Eskom Multi-Year Price Determination: Eskom and NERSA briefings

NCOP Economic and Business Development

04 December 2012
Chairperson: Mr F Adam (Western Cape, ANC)
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Meeting Summary

Eskom and the National Energy Regulator of South Africa (NERSA) explained the principles behind, basis for, and process to be followed in determining the Multi-Year Price Determination (MYDP3) of the increases requested by Eskom. Eskom firstly explained that there were a number of policy considerations to be taken into account. Eskom had requested a move to a five-year price determination, which would spread the increases and allow for greater certainty for customers. Eskom had started from the premise that security of supply, economic growth and job creation were essential. The move to cost effective tariffs was the optimal way to cover the ongoing costs now and allow for cost recovery in the future, although it was also emphasised that the MYPD3 did not cover anything new that might be proposed under the Integrated Resource Plan. If costs were not recovered through the tariff, they would still have to be recovered by government by some other means, and this was a transparent process, that also allowed for subsidisation. Eskom fully appreciated the impact of any increases and had tried to protect the poor, by moving from the Inclining Block Tariffs used in the past to a simpler and more effective tariff that would see low-use consumers pay less in the next year, would encourage energy savings and allow for cross-subsidisation. Eskom would itself embark on rigorous efficiency gains. It described its efforts to contain coal costs. The tariffs were calculated at 13% for Eskom’s own needs, plus another 3% for the Independent Power Producers, totaling 16% per annum.

A summary was given of Eskom’s primary energy costs and operating costs, and the mix of revenue. Eskom would not be able to recover capital expenditure but only depreciation, so the additional amount would have to be borrowed from the markets, and it was stressed that it had to establish and maintain good credit rating. The generation, distribution and transmission grids were illustrated, noting that Eskom distributed to about 5 million customers, of whom about 4.5 million were domestic, and supplied in bulk to184 municipalities. Its other contributions to the economy involved 35 000 people employed on the new build projects, about 12 000 learners in the skills development system, contributions to BBBEE businesses and local suppliers and one of the world’s largest energy saving programmes. It had connected 4.2 million households since 1991. The differential tariffs were fully explained, with graphs to illustrate real increases. 

Members discussed whether the emphasis should lie with pro-poor or pro-development strategies, commented on the cost of electricity affecting the middle class, and the implications for rural consumers, particularly when municipalities were charging huge additional tariffs. Members suggested that the agricultural sector needed more support and subsidies. They questioned with whom Eskom had special pricing arrangements and called for details, but were told that BHP Billiton had appealed against a court decision that details be released, so this was sub judice.
Members asked about negotiations around coal, questioned whether consumers would get the benefit of falling coal prices, whether other options were considered, including greater input from Cahorra Bassa. Eskom explained the “cost buckets” applied by NERSA. Members asked if, in principle, Eskom deserved increases, given the profit it had made in the last year, and called for more explanation on the calculations on returns and costs, and the credit rating. They asked if amounts spent on boosting staff morale were necessary and had had an impact. They also questioned the depreciation models used, and asked if Eskom had any comparative costing in other countries.   

NERSA briefly summarised the main components of the Eskom application, noted the six pillars of the MYPD3 process, noted that the date for public comments had been extended to 30 November and that over 150 comments were received. NERSA had taken radio (SABC and community) and television slots, which were listed. It also gave the schedule for the public hearings between
15 and 31 January. NERSA was hoping to make its final decision by 28 February. The new tariffs would apply to domestic consumers from 1 April and to municipalities from 1 July 2013. Members asked if there was still a process of appeal to the Minister, suggested that it would be more useful to consult with municipalities through the South African Local Government Association than with individual mayors, asked about the venues for public hearings and suggested that perhaps innovative methods such as radio programmes or phone-ins should be broadcast.  

Meeting report

Opening comments
Ms E van Lingen (Eastern Cape, DA) asked the Committee to record its displeasure at the fact that Parliament was not providing full support to the NCOP in this week; it was only the National Assembly who had completed its programme.

The Chairperson fully supported this comment and would write the necessary letter.

