Eskom's Multi-Year Price Determination application

NCOP Communications and Public Enterprise

26 November 2012
Chairperson: Ms M Themba (ANC; Mpumalanga)
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Meeting Summary

Eskom explained that the Multi-Year Price Determination 3 (MYPD3) was its third application, and that it had been submitted in October 2012.  This was the beginning of a public process in which a decision on electricity tariffs could be made only by the National Energy Regulator of SA (NERSA), which was an independent body.   NERSA's tariff decision applied only to Eskom customers, and not to all electricity consumers.  

Eskom had engaged all stakeholders in preparing its application, which had been made available and explained in various forums, including the media, for scrutiny.  The application had tried to balance the needs of industry with economic growth. It was important to remember that Eskom planned for a South Africa that was growing, and this would require continued investment in the future.  Electricity tariff increases would stop only when the price was relatively where it should be, as currently the price was cheap.

Eskom recognised the impact of tariff increases on the economy and households, especially small businesses and the poor. The company had strived for the right balance in prices and sustainability, and had thus suggested a five-year path. This would lessen the impact by gradually increasing the price, and would provide certainty. Coal and other operating costs had been contained in the application.

The application would for the first time include the introduction of Independent Power Producers (IPPs) in all three phases of the Department of Energy's (DoE) renewable energy programme, and the DoE peaker plants. Eskom was applying for only 13% to produce and maintain its operations – this was what was needed on average for the next five years. Then there was a further 3% required for the development of IPPs.  Eskom had included a long-term price path to implement new capacity beyond Kusile, but this had not been included in the revenue requirement for the five years.  Cost-reflective tariffs were important to ensure sustainability, while not burdening the taxpayer. It was important to provide confidence to lenders and investors, and to give lenders the assurance, through the tariff path, that Eskom would repay its debt.

If mining companies could produce the right quality of coal at the required volume, Eskom could adjust its application. Coal costs had the biggest impact on electricity prices, but they were unregulated. This was where the challenge was – a regulated industry (electricity) dependent on an unregulated sector (coal) for prices. Eskom had secured 80% of its coal contracts for the next five years, but what would happen beyond 2018 was an issue that the country needed to deal with.

Eskom warned that if NERSA refused the increase, it would then have to stop buying coal and that could have dire consequences, including having to close some power stations, resulting in reduced expenditure and operations, the halting of major projects, and an inability to repay its loans.

Members sought clarity on whether the input from the public hearings was ever considered when the decision on the tariff was made. Concerns were voiced over how poor people would be protected against the increasing tariffs, particularly as municipalities set their own mark-ups.  Other issues raised included the high levels of electricity theft, the need to regulate IPPs, the future role of nuclear power, and Eskom’s long-term financial sustainability.

Meeting report

Opening remarks
The Chairperson outlined the agenda for the meeting and said the Committee would receive a presentation on Eskom's Multi-Year Price Determination 3 (MYPD3). The Committee would also have to adopt the outstanding minutes, as this was the last meeting before Parliament went on recess. She handed over to Eskom.

Presentation
Mr Brian Dames, Eskom's Chief Executive Officer (CEO), explained that the Multi-Year Price Determination 3 (MYPD3) was the third application by Eskom and that the application had been submitted in October 2012. This was the beginning of a public process in which a decision could be made only by the National Energy Regulator of SA (NERSA).  Electricity tariffs were decided by NERSA, which was an independent body.   NERSA's tariff decision applied only to Eskom customers, and not to all electricity consumers.

The current three-year cycle would come to an end in March 2013, and therefore Eskom had to apply for the new tariff cycle. The process involved NERSA getting public comment and conducting hearings. Eskom had engaged all stakeholders in preparing its application. The application had been made available and explained in various forums, including the media, for scrutiny. The application had also been posted on Eskom's website.

In line with the State of the Nation address this year, it had been important that Eskom proposed a tariff that supported economic growth and job creation. The electricity price path needed was one that would ensure that Eskom and the industry remained financially viable.  Also needed, however, was a tariff that remained affordable to the poor.

The application had tried to balance the needs of industry with economic growth. It was important to remember that Eskom planned for a South Africa that was growing, and that would continue to require investment in the future. It was important that the application was viewed in line with its long-term vision. Electricity tariff increases would stop only when the price was relatively where it should be, as currently the price was cheap.

Mr Dames explained that the increase was needed to provide power to SA now, as well as for investment in future capacity.  Eskom had to cover the costs it incurred, in order to supply electricity.  Eskom was among the largest power companies in the world and generated more than 40% of electricity on the continent.  The transmission grid was about the size of Western Europe, servicing over 4m customers in SA.

