Eskom on Contracts with Smelters and Industrial Clients: Briefing

Meeting report

Opening Statements
The Chairperson stated the Committee invited Eskom to discuss their contracts with smelters and industrial clients. She noted that the title of the presentation was different. However, it did not matter because it was the same thing. For record-keeping purposes, she had to note that the title of the presentation was different.

Mr Mpho Makwana, Acting Chief Executive Officer of Eskom Holdings and Acting Chairman, replied that Eskom could switch its presentations, as they had thought that the agenda was to discuss their long-term contracts and Negotiated Pricing Agreements (NPAs). If the Committee wanted a broader discussion on the topic then Eskom could present another document as well that gave a broader view of Eskom’s dealings.

The Chairperson hoped that Eskom would be touching on their key contractors. This was what the Committee wanted to know about. She wanted to know if information about all the smelters were captured in the presentation on long-term contracts.

Mr Makwana stated that the specific matter that the Chairperson was referring to was captured in a different set of slides. Eskom would present that document as well.

The Chairperson stated that this was the first of many meetings that would be held with Eskom. She explained that the agenda for the meeting stemmed from a meeting that was held with the National Energy Regulator of South Africa (NERSA) when the Committee noticed that there was a major difference in the rates that Eskom was charging the public and the rates they were charging their special clients. The Committee needed an explanation. Whenever NERSA granted Eskom a tariff hike, they always said that the protection of the poor was being factored into their plans. The Committee had to know if this was true.

Long-term Electricity Supply Contracts
Mr Makwana stated that Eskom had a “climate” of excess capacity in the past. The NPAs had stemmed from this excess capacity. Eskom would not be reflecting on the merits and demerits of this decision; their task was to explain the progress that was being made with relieving Eskom and the country. Eskom and BHP Billiton put together a joint committee to negotiate the contracts. They had some useful engagements and Eskom was at a point where 95% of the liability in terms of the embedded derivatives had been eradicated. Eskom and BHP Billiton signed an agreement on 31 March 2010 that looked towards implementing the first phase of the agreement. Embedded derivatives were an accounting term for liabilities that arose from onerous contracts, where the liability was also linked to the future value commodity. In this case the commodity was aluminium. Last year, Eskom made an accounting loss because of embedded derivatives. Renegotiating the contracts meant that Eskom would be able to remove the accounting liability off its balance sheet. BHP Billiton would now be switched to a normal customer arrangement.  

Ms Erica Johnson, Chief Officer: Customer Network Business, Eskom, stated that the current environment made it necessary for Eskom to reflect on its experiences with NPAs and to review existing long-term supply agreements. She explained that Eskom entered into NPAs with two large industrial customers known as BHP Billiton and Anglo-American during a period of excess capacity and low cost electricity in South Africa. In the changed environment, the sustainability of these NPAs became a matter of concern to Eskom because of the future negative impact of the agreements on Eskom and the country and because of the embedded derivative volatility arising from the contracts.

The counter-parties willingly engaged Eskom on the sustainability of the agreements. They wanted to find a mutually beneficial solution for both parties. Eskom and BHP Billiton agreed in principle to amend their current long-term NPAs for the supply of power to BHP Billiton’s Mozal smelter in Mozambique as well as the smelters in South Africa. Anglo American and Eskom signed a “terms-of-reference” for engagements. Initially, they expressed willingness to engage, but now there was a perceived reluctance from Skorpion Zinc, which was owned by Anglo American.

At this point, all legal and regulatory approvals were put in place. All parties’ auditors were confirming that there were no embedded derivatives and no onerous contracts. Eskom was confident that the agreements with BHP Billiton would be finalised by 27 May 2010. Eskom will continue to pursue amending the NPA with Anglo American.

Cost of Service: A Tariff Overview
Mr Makwana stated that he hoped that Eskom could cover a lot of ground with this presentation. Eskom did not understand that this was the primary focus of the Committee meeting today. They may have to come back to the Committee with additional information if it was required.

The Chairperson stated that the Committee understood the predicament. If Eskom could not answer some of the questions, the Committee would allow them to respond to the questions in writing within ten working days of the meeting.

Ms Johnson addressed the presentation. She stated that in order for Eskom to recover their revenue, they had to follow policy that was reinforced in the Electricity Pricing Policy that said that Eskom had to have cost reflective tariffs. These tariffs would signal the cost of production. In terms of electricity generation, Eskom looked at the cost to its assets, auxiliary consumption, returns and technical losses. This power is then transferred across the country via a transmission network. There were many costs involved in moving power such as the cost on assets, ancillary services and technical losses. Power generated was also distributed to supplies.

