Department of Public Enterprises & Eskom on impact of tariff increases

NCOP Public Enterprises and Communication

15 May 2013
Chairperson: Ms M Themba (ANC; Mpumalanga)
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Meeting Summary

Eskom appeared before the Select Committee on Labour and Public Enterprises to present its response to the decision by the National Energy Regulator of South Africa (Nersa) on the tariff increase, and to explain the impact that the decision to award lower tariffs would have on the Eskom balance sheet. It was summarised that during the Multi-Year Price Determination (MYPD3) process, Eskom had applied for a determination that would realise R1 trillion over the next five years, but been awarded only R862 billion, and the R225 billion shortfall thus required Eskom to develop an Integrated Delivery Programme to minimise the impact. This programme would continue to implement the committed savings, seek further efficiencies, consider how the business could be re-shaped, identify any additional support needed, including government guarantees, and examine hw the regulatory framework and rules might assist. The key areas of reduction of the Eskom requests were for primary energy, operating costs, depreciation, Independent Power Producers (IPPs), Integrated Demand Management (IDM) and returns. Mr Adam outlined the rationale of Nersa for the lower tariff decision in each of those categories. He noted that Eskom’s projections included assumptions about coal costs, and were based on performance and other indicators, but that in certain instances, Nersa used its own assumptions and benchmarks, and that Eskom wanted to engage on these to try to reach common ground. Eskom was concerned that Nersa had mistaken the Demand Management Participation as power buy-back programmes, but this was incorrect because Eskom did not support these. The Eskom request on the Independent Power Producers was reduced because Nersa thought part of this would fall outside the five-year period. In respect of integrated demand management, Nersa took the view that this would be implemented by another agency, but Eskom believed that although this was policy, in fact it should be allowed to roll out demand management in the next two years, so as not to lose momentum. Eskom and Nersa differed on the calculations for returns and depreciation, and Eskom needed to engage with Nersa as to how the latter viewed “efficiency”. In addition, there was a need for Eskom to engage with government, the shareholder, on what role Eskom would play after Kusile build was finished, how it would handle demand management, government support and regulation of coal prices and declaration of coal as a strategic resource.

The second portion of the presentation set out the response to the Nersa decision, and noted that a  joint Shareholder-Intergovernment workgroup had been established to consider medium term constraints. Eskom would be looking to implement substantial changes within the next two years to mitigate the shortfall, and the IDP had therefore been drawn and approved. Eskom would be approaching Nersa to get clarity on several points, and would be confirming the list of capital expenditure projects for the next five years.

Members noted that they were not in a position to fully engage Eskom on its presentation before also hearing from Nersa to get a balanced perspective. However, they did raise some concerns about the impact of the decision. They enquired what guarantees Eskom might need from government, and several Members questioned the current status with Medupi, both in relation to the ongoing labour unrest, and on oversight over contractors who had apparently been paid in advance although the project was behind. They asked if Eskom was looking to electricity alternatives and how much electricity was being imported, and wanted to know the timelines for implementing the decision by Nersa and the integrated plans. They requested more information on the steps to have coal declared a strategic resource, wondered if privatisation of other companies to provide energy would address the problems, and urged ongoing discussions between Eskom and Nersa. They questioned the bonuses paid to senior management, which were regarded as extravagant, and asked about plans to address cable theft. More information was also requested on the warning that Cape Town may face power cuts, asked about the impact of the electricity usage alerts on television, cautioned that Eskom had not reached the people most affected, when carrying out public hearings on the tariffs, and enquired about the impact of the Independent System and Market Operator Bill.
 

Meeting report

Chairpersons’ opening remarks
The Chairperson welcomed everyone to the meeting. She acknowledged the presence of the Department of Energy and of the Department of Public Enterprises, but noted that the focus at the meeting would be on Eskom, and its response to the impact of tariff decreases on its balance sheet.

Eskom briefing on securing financial sustainability in response to lower tariff decision
Mr Mohamed Adam, Divisional Executive: Regulatory and Legal Affairs, Eskom, relayed an apology from the Minister of Energy, who was obliged to be present for the presentation of the budget vote of the Department of Energy on that same day.

Mr Adam said that the first part of the presentation would focus on the National Energy Regulator of South Africa’s (Nersa) decision on the Eskom tariff increase, the rationale behind the decision and its impact on Eskom. The second part of the presentation would be focusing on Eskom’s response to Nersa’s decision.