Half of Eskom's cost was coal, which was the biggest cost driver.. The electricity tariff was not used to pay for the investment that the company made, but to ensure there were sufficient funds to support the financing. The company financed its expansions through raising debt in the financial markets.

Eskom had introduced Independent Power Producers (IPPs) for the first time in its application.  It was essential for the country to have a stable supply of electricity that ensured economic growth and improved quality of life. Not planning for electricity expansion would be a failure for the country. The cost of not having electricity was larger than ensuring there was security of supply. The current prices did not cover the full cost of providing electricity, and for decades SA had seen price increases that were lower than inflation. As the country was correcting decades of under-investment, it had lost electricity generation capacity.

Eskom recognised the impact of tariff increases on the economy and households, especially small businesses and the poor. The company had strived for the right balance in prices and sustainability, and had thus suggested a five-year path. This would lessen the impact by gradually increasing the price, and would provide certainty. Coal and other operating costs had been contained in the application.

Eskom had provided for the cost of using and replacing assets, and for the servicing of debt incurred to fund investment in new infrastructure.  It was important that the cost of using and replacing the infrastructure was covered in the depreciation cost, as this would ensure that by the time the assets were replaced, there would be sufficient money to service the debt.

By mid 2012, the company had over R200bn worth of debt on the balance sheet. This would yield capital and interest expenses of over R14bn a year. There had to be sufficient cash to pay the interest.

The application would for the first time include the introduction of IPPs in all three phases of the Department of Energy's (DoE) renewable energy programme, and the DoE peaker plants. Eskom was applying for only 13% to produce and maintain its operations – this was what was needed on average for the next five years. Then there was a further 3% needed for the development of IPPs.  Eskom had included a long-term price path to implement new capacity beyond Kusile, but this had not been included in the revenue requirement for the five years.  Cost-reflective tariffs were important to ensure sustainability, while not burdening the taxpayer. It was important to provide confidence to lenders and investors, and give lenders the assurance, through the tariff path, that Eskom would repay its debt.

Eskom protected the poor in the country through targeted subsidies within the electricity price structure. Eskom believed that the subsidies for both high and low consuming customers should be increased. Universities and economists had been commissioned to work on the economic models, and all had indicated it was better for tariffs, rather than taxes, to pay for electricity. The studies had indicated that it was important to have the right price, as this would ensure that energy was used efficiently.

If electricity were used efficiently, there would be a reduced need to invest in new generating capacity. The right tariff would support investment by the IPPs and Eskom.  SA had taken a decision way back in 1998 that Eskom would not invest in expansion, as this was the responsibility of the private sector. The country had failed to adjust the energy price and, to support investment, the country ought to arrive at a “right price.”

A pact between Eskom and the country’s mining industry was required to keep coal cost increases to no more than 10%. The application assumed coal costs were likely to increase on average in the next five years by 10%. This assumption was important, because half of Eskom's cost was coal, and in the previous three years coal had gone up by 18%.  A lot of work needed to be done to ensure coal costs stayed within the 10% bracket.  Eskom could not for now apply for inflation-linked tariffs if the coal cost was higher than inflation. It would mean that Eskom would be subsidising coal mining companies.

Mr Dames said it was true that if mining companies could produce the right quality of coal at the required volume, Eskom could adjust its application. Coal costs had the biggest input in electricity prices, but it was unregulated. This was where the challenge was – a regulated industry (electricity) dependent on an unregulated sector (coal) for prices.

Eskom had secured 80% of its coal contracts for the next five years, but what would happen beyond 2018 was an issue that the country needed to deal with. Eskom would work on a conservation scheme to support consumers and ensure the demand did not grow too fast. The five-year price path would allow for a gradual move towards cost-reflective tariffs.

The largest portion of the revenue requirement for MYPD3 would go to primary energy, followed by operating costs, depreciation and returns.   Between 2020 and 2030, Eskom would decommission over 10 000 megawatts of existing power stations, and all of this would have to be replaced. The company had to ensure there were funds available for that.  The returns generated were sufficient to cover the interest and capital expenses. Eskom was aware of the impact of the tariff increases on the economy and poor households.  The poor were protected through a transparent tariff structure involving cross-subsidies.

Eskom had been asked to look at different sectors of the economy where companies might face closure. This was not the role of Eskom, but of economic policy makers.  

Eskom was growing and was adding more than 50% of power generating capacity.  It had built more than 4 000 km of transmission networks and substations over the last four years.  Most of Eskom's power stations were in their mid-life, averaging over 30 years, and were costly to maintain.