In terms of electricity consumption, Eskom supplied 45% of the energy that was generated to municipalities, while 55% of the energy was directly supplied by Eskom. The pie chart representing electricity consumption showed that residential consumers used 5% of energy generated. [Slide 7]

Eskom discussed their strategic pricing directions for tariff structures. The objective of the structure was to ensure economic efficiency and sustainability, revenue recovery and fairness and equity. Eskom’s tariffs were designed based on the cost of supply as well to reflect cost drivers. The tariff changes had to comply with the requirements of the Municipal Finance Management Act (MFMA) in order to make changes to municipal tariffs. The Multi-Year Price Determination (MYPD) stipulated Eskom’s revenue requirement. The revenue requirement was shared between local NPAs and standard tariffs and was determined by the cost to supply energy to the country. Costs were segmented into appropriate categories and allocated to customers in that category. Each customer “class” paid a tariff that was closely aligned with the cost of providing supply to that particular customer class.

Eskom stated that not all tariffs were cost-reflective. Subsidies in electricity tariffs affected the tariffs that were applied. There were inter-tariff subsidies where one tariff would subsidise another tariff. These were based on socio-economic considerations driven by government.

Eskom tariffs were cost reflective and were calculated to demonstrate the level and how costs were incurred in delivering electricity to end-customers. The level of tariff charges were determined by NERSA as they would only cover the NERSA approved costs. The price paid by consumers was determined by the amount of electricity consumed, the cost of transmitting it, and services to avail the electricity to consumers. There were many kinds of tariffs, which allowed Eskom to meet diverse customer needs, to show cost-reflectiveness, and to allow for certain customer categories to be subsidised.

Discussion
Mr C Gololo (ANC) asked where the electricity that was sold to other countries such as Swaziland featured in the pie chart on slide 7 of the tariff presentation. He noted that Eskom was working very hard on their electrification programme so that they could supply electricity to more homes. However, he wondered how much Eskom was doing for rural areas.

Mr Makwana answered that Eskom entered into an agreement with the Department of Energy (DoE) every year, as the matter of electrification was in the competence of the DoE and Eskom was the execution agency. Eskom and the DoE discussed what Eskom's deliverables would be. He proposed that Eskom could come back to the Committee to discuss the electrification process specifically, how they accounted to the DoE, how many houses they had supplied electricity to since 1994 and to give a breakdown of the amount of electricity Eskom exported to other countries. The reasons exports were not reflected in the pie chart was because it was a segment all on its own. Some exports formed part of industrial sector and some formed part of the agricultural sector. Eskom would unpack this when they met with the Committee again.

Ms Johnson added that Eskom would come back to the Committee with statistics concerning rural electrification.

Mr G Koornhof (ANC) addressed Eskom’s historical contracts. Between 1995 and 31 March 2010, Eskom did not cover the cost of supply. This meant they supplied electricity at less that the cost to the customers. Surely, there must have been cross-subsidisation in those contracts. He asked who paid the difference between the costs. He noted that Eskom only had national pricing agreements with two customers. Eskom had 138 other industrial customers, which they called segments. He asked if Eskom was renegotiating contracts with their two main customers and if they were not renegotiating with the 138 other segments such as the industrial and agricultural segments. Eskom admitted that they had made a huge mistake in 1995 to enter into the Pricing agreements. He asked if Eskom could assure the Committee that the new agreements would be beneficial for decades to come.

Mr Makwana answered that it was incorrect to say that there was an under-recovery of costs. If the Committee wanted to discuss this matter in depth then Eskom would bring their auditors along to the next meeting.

Mr Makwana stated that the renegotiation of the contracts related largely to BHP Billiton and Anglo American. The checks and balances would be done every year and auditors would take a view of whether there were embedded derivatives or not. This removed any historical liabilities and allowed Eskom to engage with the two businesses on the basis of current, applicable accounting standards. Eskom would avoid entering into any form of relationship that would create an embedded derivative. The contracts that were entered into were not as loose or open-ended as most Members thought. The agreement that was signed in principle on 31 March 2010 was also subject to an audit. The auditor’s decision would be included in the Annual Report. 
 
Ms G Borman (ANC) asked if Eskom started looking at negotiating agreements after the price hikes in the public sector or because the agreements were a burden to Eskom itself. What were the differences in set costs and what was Eskom renegotiating now? How big were the differentials between the set costs and the costs for BHP Billiton?