Eskom Multi-Year Price Determination (MYPD3)
Mr Mohammed Adam, Divisional Executive: Regulation and Legal, Eskom, noted the apologies of the Chief Executive. He said that the submission of the Eskom application was the beginning of a process, and the tariffs were finally decided by the independent regulator, National Energy Regulator South Africa (NERSA). There were a number of policy choices on which stakeholders needed to express a view. There were pressing needs in the country and the Multi-Year Price Determination (MYDP3) would finally seek the best way to balance competing interests.

The State President had referred to the need for a price path that remained affordable for the poor whilst also covering the costs of supplying electricity needed to power South Africa in the future.

Mr Adam explained that the application covered the cost of supplying electricity, for securing resources for existing operations and supported the financing of new capacity. A stable supply of electricity was essential to power economic growth and improve the quality of life. Eskom had to cover its costs of producing electricity, something that had not been fully covered in the past. The MYDP3 proposed cost-reflective tariffs. Eskom fully realised that any increase in prices would have impacts on the economy, business and the poor, so that Eskom had to find the right balance.

The current cycle of tariffs ended in March 2013, and now Eskom was proposing a longer application period, with a five-year price path. The previous three-year cycle contained some undertakings and commitments, which would have got it to cost-effective tariffs in time, but the price increase path would have been very steep. A longer period of determination would not only lessen the impact year on year, but would give better certainty on prices for the future.

Eskom accepted that it owed a duty to the country to be as efficient as possible, and there must be checks and balances. One of NERSA’s primary functions was to allow an efficient licensee to cover costs and earn a reasonable return. Mr Adam asked Members to ignore, for the moment, the different ideas around capacity expansion, and said that the first aspect of the tariff was inflation. Over the last twenty years, if inflation was taken into account, there had been in fact a real decrease in prices. Secondly, Eskom had to take extraordinary efforts to ensure that it could run the power stations, including more expensive options for running the plant. Coal cost was one of the biggest input costs into the price of electricity, and if those costs could not be contained, it would be impossible for Eskom to limit its price increases. Eskom was not yet in a position of normality. The tariff also therefore had to provide for the costs of the existing plants, as well as the costs of servicing debt. The application included the introduction of new Independent Power Producers (IPP) in all three phrases.

The increases were, per annum, calculated at 13% for Eskom’s own needs, plus another 3% for the IPPs – a total of 16% per annum. These decisions were based on the decisions already made for building the power stations, such as Kusile and Medupi. However, Mr Adam stressed that this did not take account of extra capacity that may be required by the Integrated Resource Plan (IRP), and he noted that the price impact would be the same, no matter who built the capacity. If different policies were to be adopted, NERSA would have to take that into account. If more capacity was needed, the costs of production plus a return on that new investment must be allowed.

Eskom had done some economic impact studies, which concluded that the best route was a migration to cost-effective tariffs. This meant that the user of the product would pay. It sent the right price signals to encourage energy efficiency. If cost was not recovered through tariffs, it would still have to be recovered from elsewhere in the economy, which would result in more taxes, or borrowing, another cost for the economy. By using recovery through the tariff, those who used the most electricity would get the benefit of a subsidy, which was an investment in the economy.

Eskom acknowledged the need to have a sustainable migration path to the new cost recovery system. It had assumed sales growth of 1.9% on average over the period. The projections were done top-down, and bottom-up. There was a country pact to keep coal costs to no more than 10%, and Eskom was confident that it could achieve this, because it had already contracted a large portion of its requirements. The costs were coming down. The small portion that was not already contracted was covered by a “stakeholder pact” with the coal mining industry to keep costs of coal down. Mr Adam explained that during the last year of the MYPD2, Eskom voluntarily decided to reduce its request, from the 25% initially proposed, to 16%, but in return had called for stakeholder commitment to help smooth the increase. NERSA would have rules to deal with deviations, or re-open the determination, if necessary, but this was unlikely.