Eskom was committed to connecting new private sector players to the grid. Although the company supported the reduction of carbon emissions, it had to be borne in mind that green energy did not always mean cheaper energy. Renewable energy would be more costly than the current prices at which Eskom was producing electricity.

Transmission revenue requirement represented about 7% of total revenue.  Transmission was important because it was the unit that managed electricity and ensured that it was available throughout the country. Another important aspect was distribution.  Eskom supplied directly to about 40% of the end-use customers in SA., while municipalities supplied most households.

Mr Dames said Eskom's investment in infrastructure would total R337bn over five years, including capacity expansion, upgrading and refurbishment.  About half of the amount would go to the big projects, with the rest of the money going to transmission, distribution expansion and refurbishment.  Medupi and Kusile build costs were in line with international standards. On completion, the company's build programmes would have added 11 356 megawatts to Eskom's capacity.

The expansion programme had created thousands of job opportunities. More than 35 000 people were currently employed at the new build projects; 12 000 learners in the Eskom skills development system; and R72bn had been contributed to Broad-Based Black Economic Empowerment companies.  Eskom ran one of the world's largest energy-saving programmes, with 57m energy saving bulbs and 285 000 solar geysers in use.

Ms Tsholofelo Molefe, Eskom Group Executive, said Eskom had applied for a revenue requirement that was translated into specific increases for each customer category.  Eskom proposed that there be targeted protection for the poor, to ensure they did not feel the impact of the increase. She explained the minimal decreases that poor households could expect from the tariff structure, and said the tariff was structured in such a way that households were encouraged to conserve electricity. The lower the consumption, the less the customer should actually pay.

Ms Molefe said the cost to supply lower-consumption customers was much higher than it was for higher consumer customers. There were different models for protecting the poor. The existing mechanism included the Inclining Block Tariff (IBT), which had ensured that the lowest block had experienced below-inflation tariff increases during MYPD 2. There was also free basic electricity of 50 kilowatt per month for indigent customers.  Challenges to the IBT system included that it was too complex for customers to understand, and did not cater for multiple dwellings on one property. The tariff was not targeted, because high consumption customers also benefited.  Eskom was now proposing that high consumption customers should not get the same subsidies afforded to low consumption customers.   Eskom proposed to simplify and refine the current residential tariffs.

Mr Dames said Eskom relied on only three sources for revenue: tariffs, borrowings and equity.  R355bn would go to coal producers over the next five years, while R270bn would go towards Eskom's operating costs.   The price shocks were the result of not having depreciated the assets correctly. It was important that in future, Eskom took replacement costs into account, as this would prevent sudden changes in prices.

The returns were currently negative and catered for both debt and equity costs. The returns that would be earned at the end of the five years would be less than the actual cost of capital. After paying for finance costs of R140bn, R47bn would remain as returns.

Last year, the company had made R12bn, which was not enough to pay for one year’s interest. It was important for Eskom to earn enough money to pay back the interest and the debt. The little amount that would be left as returns in the next five years would be paid to government. This was also important, especially to the rating agencies, as Eskom had been downgraded. As a stand-alone company, Eskom was a sub-investment grade, so it was important for Eskom to achieve financial stability.

NERSA had indicated it would undertake public hearing in January 2013, and by February a decision would have been made. The new tariff would be applicable to Eskom customers on 1 April, and municipal customers on 1 July 2013.  Eskom was committed to open and on-going communication and had thus urged all stakeholders to participate in the consultation process. A stable and secure supply of electricity was essential to support economic growth and development.

Mr Dames said tariffs were still the fairest and most efficient way to pay for electricity. Prices should cover the full cost of producing electricity. If NERSA refused the increase, Eskom would then have to stop buying coal and that could have dire consequences, including having to close some power stations, resulting in reduced expenditure and operations, the halting of major projects, and an inability to repay the loan. These were massive implications.

He said the country should look at regional options, which could help Eskom meet its future energy needs. Eskom should look at the option of gas (natural or otherwise) and nuclear power as other energy sources. It was important that the country considered these options because if it did not, it would be constrained in terms of energy sources.

Discussion
Mr H Groenewald (DA, North West) asked if public hearings had any relevance when it came to the processing of the application. Did Eskom listen to the public; what was the company doing regarding the input from the people? It would be ideal if Eskom could provide examples of what it had done with the input previously?

Mr Dames replied the hearings were done by NERSA in order for the public to discuss the Eskom application. Eskom listened and had engaged with business and with the public, but it was Eskom's responsibility to give people the reality of the situation.

