to increase its supply of energy and to decrease the price of electricity. There were almost 23 IPPs that had applied to be energy producers. China opened its market to IPPs and power stations were built. Due to an increase in energy supply, the prices decreased.

Mr Mokoena said that matters regarding the two consumers were a historical matter, which had to be addressed by restructuring the industry.

Mr Mokoena said that the IPP issue was a policy matter that concerned economics.

The Chairperson commented that NERSA did not negotiate with Eskom. She did not think it was their role to do so.

Mr Gololo asked if the amount of Free Basic Electricity (FBE) would decrease now that tariffs had increased, or  would it remain the same?

Mr Mokoena said that the amount of FBE would remain the same for the poor.

Deputy Minister Godongwana said that the FBE was limited to 50 kilowatts. There was a proposal that the FBE be increased from 50 to 70 kilowatts. The National Treasury would subsidise the increase.

Mr M Nhanha (COPE) said that there were entities such as SASOL that were planning on generating their own energy. He asked what impact this would have on Eskom and the energy supply.

Mr Mokoena answered that creating one's own energy was a programme that NERSA initiated to promote energy production and to increase the reserve margin. Eskom would be happy if entities could generate their own power.

The Chairperson understood that NERSA would deal with a second round of comments from municipalities after considering Eskom's application. She noted that the profit municipalities charged consumers when supplying electricity was not regulated. This was a problem. She wondered why it was that people in poorer communities were paying more for electricity.

Mr Mokoena replied that the problem was the fragmentation of the electricity distribution industry. Hence, there was a need for its restructuring. There was a very large number of tariffs. This called for the consolidation of the electricity distribution industry. There was a need for municipalities to adjust prices within a certain price range.

The Chairperson thanked NERSA for the briefing. There were policy issues that the Committee needed to clarify, but they would discuss it with the Ministry. The Committee was aware that there was a need to call upon Eskom again as well as the Department of Public Enterprises to discuss the protection of the poor.

Adoption of Minutes
The minutes for 1 and 8 September 2009 were adopted.

The meeting was adjourned.