NERSA's MYPD approval of 8% instead of 16%: response by Eskom & South African Local Government Association

Energy

23 May 2013
Chairperson: Mr S Njikelana
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Meeting Summary

The meeting looked at the rationale behind the National Energy Regulator of South Africa’s price determination of 8% in response to Eskom's request for a 16% tariff increase. The South African Local Government Association (SALGA) was asked to respond to the 8% increase on behalf of municipalities.

Eskom had applied for R1.087 trillion in revenue. NERSA had not approved its 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 R30 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

The finalisation of the integrated delivery programme would be done in consultation with stakeholders and with government being the majority shareholder. Key reductions were spread across the requests on primary energy, operating costs, depreciation, Independent Power Producers (IPPs), Integrated Demand Management (IDM) and returns.

Eskom said this winter would be different in that generation maintenance would be done and not deferred. Eskom was committed to maintaining at least nine generation units between April and August to ensure the long-term sustainability of the plant. There was sufficient capacity to meet the demand most of the day.  However, the concern was the peak demand between 5pm and 9pm. If that could be reduced by as much as 2000MW, the security of electricity supply would be adequate. Eskom could not tackle the challenges of electricity supply alone, all partners and stakeholders needed to be actively involved in managing demand. Power stations were ageing as they were being run hard, therefore sustainable high levels of planned maintenance were needed to ensure reliable performance. Eskom usually reduced maintenance to the minimum in winter to meet higher demand but the planned maintenance could not be deferred. Demand during winter evening could rise up to 3000MW in 1 hour, as households switched on lights, heaters and cookers. South Africans were therefore urged to switch off non-essential appliances from 5-9pm. Deferring planned generation maintenance would have severe consequences.

The South African Local Government Association presentation noted the reduced electricity tariff increase of 8%. It spoke about the expected projections on surcharges by municipalities to address possible financial shortfalls. It looked at the reasons for the substantial electricity pricing variation at municipalities and the effect this had service delivery. It discussed infrastructure maintenance and development including skills and capability development and the factoring in of the Approach to Distribution Assets Management (ADAM). Finally it spoke about non-payment by municipalities to Eskom.

NERSA said it had approved the following tariffs for the 2013/14 financial year: Local Authority Tariffs were approved 7.3%, Non Local Authority Tariffs were approved 8.4%, Urban tariffs were 9.6%, Rural tariffs 9.3% and Residential tariffs got an approved tariff of 5.0%. In total the MYPD3 approved tariff was 8.0%. Currently municipal tariffs were approved on an annual basis, and the process involved about 190 municipalities, Eskom as well as private distributors.

Members questions and comments included:
- What financial costs did the delays in Medupi and Kusile have on Eskom as a whole?
- What kind of actions would be taken for complete negligence by contractors?
- How was Eskom and NERSA trying to find a balance in bridging the differences they had?
- What impact did Eskom’s inflation figures have on the economy?
- Eskom had secured about 80% of its funding from guarantees. How much of the guarantees had already been used, and how much was still remaining?
- Was the current building of power stations a sustainable solution in the long run?
- The ADAM pilot project had only been rolled out to seven municipalities. How long did the other municipalities have to wait for the roll-out?
- SALGA was awarding free electricity to people who could afford electricity, instead poor people who could not afford electricity were suffering from shortages.

Meeting report

Opening remarks
The Chairperson said it was a very busy time in Parliament with the Budget Votes. As the presentation sizes were quite voluminous; presenters were encouraged to bear in mind the time. He added that the main agenda of the meeting was to handle electricity pricing, with a focus on the Multi Year Price Determination (MYDP3). The National Energy Regulator of South Africa (NERSA) had made its price determination and it was asked to present its rationale for its price determination. It therefore made sense that Eskom also be invited to respond.  He added that although the matter was already handled by the National Council of Provinces; the Committee took a slightly different approach. The Committee understood that price determination did not end with Eskom, but also extended to the municipalities. This was why the South African Local Government Association (SALGA) was also invited to the briefing by NERSA and Eskom. It was important that the effect of NERSA’s tariff decision on municipalities also be understood.