Mr Makwana replied that it was important to note that in talks about special pricing agreements; two pieces of information were factored in. These contracts would not have been an issue today if the changes had not occurred in late 2002 when there was a financial instrument called the International Financial Reporting Standard (IFRS) in place. Since 2003, in various Annual reports, Eskom had been articulating the role and nature of imbedded derivatives as they impacted on the contracts. These have been reported on annually. It was a global phenomenon where commodity pricing was involved. So it was not just South Africa that had to deal with the matter. The ramification was that how it was dealt with outside the House would reflect on the country. It could be that the effects of the recession accelerated BHP Billiton's contract negotiations with Eskom. He reiterated that this was a global phenomenon.

Mr A Mokoena (ANC) wondered how long Mr Makwana would be acting as the CEO.

The Chairperson replied that it was not fair for Mr Makwana to answer this question. The Minister had appointed him at the beginning of November 2009.

Mr M Nhanha (COPE) stated that the Committee would have to invite the South African Local Government Association (SALGA) and the National Energy Regulator of South Africa (NERSA) to future meetings that would be held with Eskom, especially when the use of tariffs was being discussed. His concern was around the supply of electricity to BHB Billiton and Anglo American. The Member did not have anything against South Africa's sister countries in the continent benefiting from the infrastructure that South Africa had. However, it was important that a balance was needed in terms of where the energy was supplied. He knew that Eskom was supplying BHB Billiton's smelter in Mozambique and that they were supplying energy to Anglo American in Namibia. Yet, there was a smelter in the Port Elizabeth (PE) that needed electricity and would close down if it did not get it. He asked how much electricity Eskom was giving to the two companies. Was it more than the amount that the smelter in PE needed?

The Chairperson noted that this was a difficult question to answer. Different smelters used different amounts of electricity.

Mr Makwana replied that NERSAs involvement in setting tariffs was a matter that was governed by the Multi-Year Price Determination (MYPD) process. Every submission was made public on the NERSA website. Members could refer to the website for information.

Ms Johnson added that Eskom had bilateral trade arrangements with neighbouring countries that used approximately 4-5% of South Africa's total energy production. Eskom would provide the Committee with the correct percentages and details as soon as they received them.
 
Mr P van Dalen (DA) added that the Bayside and Hillside smelters use approximately 2960 gigawatt-hours a year. This was more than what the City of Cape Town would use in a year. It was shocking for Eskom to say that only two of its customers had special agreements with them. If one looked at the percentage of the overall amount of energy that was generated, it showed that the two companies used approximately 15% of it. This was the amount needed to have a safe reserve margin. These companies used 15% of the overall amount of energy that was generated and they received special prices. Motraco, which was set up in conjunction with Eskom, received approximately electricity at about 12c a kilowatt-hour from Eskom. Motraco then sold 95% of the electricity to Mozal. Mozal belongs to BHP Billiton. Therefore Billiton would pay Motraco, which means they were making a large profit. The Member also knew that Motraco owed Eskom approximately R100 million. He clarified that Eskom was selling energy to Motraco. Motraco was then selling it to BHP Billiton at a profit, while they still owed Eskom about R100 million. He wondered why Eskom did not take the smelters' contribution to Gross Domestic Product (GDP) into account. These smelters imported aluminium and used South Africa's cheap electricity to melt it so that they could export it back to the countries they imported it from. The only thing that smelters did was to create a few jobs. Clearly, Eskom did not learn from its past mistakes as it still signed a contract in the year 2000 to sell electricity at 12c per kilowatt-hour. He asked how the renegotiated contracts would affect the 24% tariff increase that was granted to Eskom. He could not find their contracts with Anglo American or BHP Billiton anywhere. There was no mention made of the special agreements in the NERSA application. If he was working for NERSA he would have told Eskom to renegotiate their contracts with the two companies instead of asking the poor people for more money.

The Chairperson stated that she had to rule the Member out of order because he was talking about things that involved NERSA.

Mr Van Dalen replied that NERSA did not know about the special contracts when Eskom applied for the tariff increase. Eskom hid this information and lied to NERSA.

The Chairperson stated that Mr van Dalen had to prove that Eskom had lied to NERSA.

Mr van Dalen stated that he had proof in a document that was labelled “Secret”. He could not give this document to the Committee.