In summary, he explained that Eskom had made application for an increase but that Nersa had not approved that application, and had awarded a lower tariff, which left Eskom with a revenue shortfall of R225 billion over the next five-year period. Without appropriate interventions, the Nersa decision would impact severely on Eskom, as such a huge shortfall could not be made up with efficiencies alone. In response, Eskom tabled an integrated delivery programme for finalisation. The programme would:
- continue to implement the committed savings of R 30 billion and find further efficiencies
- consider how the business could be reshaped
- identify additional support which may be required
- look to the regulatory framework and rules to assist in addressing the challenges

Mr Adam said that the finalisation of the integrated delivery programme would be done in consultation with various stakeholders and pointed out that government was the majority shareholder. During the Multi Year Price Determination (MYPD3) application process, Eskom identified key areas where partnerships with various stakeholders were crucial for the future. He explained that the way the tariff was determined was that Nersa looked at Eskom’s primary energy costs and operational costs, and then gave what it regarded as an appropriate return, taking into account depreciation. This formula would then determine tariff increases. With regard to costs, he noted that Eskom kept costs at a single digit increase of 8.6%. From a policy perspective, the application was kept in line with the Electricity Pricing Policy of 2008. As for government support, a total of R350 billion in debt guarantees was extended to Eskom, and its debt levels were covered by these guarantees. The aim of the MYPD3 application was to achieve cost reflectivity, to improve Eskom’s financial profile, and to complement its ability to fund itself, with lower risk and government support.

Eskom had applied for R1.087 trillion in revenue, but Nersa approved only R862 million. Nersa’s disallowances thus resulted in a R225 billion cash flow gap over the five-year period. Key reductions were spread across the requests in respect of primary energy, operating costs, depreciation, Independent Power Producers (IPPs), Integrated Demand Management (IDM) and returns. Nersa’s disallowances were weighted heavily towards the end of the five-year period, so that Eskom would thus be attempting to do as much work as possible in the first three years of the five-year period. Stakeholders would be engaged for financial stability and security supply throughout the five-year period.

Mr Adam outlined some of the rationales of Nersa for the lower tariff decision.

In respect of primary costs, he noted that Eskom requested R355 billion and was granted R293 billion. Some of the reasons for this included high coal costs based on the MYPD2, the assumed lower water costs and the used nuclear fuel benchmarks. Applications by Eskom were based on five year projections, based on performance and other indicators. Nersa had, however, made assumptions, based on Eskom’s performance and Nersa’s benchmarks. Eskom wanted an opportunity to engage with Nersa on its benchmarks and assumptions, in order to reach a common ground.

In respect of Demand Management Participation (DMP), Mr Adam firstly explained that this was a tool used for customers to participate in demand on a short term basis, so that Eskom could manage the system in times of constraint. Eskom requested R11 billion, but Nersa approved R1.9 billion. The explanation given by Nersa for the cut was that when Medupi and Kusile power stations came back online, they would address the energy shortfall. However, Eskom believed that Nersa mistook the DMP as power buy-back programmes, which in fact Eskom did not support, so that no money was included in the MYPD3 application for power buy-backs. Power buy-backs were there to manage the constraints experienced by the system, by contracting with customers for a fixed period to reduce demand, in return for compensation. However Eskom did agree that the solution was short term.

Eskom had requested R78 billion from Nersa for the Independent Power Producers (IPPs), but received R65 billion. The explanation given to Eskom was that IPPs would come in outside the MYDP3 period, hence the deduction from the proposal.

In respect of  Integrated Demand Management, Eskom had applied for R13 billion from Nersa, and R5 billion was approved. Nersa explained that IDM would be undertaken by a government agency, which would be responsible for demand management. Eskom agreed that it was government policy that the IDM needed to be handled outside of Eskom. However Eskom’s concern was that, given the urgency of the first two years of the five-year period, it was crucial that Eskom not lose momentum, and so Eskom should be allowed to rollout demand management. From an efficiency perspective, Nersa argued that the IDM was a high cost with very low efficiency.

In respect of Returns, Eskom had applied for R187 billion and was granted R138 billion. Nersa re-evaluated Eskom’s Return Asset Base (RAB) and recalculated the target return. However, Eskom maintained that Nersa’s recalculations were incorrect as they excluded inflation. In regard to depreciation, Eskom applied for R185 billion and was granted R140 billion.

Mr Adams explained that all these costs were meant to strengthen Eskom’s balance sheet. However, Nersa believed that Eskom could do more things efficiently. There were differing views on what “efficient” meant, and so Eskom would like to engage with Nersa to discuss these different cost benchmarks and assumptions, in an attempt to reach common ground and understanding. For example, Eskom’s coal costs were significantly higher than those projected by Nersa. Other strategic implications from Nersa’s decision were that Nersa did not explicitly limit Eskom’s mandate, so Eskom would have to address policy issues with the shareholders, to ensure alignment, in respect of Eskom’s role in building, after Kusile, the future role of Eskom in IDM and further government support.

Mr Adams also noted that the regulation of coal prices in South Africa, and coal being regarded as a strategic resource, were vital. For Eskom, input coal costs had to be controlled to ensure sustainability.