Mr Adam explained that because the supply of electricity in the country was still facing constraints, the normal supply/demand ratios would not apply and higher demands would still lead to higher costs. For this reason, Eskom would run ongoing energy conservation schemes to support “keeping the lights on”.

One-third of Eskom’s costs were made up of primary energy costs (including coal). Operating costs accounted for 25%, increasing by about 8% per annum. The IPPs made up 7% of the revenue, but would increase in the MYPD3 period. He explained the returns and depreciation component. The NERSA formula would allow for recovery of primary energy, operating costs, depreciation and a return on the assets. Eskom would not be able to recover capital expenditure that it incurred. It could only recover the depreciation, so the additional amount would have to be borrowed from the markets. Eskom was funded through a mix of borrowings, equity and revenue from the tariffs. Lenders would look at the revenue, to determine the funding allowable. Eskom was at the moment anticipating returns of 0.9%, rising to 7.8% at the end of the period. This averaged out at about 4%. NERSA calculated the returns at around 8.16%. Government was investing around R2 billion in the economy to smooth the price path.

Mr Adam noted that the value chain was complex, huge and expensive. Generation represented about 75% of the total revenue. Power stations were generally at mid-life, making them increasingly expensive to run. Given all the constraints, Eskom could not do everything on its own, and welcomed private IPPs. However, it had to be transparent on the implications of those choices. The total IPP costs would increase from 125c per Kilowatt hour (c/kWh), to 232 c/kWh. The country must also commit to greener energy.

Transmission was done through a massive grid. Eskom distributed to about 5 million customers, of whom about 4.5 million were domestic. It supplied in bulk to 184 municipalities, who then distributed on to customers in their area of jurisdiction.

Eskom contributed to the economy in other ways. More than 35 000 people were employed in the new build projects. There were about 12 000 learners in the skills development system. It had spent R72 billion on Broad Based Black Economic Empowerment (BBBEE), and had placed more than R75 billion of contracts with South African suppliers. It had one of the world’s largest energy saving programmes, with R57 million energy saving bulbs and 285 000 solar geysers, and had connected 4.2 million households since 1991.

Ms Tsholofelo Molefe, Group Executive: Customer Services, Eskom, then explained that although the MYPD request 16% increase on average, different customers would see different increases. For instance, there would be continued targeted protection of the poor, who would pay less than the rest of customers. Industrial and commercial customers would cross-subsidise. The municipal tariffs would have a 7.6c increase, and the urban (industrial and commercial) would see a 21% increase. Rural and agricultural would have a 15% increase. Eskom had proposed a move away from the Inclining Block Tariffs (IBTs) and poorer and smaller users would have a lower price increase. A single energy rate would apply, that would result, in year 1, in a reduction of 1%, whilst low to medium users would see an increase of 5%. Customers must manage their consumption properly to get the lower tariffs. The high usage customers would contribute to a fixed charge, and would be subject to a 14% increase. The smaller customers would not in fact be paying the full cost of supply, as they would be subsidised by the larger customers. The graph on slide 27 illustrated the tariffs (see attached presentation).

Ms Molefe outlined the current subsidies of the IBTs, but said they had been complex to understand, had not catered for backyard dwellings, and gave benefits to affluent customers as well. Eskom was now moving to a two-block tariff that did not use a one-size-fits-all calculation, and would simplify and refine. An illustration was given on slide 29. Those using under 400kWh would actually pay reduced prices in the next year, with a balance over the following years. She too stressed the need for energy efficiency. Subsidisation would increase from R9 billion to R11 billion, primarily from the urban (mostly industrial and commercial) customers.

Mr Adam had already highlighted the main principles, and now illustrated them with figures, from slide 32 onwards. Revenue and borrowings were set out on slide 32. The cost components of MYDP3 were summarised in slide 33. In real terms, the prices increased, per kWh, from 61c to 84c, but if Eskom had maintained the previous calculations of MYDP2, this would have shown a much higher increase.  Operating costs would also be limited by conscious efficiency gains. Eskom wanted to increase from 44 000 to 45 000 employees. It had set a target to save R30 billion in the business, and it intended to work smartly and efficiently. It would not compromise maintenance.