Mr Groenewald commented that on oversight visits it was clear people had resorted to stealing electricity; he asked if Eskom had any policy to deal with the matter, especially in informal dwellings.

Mr Dames replied Eskom knew exactly how much electricity it generated, distributed and recovered. The total loss of electricity was just under 2,5% of the total sales, or about R1.2bn of the revenue per year. This was an issue that had been raised with Parliament.   Electricity theft was not seen as a crime. Unless this was legislated, there was not much Eskom could do about it.  Most theft incidents occurred among informal settlements dwellers, while in terms of value, it came from business. The perception that theft was happening only in informal settlements was not correct. All stakeholders had to work together to deal with it.

Mr Groenewald asked for a comment on how the future energy scenario looked in SA. He sought clarity on the ownership of the coalmines, and on where the eleven power stations were located around the country. He asked for specific details around the closure of Morelete power station just outside Pretoria.

Mr Dames replied he knew nothing about the Morelete power plant.  It did not belong to Eskom. There were contracts for all power stations operated by municipalities to keep them running. The City of Tshwane and the City of Johannesburg were paid to keep Eskom power stations running. If Eskom could be provided with details on the Morelete power station, it could follow up the matter.

In SA all mineral resources belonged to the state; but mining companies had the right to price the coal. Coal was not expensive and was the cheapest method of producing electricity in SA. It was important for coal to be used to control the energy cost.

Mr Groenewald asked for an update on Medupi and Kusile. Were the two power stations still in line to meet the delivery date of 2013?

Mr Dames replied Medupi would be operational next year, so nothing had changed. With Kusile, the first unit would be commissioned towards the end of 2014.

Mr D Feldman (COPE, Gauteng) commented that judging from the presentation, the electricity provision situation was bad.  Eskom needed the tariff increase, and there was no way out. He sought clarity on the regulation of the IPPs; these were coming from outside and merging with BEE companies. It appeared the IPPs were more like competition to Eskom; why were they allowed?  He wondered if Parliament could get involved in the issue of mining companies and the cost of coal. There was a need to explore nuclear energy further.

Mr Dames replied that the decision on the IPPs had been a policy decision by the government, and Eskom was implementing the policy.  Eskom believed there was a need for outside players, as it recognised it could not supply electricity alone.  However, the country ought to understand that the return requirements were different.

Mr O De Beer (COPE, Western Cape) commented that protecting the poor against higher tariffs was useless, as municipalities did their own mark-ups, and decided on their own tariffs on top of what had been charged by Eskom.  He wanted to know if Eskom protected poor communities through the licence conditions to the major distributors. He asked if the apparent ganging up against households by municipalities and Eskom did not amount to price fixing.

Mr Dames replied that the issue regarding protecting the poor had already been addressed.

Mr De Beer said that judging from the presentation, he doubted if Eskom could ever get to a point where it charged tariffs based on inflation. It appeared that for the next 20 years there would never be an independent State Owned Enterprise (SOE) where the inflation rate was the benchmark.

Mr Dames replied Eskom could get to inflation-based tariffs only if it stopped expanding.

Mr M Sibande (ANC, Mpumalanga) wanted to know, in the light of the application covering only the period up to 2018, what would happen beyond 2018, especially regarding issues of capacity. Why were municipalities allowed to supply?  This was a double charge – how were the poor protected?

Mr Dames replied it was important that decisions be made urgently around the Integrated Resource Plan (IRP) looking beyond 2018. The IRP indicated that the country would need further renewables, coal and nuclear.

He said municipalities had a constitutional right to supply electricity.  Secondly, NERSA provided a licence for them to supply. Thirdly, NERSA provided guidance to municipalities regarding electricity prices; what municipalities charged their customers was up them, as indicated by their own legislation. Fourthly, most of a municipality’s income came from the sale of electricity. If one changed this, the whole funding model for a municipality would be affected.  Eskom had looked at the protection of the poor in terms of the Eskom customer base. How municipalities applied that was really up to each municipality; this was allowed for in terms of the legislation.

Mr Sibande commented that his impression was that nuclear would be punted as an alternative.  Nuclear plants were expensive to build, but much cheaper to maintain.  Electricity theft extended to areas such as farms. How many kilowatts was Eskom losing in that area?