Mr Adam continued with the second part of the presentation, which dealt with Eskom’s response to Nersa’s decision. He acknowledged that when making the MYPD3 application, Eskom was aware that there was a need to balance its needs with the South African economic situation. A joint Shareholder-Intergovernment workgroup had been established to consider medium term constraints, as well as the implications of Nersa’s decision. Eskom was also busy engaging with Nersa on its reasons for decisions, and assumptions made on the MYPD3 determination. One matter which was to be discussed was Nersa’s benchmarks.

In responding to the Nersa decision, Eskom had developed a holistic Integrated Delivery Plan (IDP), to address the challenges posed by the determination. Eskom had a two-year period in which to implement substantial changes to mitigate the R225 billion shortfall. The IDP was therefore initiated to engage stakeholders and to ensure financial sustainability. The IDP had been approved by the Board and was supported by the shareholder (government). It thus encompassed a systematic, rational approach to ensure Eskom’s sustainability.  

Given that there were several key issues, Eskom intended to approach Nersa to get clarity on the application of the regulatory rules and framework, to inform the necessary decisions towards achieving Eskom’s financial sustainability. These had been described already, and were more fully set out in the attached presentation.

Finally, Mr Adams noted that Eskom’s next steps following the decision were to:
- stabilise the business for the next two years, and roll out of business productivity, whilst also re-shaping the programme to identify and extract operating and capital efficiencies
- take steps to achieve a country pact on coal prices
- deliver on the Eskom capacity expansion programme
- determine the maximum amount that could be recovered by applying the RCA methodology
- agree RCA principles and implementation process with Nersa
- confirm Eskom’s role beyond Kusile
- explore shareholder support
- confirm the list of projects for next five years, which were aligned to capital expenditure

The Chairperson thanked Eskom for the presentation, and said that it seemed that things were very difficult between Eskom and Nersa.

Discussion
Ms L Mabija (ANC; Limpopo) noted that in the year 2011/12 Eskom had identified a financial gap of about R190 billion over seven years, but the 8% tariff increase by Nersa created a R225 billion gap for the 2013/14 financial year. She asked whether the R225 billion gap included the R190 billion gap from the previous financial year.

Mr Z Mlenzana (COPE; Eastern Cape) said the meeting had not been an easy one and Members needed to apply a balanced objective. He thought it would have been preferable for Nersa also to be present and suggested that the Committee should set up a meeting with Nersa, to hear Nersa’s perspective on the matter before the Members gave any solid responses. It was important that the Committee not be seen as “taking sides” between Eskom and Nersa. The Committee was responsible for adjudication on such matters.

Mr Mlenzana added that Nersa’s determination came at a time when Eskom faced other challenges, such as significant cost overruns, and crisis at Medupi linked to labour unrests.  He asked whether Medupi and Kusile were fully funded and whether they would receive any further debt guarantees from Eskom. He also asked what progress Eskom had made in the rollout of transmission and distribution networks.

Mr O De Beer (COPE; Western Cape) agreed with Mr Mlenzana that Eskom and Nersa did not appear to be on the same page, as the information presented by Eskom disputed that of Nersa.

Prince M Zulu (IFP; KwaZulu Natal) supported the suggestion that Nersa should be invited to appear before the Committee and to present on its decision on Eskom.

Mr De Beer asked for clarity on Eskom’s capacity and a further explanation on the progress made in declaring coal as a strategic resource. He wondered whether declaring coal as a strategic resource would regulate pricing. He also asked if the stakeholders had expressed a view and if any guarantees were likely to be extended.

Mr H Groenewald (DA; North West) pointed out that Eskom was a monopoly, but it had failed to ensure energy security in South Africa. He asked whether other companies would be privatised to curb the energy insecurity in the country. He also wanted to know the progress pertaining to the building of six nuclear power stations, and whether Eskom would be re-examining the IRP, seeing that it provided a 20 year plan for the country. The IRP gave some guidance for the building of new coal stations. Discussions about energy were crucial between Eskom and Nersa, and these should be an ongoing process.

Mr Groenewald wanted to know what progress Eskom had made in finding energy alternatives, for example, gas and wind energy, and asked how much electricity was being imported from other countries.

Mr Groenewald sought an explanation for the huge bonuses received by Eskom’s top management, and questioned the necessity for “such extravagance”.

Mr Groenewald requested a progress report on the delays in union negotiations for Medupi. He suggested that in future Eskom needed to be in communications with unions before major problems erupted.

Mr Groenewald asked what mechanisms Eskom had in place to deal with illegal cable theft.

Mr M Jacobs (ANC; Free State) said that initially, Eskom applied for R1 trillion during the MYPD3 applications to Nersa, however Nersa granted Eskom a lower amount. He wondered if this had been merely a bargaining tactic by Eskom. He also wanted to know what the timelines were for implementing Nersa’s decision and Eskom’s IDP

Mr De Beer said that Cape Town residents were warned to prepare for power cuts during the week. He asked why this was so, especially since Eskom had given a guarantee that there would be no more power cuts nationally.