Mr Adam stressed the difference between interest and equity in the returns. Most of the returns went to cover interest costs of around R140 billion. The balance of the returns, after paying interest, was regarded as equity. This could only come from a strong and regulated revenue base, and government loans and guarantees depended on certainty of regulation that would ensure Eskom’s ability to repay debt. Rating agencies had said that Eskom’s strengths lay in its dominant market position and continued government support. Its weaknesses lay in its highly leveraged position and weaker credit metrics on funding. Although Eskom was investment grade at the moment, because of government guarantees, the rating agencies had suggested that if anything happened that would result in a drop, then it might not meet investment grade credit rating. One of the crucial aspects was the money obtained through borrowings. Slides 44 and 45 set out some long-term scenarios on pricing implications, depending on different involvement of Eskom and IPPs. There were a number of policy decisions that would influence exactly how this unfolded. The IRP of the Department of Energy (DOE) was also subject to review of technology choices.

Eskom had been engaging with a number of stakeholders. It was committed to an ongoing and open process. The MYDP had been open for public comment and public hearings were planned from 15 to 31 January. The new tariffs should be implemented for Eskom customers from 1 April and for municipalities from 1 July. He again summarised the principles of the move to cost-effective tariffs, the need to migrate to this as quickly as possible, and smooth the path, by taking into account affordability for the poor. Eskom believed that it had achieved a good balance, although there would be impacts on the economy. He summarised again that even if Eskom received everything it had requested, this would not cater for all capacity contemplated in the IRP, and additional decisions on the IRP would have implications on the prices.

Pro-poor considerations
Mr K Sinclair (Northern Cape, COPE) noted that a strongly pro-poor approach had been taken. However, he wondered if it should not have rather taken a pro-development approach and to consider the role of society in a developmental state. The two were not mutually exclusive.

Ms B Abrahams (Gauteng, DA) thought that the pro-poor approach was not working: the poor were still suffering. She wanted to know how the subsidies were given and if people had to register, for several people in her constituency were not getting the relief they needed, including Free Basic Electricity (FBE). She also asked about the impact of backyard dwellings on the FBE.

Ms E van Lingen (Eastern Cape, DA) said that although she recognised the need for pro-poor strategies, there was also a reality that for the working and middle class, electricity prices were perceived as rising out of all proportion. Short supply of electricity also meant that there was not actually economic growth, and the increases were impacting adversely on jobs and job sustainability. Mr Shaun Nel, from BDO Consulting,
had commented that the electricity input costs for businesses that were electricity-intensive had risen from 10% to 40% over the last five years, and the same applied to cost of living increases and salaries.

Ms M Dikgale (Limpopo, ANC) questioned the difference between the prices paid by rural and urban consumers, asked for an explanation on what “urban” meant, and thought that a better subsidisation arrangement was needed, perhaps a 50:50 arrangement.

Municipality charges
Ms van Lingen pointed out that when Eskom sold in bulk to municipalities, the latter were imposing “wickedly high taxing”, selling R40 of electricity for R100 to residential users. If they did not pay, they would be disconnected, but Eskom did not seem to apply the same penalties to municipalities.

Ms Molefe addressed the questions around subsidisation and attempts to keep tariffs affordable for the poor. Eskom had proposed a national tariff subsidy framework because it was aware of the impact of rising prices on the poor. NERSA would be working with stakeholders on the subsidy arrangements, which were not new. The Inclining Block Tariffs had applied in the MYPD2. She explained that “Home Light 20” were those running few appliances and using less electricity. They would not see any increases. However, high users were probably the more affluent and they could afford to install energy efficient technology and reduce their consumption, and they would be paying higher rates. In the past, under the IBTs, the affluent had also benefited. The new arrangements would categorise people differently.

Ms Molefe agreed that the middle class users would see an impact, but they would not necessarily fall into the high user category, and would, under the two-block tariff, actually pay less in the following year. Again, she stressed the importance of the energy efficiency programmes, and said that Eskom would be continuing with its solar programmes, and rebates.