The Chairperson stated that Mr van Dalen would be ruled out of order until the Committee could see the document. She wanted to know who had marked the document as “secret”.

Mr van Dalen stated that he could not tell the Committee who had given him the file.

The Chairperson stated that she would defend Eskom until she could see the document. Until then, she would defend her belief that Eskom had not lied to NERSA.

Mr Makwana responded to other matters raised by Mr Van Dalen. He stated that there were inaccuracies in some of the statements made about Motraco as well as the percentage of overall energy that was being used by them. The right figure was 9%, not 15%.

Ms Johnson added that Motraco was recovering its costs. Eskom supplied Motraco who had a contract to supply energy to Mozal. If there were any costs for the network of Motraco to take the energy from South Africa to Maputo, Motraco would administer it.

The Chairperson wanted to know who benefited from this arrangement.

Ms Johnson answered that Motraco was owned by South Africa, Mozambique and Swaziland. Since South Africa was selling energy to the Mozambique smelters, the cost recovery would go to South Africa.

Mr Van Dalen commented that it was fine for Motraco to make a profit by selling the energy to Mozal. However, it was not okay for Motraco to hold off on paying off the money that was owed to Eskom. They were not contributing to the country's GDP.

Ms Johnson replied that Motraco was a vehicle by which Eskom was selling power to Mozambique. Whether aluminium companies were benefiting South Africa was a different discussion.

Mr Makwana added that South Africa benefited in the way that when we could get extra megawatts of energy when it was needed.

Mr L Greyling (ID) noted that most of the energy that was sold to Motraco by Eskom was bought from other places. He wondered if Eskom was buying energy from these places for less than 12c per kilowatt-hour and then selling it Motraco for 12c per kilowatt-hour.

Mr Makwana answered that he would prefer to respond in writing because “there was more than the face value of the question”. The Committee seemed to be single-minded about the concept of value. There were other components of value that were embedded in the contracts as well as obligations that the country had to deliver on. Eskom would respond to the question fully in writing.

Mr S van Dyk wanted to know how much electricity was exported to other countries such as Namibia and Botswana. How much was Eskom charging those people? He stated that there should have been a third part to the pie chart on slide 7 in the presentation on tariffs. The chart should have shown the percentage of electricity lost to illegal use and theft. It was said that, in principle, contracts with smelters would be reviewed. When would this turn into reality? He wondered what the price would be in the new contracts and if it would be in line with other consumers. Will this price be fixed or will it take in to account changes in the economy and commodity prices?

Ms Johnson replied that she would update the pie chart top reflect total energy generated as well as the losses, technical and non-technical or theft.

Mr Greyling stated that the fundamental problem that was happening in the country seemed to be around energy planning. What happened in the 1980's was that Eskom build excess capacity. He asked why they did this. Going forward, the country had to ensure that the same problems were not repeated. He had some problems with the projection for how much energy was needed, because Eskom has messed this up before. They tried to use this excess capacity as a comparative advantage in the country's economic development. So, they tried to sell cheap energy to attract energy intensive companies such as aluminium smelters to the country. Eskom did this without putting in some kind of developmental benefit in the plan. This was the fundamental problem. He asked if the Department of Trade and Industry (DTI) was involved in the renegotiation of the contracts to ensure that there would be some developmental benefit. He noted that Eskom had an accounting loss. This was quite an issue given that Eskom also supplied electricity at below what it cost them to produce it. The Committee needed to unpack this issue.

Mr Makwana replied that a dedicated discussion would be needed for the topic on excess capacity.

Ms Johnson added that the Second Integrated Resource Plan (IRP2) process would have a section dedicated to economic forecasting and electricity growth forecasting. Everyone had a different way of forecasting long-range economic projections. Eskom's one was based on what their industrial consumers and municipalities planned to do. Eskom also had projections on what electrification rates would be and the elasticity of demand would be depending on economic conditions. The process of forecasting economic growth and consequent electricity projections was part of a project that was being run by the DoE.

Mr M Sonto (ANC) stated that the country found itself in a predicament because of the electricity supply plan was never adequately juxtaposed to the cost recovery strategy. Eskom's negotiations were still going forward. This had to be monitored. In terms of their cost recovery plan, Eskom had to understand that all costs had to be monitored and that they had to find a way to cover the costs incurred from the illegal use of electricity.

Ms Johnson answered that Eskom's applications to NERSA showed very clearly the amount of cost recovery they were making from their industrial base. Eskom would come back to do another presentation on this.