Ms Mabija asked whether Eskom monitored the entrepreneur service provided concerning the tender process. Medupi was, for example, running over by eight months and the construction companies had been paid long in advance.

The Chairperson said that it had been mentioned to the Committee that the Independent System and Market Operator (ISMO) Bill could have a negative impact on Eskom’s balance sheet, and enquired if Eskom was well prepared to deal with that challenge.

Mr Adams responded that the funding gap was all-inclusive and it included the gap from the previous financial year, as well as that of the current financial year. He added that the task ahead of Eskom required a lot of work, and the manager appointed to lead the IDP was developing a very detailed project plan, with milestones, for successful implementation. As to the question whether Eskom would need further guarantees, he answered that Eskom would first be looking internally to see how it could reshape the business, so that all gaps could be identified. When that had been done, Eskom would then be in a better position to estimate whether or not more funding and support was needed. Eskom had not yet completed its evaluation process.

Mr Adam said that the funding for transmission networks would be allocated based on priority, and assured Members that transmission would therefore not be affected negatively by Nersa’s decision. Eskom was committed to meeting the deadlines it had set for itself. In the next two years, Eskom had no issues with funding. Nersa’s decision thus would have no impact on Eskom’s build programme; and there would be no delays. Should problems arise, stakeholders would be engaged.

The approach that Eskom had adopted to coal being declared a strategic resource was twofold. Firstly, Eskom would be motivating to government that coal should be dedicated to energy and power supply nationally. Secondly, there was a need to engage on pricing because Eskom needed to manage the pricing of coal when it became a strategic resource.

Mr Adam noted the points about Eskom failing to secure power supply, but pointed out that many of the policy issues fell within the domain of the Department of Energy, and the IRP. In terms of alternative energy, Eskom did not determine the generation of gas energy and wind power as this too fell under the mandate of the Department of Energy.

Mr Adam noted the points about labour and construction contracts, but pointed out that contracting was a huge and complicated process, and Eskom was contracting out huge tenders, and therefore needed to hold the contractors to account. It was attempting to do this through Project Labour Agreements, and would ensure that what was in the agreements was fair and reasonable. Eskom had become more involved and proactive in encouraging good labour practice.

As to whether Eskom evaluated the tender process, he said that Eskom provided detailed monitoring and there were processes in place to ensure fairness transparency. An internal auditing process did take place before a major tender was allocated and large projects were therefore monitored very closely to prevent financial loss.

Mr Adam conceded that cable theft was a big concern for Eskom, but that it had partnerships with the industry to try to resolve the issue. This was not only a financial issue, but also a security supply issue. Illegal connections were very problematic.

Mr Adam said that he would have to investigate and get back to the Committee in regard to the warnings about possible power cuts in Cape Town. Eskom was however committed to keeping all lights on, but all South Africans needed to contribute to the cause by using electricity efficiently.

Mr Groenewald asked about the effectiveness of the electricity usage alerts on television.

Ms Hilary Joffe, Spokesperson, Eskom responded that the power alerts were very effective. A monitoring system was in place. A new programme; the Power Bulletin, had recently been launched designed specifically to get people off the grid during peak hours of 17:00 to 19:00.

Mr Adam said that Eskom agreed that no employees should be paid excessive amounts and there were guidelines from the Minister on remuneration of employees.

Mr Adam noted that Eskom proposed to move along with different phases in relation to the ISMO system. A separate state entity would therefore be looked at in a phased approach.

Mr Adam summarised by repeating that Nersa’s decision had a huge impact on Eskom, but a plan was put in place by Eskom to try and solve the problem. As soon as the issues and plan were more clear, Eskom would be engaging with stakeholders and would be in a better position to evaluate whether it needed government guarantees, and what projects would be affected. He repeated that Eskom was willing to work with Nersa to find how best they could move to achieve a single goal.

Mr R Tau (ANC; Northern Cape) said Eskom’s plan would become clearer with time. He commented that the extent to which Eskom mobilised society created problems for itself, because during the application process, the public participation programme was seen as elitist and failed to reach those who were most affected by power insecurity.  The Congress of South African Trade Unions (COSATU) had complained that Eskom was not speaking to the right people, and had failed to mobilise enough support from the people. He wondered why it was taking so long to settle and reach agreement with the unions at Medupi, and asked if there was any sabotage involved.

Mr Adams said he could not comment on the labour and possible sabotage at Medupi.

The Chairperson thanked Eskom for the presentation, and confirmed that Nersa would be invited to brief the Committee on the tariff application at a later stage.

The meeting was adjourned.
 

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