Ms Molefe noted that Eskom relied upon the municipalities to identify indigent customers, and they would be noted on the system to ensure that FBE was given. In some parts of the country, however, it was true that those entitled to FBE were not collecting it. Eskom was trying to work with the Department of Cooperative Governance and the municipalities, as well as putting mobile customer service hubs in place, to try to ensure that the register was complete. Other concessions had been made in the past, through the IBTs, but there were also rural and electrification subsidy concessions, and free rollout of CFL bulbs. A national subsidy framework had been proposed to try to standardise so that customers would not receive a variety of subsidies.

Ms Molefe explained that “urban” referred to industrial and commercial customers, as opposed to “residential” which was households.

Ms Molefe said that the municipalities followed a separate process, which NERSA considered under a Municipal Finance Management Act (MFMA) process, and it was working with the South African Local Government Association (SALGA) on the municipal tariffs. Eskom had never had to cut off the municipalities for non-payment, and would follow processes to ensure that it was paid.
Standard credit management policies would apply to all. Some municipalities were recovering more than the cost of supply.

Mr Sinclair was concerned that slide 26, showing increases for different categories of consumers, showed higher percentage increases for the rural and agricultural sectors. He thought there should be a distinction between rural and agricultural and that, given the importance of agriculture in society, farmers must be helped to reduce the costs of food production.

Ms van Lingen agreed with Mr Sinclair and reminded the Committee that the
agricultural sector in South Africa was not subsidised, as it was in the rest of the world.

Ms Molefe said that farmers were subsidised for electricity, at about R5.5 billion, as set out in slide 27. There was a cross-subsidy noted of 50,69 c/kWh. Slide 30 showed that urban (industrial and large customers) were paying around 9% of the subsidy contribution in 2013/14

Distribution network
Mr Sinclair asked about the distribution network. It was important to focus on generation, but it would not help to increase this without distribution.

Ms Molefe confirmed that Eskom was concentrating on all aspects of generation, distribution and transmission.

Special pricing agreements
Mr Sinclair referred to special pricing arrangements, noting that Media 24 had sought details in a recent court case, and he wondered why the details were being kept secret. He asked if Eskom could provide a list of the special agreements with all customers.

Ms van Lingen agreed that the Committee needed this information.

Mr Adam responded that a question had been raised in other committees why there was a need for any special dispensations. There were three special dispensations, with two customers, Anglo and BHP Billiton. They were
entered into when there was surplus capacity and to attract investment. The BHP Billiton arrangements had been referred to NERSA for consideration. Everyone else paid standard tariffs. He explained that the court case related to a request to Eskom that it give information on the contracts with BHP Billiton, and the latter had objected to the information being released. Media 24 made an application for access to the information, which Eskom did not oppose, but BHP Billiton did. The Court had ruled in favour of Media 24 but BHP Billiton had taken this on appeal. Until the court case was finalised, no information could be disclosed.

Coal and other sources
Ms van Lingen raised a concern that Eskom had apparently refused to say where it was buying its coal. It was alleged that a certain proportion of coal was being sold to a BBBEE company, who would then on-sell to Eskom, at a higher price. She also pointed out that Exxaro claimed to be making losses because the coal price had dropped. 

Mr B Mnguni (Free State, ANC) said that if coal was a large portion of pricing, perhaps Eskom should be looking at having its own mines to directly supply it, and to do away with price fluctuations. He agreed with Ms van Lingen’s point on Exxaro. He asked if price decreases in coal would be passed on to consumers. Eskom should also perhaps be looking at more specific agreements.

Mr Mnguni asked how much power was being obtained from Cahora-Bassa; he thought that the production costs from there might be lower. He wondered if it was possible to increase the draw from there, to limit price increases.

Ms van Lingen also raised questions around natural gas in Mozambique. In Russia, natural gas prices were linked to oil, which made it expensive, whereas in America they were linked with shale gas prices and were cheaper. She had understood that South Africa had an old treaty with Mozambique, and new gas discoveries there were huge. She wondered to what extent this was being taken into account, and urged that a more comprehensive approach must be taken.