The Chairperson observed that the Committee needed to have a meeting with SALGA, NERSA and Eskom to relook at issues concerning the tariff increases as well as a range of other topics. She wondered what lessons Eskom had learnt about renegotiating contracts going forward. It was important for them to learn lessons so that they could not make mistakes in the future. Eskom needed to compare the cost of producing a unit of electricity with the price of one unit of electricity. The Committee would then know if they were under-charging or over-charging the public. There was a suggestion that Eskom should cease to be both a generator and distributor of electricity. If this was realised, would the scenario change in terms of tariff structures? The Committee would be taking note of Eskom and they had to report back to the Committee after the FIFA World Cup.

Mr Makwana answered that more time would be needed to discuss the lessons that were learnt from problems Eskom had experienced.

Mr Koornhof stated that Mr van Dalen brought up information that he received from a secret file. He wanted the Chairperson to make a ruling on this. Some questions were asked that stemmed from the file. Whatever was supposed to be kept secret was now put into the public domain. The Chairperson had to make a ruling as to whether the Committee was going to compromise Eskom or whether the questions would be riled out of order. Historically, in Parliament, if information was confidential, the Committee would sit with the entity and decide whether the meeting would be closed or not so the matter could be discussed.

The Chairperson answered that the issue of the secret file was out of order. She asked Members to desist from asking questions that stemmed from confidential information. She did not think it was appropriate, especially for Members of Parliament, to receive secret information from employees of entities such as Eskom. There was a better way of doing things. Members should not be tempting employees of State Owned Employees (SOEs) to give them confidential information. She ruled Mr van Dalen’s question out of order and said that this kind of incident would not happen again.

Mr Mokoena suggested that the Chairperson take the matter to the Rules Committee of Parliament.

The Chairperson stated that she would make sure that Parliament looked in to the matter. She would not be reporting on Mr van Dalen. She would be reporting on the matter as a concern from the Committee.

Mr Makwana stated Eskom was now faced with a situation that could be seen as a form of crime. It was a serious crime that information was being leaked from Eskom. He would consult his legal department as soon as possible and proceed from there.

Mr Makwana noted that there was limited time left in which to answer all the questions. Eskom would set aside more time to have more in depth discussions with the Committee.

The Chairperson stated that the Committee would send the questions, in writing, to his office. He could respond to the unanswered questions within ten days of receiving the letter.

The Chairperson stated that there was an awkward situation. Eskom had prepared one presentation but had also presented another one. Many of the questions were based on the second presentation that Members had just seen. The Committee agreed that there were political obligations and imperatives embedded in some of the contracts. However, times were changing. There were so many service delivery protests happening around the country these days. Therefore, everyone was responsible for the economic growth of the country.

Dr M Oriani-Ambrosini (IFP) asked the Chairperson to recognise him as he had a point of order.

The Chairperson stated that he would not be recognised, as he had left earlier in the meeting when questions were being asked by Members. The Committee was done asking questions.

Dr Oriani-Ambrosini repeated that he wanted to raise a point of order. He asked the Chairperson to recognise him.

The Chairperson stated that she was about to close this meeting.

Dr Oriani-Ambrosini stated that he wanted to be recognised. The Chairperson was always abusing her position of power and it had to end. This was not the way to Chair a meeting. He requested that she recognise him or give an explanation as to why she would not.

Mr M Nonkonyana (ANC) stated that Members had to treat each other with respect. Honourable Oriani-Ambrosini had left the meeting earlier and in his absence the Committee had agreed to a process where every Member had been given an opportunity to speak. Now was the time for Eskom to respond to issues that were raised. He hoped the Member would understand this.

Dr Oriani-Ambrosini stated that he wanted to raise a point of order.

The Chairperson stated that the Member had not said that he wanted to raise a point of order. He said he wanted space to speak. All the questions relating to Motraco would be answered in writing and sent to the Committee.

Dr Oriani-Ambrosini stated that he wanted to make a point of order about the Chairperson’s ruling on this matter. He stated that the Chairperson should speak with the voice of the Committee. Therefore, she had to hear what the Committee had to say on the matter before she could make a ruling.

The Chairperson stated that she was closing the meeting. If Dr Oriani-Ambrosini thought she was abusing her position then he could complain to the Speaker. If so, he should tell the Speaker that he disappeared for the bulk of the meeting and came back when she was just about to close the meeting. When she refused him an opportunity to speak, he deemed her conduct as an abuse of power.

The meeting was adjourned.