Ms Molefe replied that a number of initiatives had been launched in 2010, like Kanyisa, to educate communities about electricity theft. This had been done in collaboration with Business Against Crime and PrimeMedia. Had that not been done, more electricity would have been lost.  Eskom was also working with law enforcement agencies. There had been a series of arrests, with 81 cases opened.  More could be done.  In the past, electricity theft was not regarded as a crime, but the country was moving in the right direction. Information on how much had been lost through electricity theft would be provided.

Mr Dames said the nuclear matter was a policy choice. The country had to make some choices.  The first one involved what SA wanted in terms of carbon emissions.  Coal was cheaper, but it had much higher carbon emissions.  Coal should play a role in future, but it had to be cleaner. Nuclear was a lot more expensive to run in terms of capital, but cheaper to use.

Mr Sibande asked for an update on Cabora Bassa. He also sought clarity on what Eskom did with profit, as it appeared that the company borrowed all the time. He commented that the government subsidised Eskom to produce electricity.

Mr Dames replied that Eskom still bought electricity from Cabora Bassa, and work was ongoing to expand Cabora Bassa.  He said profit was re invested back into the business for expansion purposes, for servicing debt and also to cover inputs.

Mr Sibande commented that Eskom’s vision was so negative. Mpumalanga had nine power stations and yet electricity was so expensive, taking into account the rate of unemployment. Why was electricity so expensive in Mpumalanga?   This was egg on the face of Eskom in the light of its earlier claim of protecting poor people from the tariff.

Mr Dames said the prices that Eskom charged its customers was not determined by Eskom, but by NERSA.  Eskom could not charge its customers different prices; the Regulator determined the price and this was the price charged.  Eskom did not have the discretion to change that.

Mr M Jacobs (ANC, Free State) commented that the presentation was highly technical. He asked if Eskom would be financially independent after the MYPD3.  It was not good that government supported SOEs, as the purpose was for them to be financially independent so that they could support communities.  Now, however, money was being channelled into sustaining SOEs, and as a result there was not enough money to spend on priority projects for the people.

Mr Dames replied that Eskom was in a different financial position today.  It was financially viable and did not get any bailouts from government. For the past three years, Eskom had recorded profits. A while back, the company had received R60bn from government, and there was also a guarantee of R350bn. This had been used by Eskom mainly to raise funding.  The most important thing was that Eskom had achieved a stand-alone investment grading.  With stand-alone status, the company could raise the money it needed to deal with electricity and make sure that the government could use its funds in other areas. This was the ideal position that Eskom wanted to achieve.  If the application was approved, then Eskom would achieve this position by the end of this financial period.  Eskom was not dependent on the state.

Mr Jacobs asked if there were any alternatives to coal that could be tried. He sought clarity on the 5m customers that Eskom supplied with electricity. He also sought clarity on the skills transfer at the major projects.

Mr Dames replied the vision for alternatives to coal was contained in the IRP.  The country needed to double its capacity, and 42% of that increase would be through renewables, 23% through nuclear, and the rest would be coal.  He disputed the impression that it was expensive to generate electricity from coal.

The 5m figure referred to the accounts that were sent out – they could be for a household or a municipality.  Eskom did not supply most of the residential households in the country; municipalities supplied them.  Over 83% of South Africans had access to electricity, and this statistic was also indicated in the census report.

Most of the welders that Eskom used were foreign, but the company had since set up a welding academy. Some of the welding skills did not exist in SA..

Mr Jacobs commented that it was impossible for Eskom to make up for the amount of electricity that was wasted. If Eskom could curb electricity theft, it would help to compensate, but sadly the company was doing nothing about it.

Mr Dames replied that a lot of money had been spent on fighting electricity theft.  The company would appreciate an intervention from Parliament in the form of legislation.

The Chairperson sought clarity on the statement that Eskom had already bought 80% of its coal for the next five years.   What would happen beyond this?

Mr Dames replied that over 30 coal mines would have to be opened in the next five years. This was something that government, the coal industry and Eskom needed to think about and devise a long-term coal strategy. Eskom believed that coal was a strategic resource within the country.

The Chairperson asked if residential customers, most of whom were not Eskom customers, would experience any changes in the price of electricity. She asked the officials to comment on the risks underlying the Integrated Resource Plan that would be updated in March 2013.

Ms Molefe replied there was a process for municipal customers.  NERSA would regulate that and ensure it was in line with the Municipal Finance Management Act. Their increases would come into effect on 1 July. The increases shown in the presentation were specific to Eskom's residential customers and if approved, would commence on 1 April.

The Chairperson said information on Eskom's programmes was needed for constituency offices. Other outstanding matters could be provided in writing to the Committee.

The Committee adopted outstanding minutes.

The meeting was adjourned.

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