Mr Adam said that if Ms van Lingen had any information about the alleged purchase at a higher price from a BBBEE company, Eskom would appreciate it, for it was not aware of any such arrangement. Eskom tried to ensure that all contracts were negotiated on best terms.

Mr Adam explained that customers would enjoy the benefits of any lower costs. A division within Eskom looked into coal costs, joint ventures, strategic partnerships and similar matters. Some of the contracts were based on cost-plus arrangements, where Eskom would pay the costs, but the mines would do the mining, since Eskom had no expertise in mining. The NERSA formula allowed for different “cost buckets”. The first related to incentives and covered operational costs and maintenance. If Eskom applied for a cost-recovery, and managed to contain it still further, it would be allowed to retain the funds, but if it spent, it could not recover more from the consumer. The pass-through bucket related to capex and if Eskom had committed to building a power station, it had to do so, and could not divert that funding anywhere else.
The same applied to the IPPs. If NERSA projected spending a certain amount to produce a number of mWh, any credits would have to be passed on to the customer in the next MYPD, using sophisticated tracking mechanisms, so there were no gains to Eskom in inflating costs. If Eskom exceeded the projections, and this was reasonable, NERSA could allow them. The last cost-bucket was a “hybrid”, where it was recognised that some costs were within Eskom’s control, but others were not. A benchmark was set for every determination period, and if something like coal costs ended up higher or lower than benchmark, the difference would be split between Eskom and customer. In this way, the customers would get the benefit of lower coal prices.

Mr Adam noted that the Cahora Bassa and energy mix were determined by the IRP, and it would be a DOE decision.

Ms Molefe added that currently South Africa was drawing 1 250 Mw, an increase from 900 Mw. It looked at all opportunities in the SADC region.

Mr Adam continued that Eskom was exploring other options also, with gas being one of the key primary energy fuels under consideration. It was exploring the lowest cost options for the current fleet. If there were additional IPPs, gas or other implications in the IRP, they were unlikely to be felt in the current MYDP. They were not built into the 16% increase. However, it did take into account the renewable build, the current build and peak production requirements.

Mr Sinclair noted that there were differing views on use of nuclear and other alternative energy sources. He was surprised at the Department of Energy’s announcement that a nuclear plant at Thuyspunt would shortly be constructed and asked for comment. He also commented that there were misperceptions that alternate energy would be cheaper, whereas it was currently coming in at about twice the price of the current sources.

Mr Adam said that he was aware of the decision by Cabinet that Eskom would be an operator but could not give any detail. There had been no identification of the sites. He agreed on the costs of alternative energy.

A DOE representative noted that both gas and hydro-power were contemplated in the IRP

The Chairperson said that the Committee had made an application to attend the IRP and engage with the DOE on alternative technologies.

Mr Sinclair said that the reality was that Eskom must get smaller and more IPPs should be involved.

Ms Abrahams asked how many of the learners taken on by Eskom would be employed, and how many jobs that it quoted as having created were sustainable.

Mr Adam said that Eskom was trying to adopt a developmental approach that would support job creation, in addition to specifically targeting the poor and unemployed. Despite that, some of the studies highlighted the negative impact of electricity price increases, including job losses, but it was impossible to predict that. He pointed out that the country had actually benefited from amongst the cheapest electricity prices in the world, over the last two decades, and the question now was whether electricity prices alone would deal with the fears, or if other targeted interventions were needed to put Eskom back on the correct footing.

Cost increase vs profit and general pricing queries
Mr Sinclair said that he wanted to hear Eskom’s comments on the need for these increases, given the recent announcement of R13.2 billion net profit made by Eskom. The public did not readily understand the requests for increases.

Mr Mnguni asked for more explanation on the calculations on the returns and costs, pointing out that all projects were assessed for viability. He asked if Eskom’s figures represented return on assets (ROA), or return on equity (ROE) and what was taken into account. He pointed out that the cumulative costs over the next years would actually amount to around 100% over eight years or so, and wondered if this could be justified.

Ms van Lingen noted that the new build programme was not included in the price-increase. She was not sure how the 7.8% return on assets had been calculated and thought that perhaps a 5.5% rate would have been more realistic.

Ms van Lingen said that the comment about boosting the balance sheet to gain credit rating had been made before, but this did not take into account that Eskom would never need to replace its entire structure simultaneously. Whilst it would be desirable to try to reach a debt-free situation in relation to the build programme, she pointed out that customers wished to pay for what they were getting now, not for future assets that would not benefit them directly.

Mr Mnguni noted that some time ago Eskom had spent a considerable amount of money on boosting staff morale. He asked if anyone had analysed the results of this spending, in terms of productivity gains, and whether this kind of spending was justifiable.

Mr Adam responded, on the question of staff morale, that Eskom had been through difficult times and its staff were required to work inconvenient and long hours, making abnormal input. In the regions, and at the power stations, Eskom therefore offered “family fun days” to try to offer some compensation and recognise the staff commitment. However, this did not entail flying people to any other destinations, but was limited to entertainment. Mr Adam reiterated, overall, Eskom’s commitment to efficiency, and said that this spending was not, as the media had reported, merely frivolous spending, but was carefully planned to maximise the input that its staff would make and to improve its working environment.

Mr Adam then explained that the price increases were indeed necessary. From an economic perspective, Eskom had to move to the position where it was recovering costs. The question was what that migration path should be. For the last 20 years, in real terms, electricity prices had been declining and were back to the 1978 levels. A rough modeling had concluded that if Eskom had been charging CPI increases, this would have made a big difference to its financial position. Eskom had realised that it was not sustainable, in the long term, to build the economy on the back of electricity prices. It was necessary to look at the business case over the period and its borrowing. Eskom was still borrowing around R360 billion. If it were to cut its profits, it would have to borrow mores, and this would also raise the costs. Profits were essential to the mix, since the balance would be reinvested. In essence, cash was needed for the next five years to keep the business afloat. Eskom must reach and maintain stand-alone investment grade. If it could not meet the thresholds, its position was not sustainable. It must be remembered that everything Eskom did would benefit the whole economy, and if it was a drag on the fiscus, this would impact on a host of matters, including job creation.

In relation to the returns, he emphasized that the starting point was 0.9% return on assets, but this would rise to 7.8%. Cost of debt was about 7.82%. The cost of equity was 13.95%, but weighted average cost was about 8.37%. Over the next five years, Eskom would be getting back about 3.7%, or about half of the total, but that was an investment in smoothing the tariffs for the benefit of the economy.

Mr Adam clarified that Medupi and Kusile costs were included. Other capex costs related to transmission, refurbishment and strengthening. NERSA would allow Eskom to recover depreciation and return on all assets in operation (ROA), a common regulatory mechanism that, by allowing return on works under construction, avoided sudden pricing spikes when the plant came into operation. IRP contemplated additional capacity, such as other coal stations, but ROA and depreciation of those was not factored in. Some possible models were sketched out in slide 45.

He noted that there was a debate on whether tariffs now should cover future costs. What was put in today would benefit society in the future, but he stressed again that the tariffs were not looking to future capacity. South Africa was very energy intensive, because when South Africa was enjoying low prices, its energy intensity had doubled. For this reason, it was necessary to increase its energy efficiency. Eskom had tried, in its calculations, to mitigate any negative effects and find a balance that would allow for sustainability.

Ms van Lingen noted that 5.5% average returns would apply, for instance, to returns on the Johannesburg Stock Exchange, but Eskom was not operating under the same conditions in the market, as it required perpetual guarantees from government. NERSA should take cognisance of the fact that Eskom had suddenly adopted modern equivalent assets as a way of calculating depreciation, which resulted in higher recovery costs being noted.

Mr Adam answered that slide 38 indicated that, whatever valuation methodology was used, whether historical or replacement costs, the life cycle would be the same. What changed was the rate of recovery. If a new plant was needed, the Replacement Cost Value Methodology would allow the same recovery, but over a better time span. He also noted that some of the borrowing was international, and the prices would fluctuate. It was necessary to cover the borrowing costs through the tariffs. 

Mr Mnguni noted that the steel companies were complaining of tariff increases, and said that China had decided to manufacture in its own country at much lower costs. He asked if Eskom could indicate any comparative costs.

Mr Adam responded that Eskom had done some research on costs, using the NUS Survey, and South Africa had now moved from the lowest to around the middle of comparative costings. However, he pointed out that straight comparisons were not possible because it was difficult to tell what the subsidy component might be. There was a need to examine the economic policies and determine where interventions might be necessary, particularly for vulnerable sectors. In the trade and industry environment, there was linking of subsidies to key performance indicators, but it was necessary to consider whether subsidies actually added value or were compensating for inefficiencies. The Eskom website and the MYPD application set out some comparisons.

National Energy Regulator South Africa overview of the MYPD process
Mr Brian
Sechotlho, Head of Division: Electricity Pricing and Tariffs, NERSA, confirmed that the Eskom application for five years had been received, not only setting out a 16% increase, but also an application for restructuring of tariffs, as already outlined. Residential tariffs had to be restructured and to help the poor, and Eskom had asked for unbundling of tariff components, and revision of the time of use tariff to reduce the peak high demand (winter) energy price.

The MYDP methodology was based on a rate of return mechanism. The six pillars of the MYPD process were set out (see NERSA presentation for details). Pillar 1 involved planning, including reviews of previous decisions, analysis and draft process plans. Pillar 2 involved organisation, and breaking down the key elements. Pillar 3 involved analysis, and pillar 4 was consultation, which would include public hearings in all provinces. Pillar 5 would involve determination, consolidating all evidence and public interest issues. Pillar 6 was communication of the decision to Eskom and the Minister of Energy, followed by a media conference.

The original date for public comments was 20 November. More than 150 comments had been received, and some had requested an extension of time, which was granted, up to 30 November. There were also discussions with the public, through radio and TV shows, including SABC and community radio stations and public hearings would be held in all provinces. A list of the radio stations was given on slide 9, and the schedule of public hearings (between 15 January and 31 January 2013) was shown on slide 10. Two public hearings were planned for Gauteng. The final decision of NERSA should be made by 28 February 2013.

He concluded that NERSA was committed to a transparent consultative process in its decision-making process. The discussions with the general public and stakeholders would provide an opportunity to interrogate the application. NERSA would also ensure communication with the Parliamentary Portfolio Committees on Energy, Economic Development, Cooperative Governance, Public Enterprises, and the NCOP Committees, the Department of Energy, the Mayors of identified towns and cities and traditional leaders in relevant towns.

Mr Sinclair asked for clarity on the statement that NERSA would communicate its decision to the Minister; he thought that there was an appeal process to the Minister. 

Sechotlho responded that this communication to the Minister was done to ensure that the Minister was aware of the reasons before the media. The appeal rights indeed still applied.

Mr Sinclair thought that consultation with local government should be done through South African Local Government Association (SALGA), rather than through individual municipalities.

Sechotlho confirmed that NERSA did engage with SALGA but also engaged with as many Mayors as possible, when it moved around the country.

Ms Abrahams noted that the public hearings in Gauteng would be in Roodepoort, a small centre, and wondered how NERSA was intending to cover the rest of the province.

Sechotlho said that in the past, NERSA had used the city centre of Johannesburg and there had been complaints that the Western parts of the city were not consulted. There was limited time and resources and NERSA could not cover every area.

Ms M Dikgale (Limpopo, ANC) suggested that NERSA must be creative and perhaps consider more use of radio time to enable those outside the cities to engage.

Mr Sechotlho said this was a good point to consider.

Ms van Lingen reminded NERSA that in the past years it had reduced the tariff proposals by Eskom substantially, and recommended that the same be done again, particularly since Eskom had made such a large profit.

Ms Dikgale concurred with Ms van Lingen on this point.  

The meeting was adjourned.


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