Eskom briefing on securing financial sustainability in response to lower tariff decision
Mr Mohamed Adam, Divisional Executive: Regulatory and Legal Affairs, Eskom, said that the first part of the presentation would focus on NERSA's decision on Eskom's proposed tariff increase, the rationale behind the decision and its impact on Eskom. The second part of the presentation would be focus 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 had tabled an integrated delivery programme for finalisation. The programme would:
- continue to implement the committed savings of R30 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 billion. 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.

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 shareholder, 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.

Eskom’s response to NERSA’s decision
Mr Adam 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-Inter-government workgroup had been established to consider medium term constraints, as well as the implications of NERSA’s decision. Eskom was also engaging with NERSA on its reasons for the decision, and assumptions made on the MYPD3 determination such as 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.  

Finally, Mr Adams noted that Eskom’s next steps following the decision were to:
- stabilise the business for the next two years, roll out 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 Regulatory Clearing Account (RCA) methodology
- confirm Eskom’s role beyond Kusile
- explore shareholder support
- confirm the list of projects for next five years, which were aligned to capital expenditure

Update on Eskom Build Programme
Mr Prish Govender, General Manager: Enterprise Development, Eskom said he would be taking members through the build programme. Eskom’s Engineering, Procurement, Construction and Project Management (EPCM) organisation was amongst the largest construction projects in the world. The Medupi and Kusile Projects were ranked amongst the top five power generation projects in the world in terms of capacity. He added that the build programme’s portfolio was diverse and included projects in the energy, transportation, water and communications sectors. Geographically, the newly constructed projects were positioned all across South Africa. Eskom was also actively engaging in projects in Southern Africa. Through the delivery of its build programme, Eskom continued to invest in improving its engineering, procurement, construction and project management capability; its people , its systems, processes and tools. The build programme therefore focused on delivering on large construction projects.

Contract management, financial systems, project controls, project system and processes, quality standards and safety had also been aligned with that of Eskom’s peers. This alignment had also been embedded into the EPCM organisation. Increasing supply from the local industry and creating jobs was critical. This thus required knowledge, skill and technology transfer. The build programme was continually and actively driving these by incentivising industry partnerships, employing local labour and through training. Since 2005 the programme has delivered 6 017 MW of generation capacity, 4 626 4km of transmission network and 23 775 Mega Volt Capacity (MVA) of substation transformers. The infrastructure currently under construction would create approximately 40 000 jobs and more than 50% of the spend would be local.

Mr Govender said over the next five years, R337 billion would be spend by the programme. When one compared the yearly expenditure with some of South Africa’s construction companies, it was very high. However it was on par with that of its international peers. In terms of meeting its targets, Eskom delivered 261 MW of power, 787 Km of transmission lines and 3 580 MVAs at substations.

In terms of the Medupi Project, the team was targeting to synchronize the first unit by December 2013. However the following areas could experience some challenges:
▪ Control and Instrumentalisation
▪ Boiler- Post Weld Heat Treatment
▪ Boiler- Welding Procedure Qualification Record
▪ Electrical System
▪ Balance of Plant Mechanicals

He said that Eskom had a number of interventions in place to deal with these issues. These included closer cooperation and working with suppliers to try and expedite the work, closer monitoring of activities on site and in factories and offering technical advice where it was needed. At an executive level, management appropriation had also been improved. This included senior management being at site, transparency was also increased through tighter reviews, new partnership agreements were put in place on site to tackle labour issues. Eskom had therefore assumed a closer monitoring and facilitation role. With regard to supply development and localisation efforts, there were four key areas of focus:

Local to site procurement
Contracts worth R1.67bn have been placed with Lephalale and Waterberg-based suppliers. Eskom alone was procuring R202 million locally, with 70% of the companies owned by black women.

Job creation
At the end of March 2013, there were about 16 800 employees on site. 43% of the workforce were Lephalale residents. 73% of the unskilled and semi-skilled workers came from Limpopo, and 95% of the workforce was South African. 53% of the workforce were the youth - those aged 35 years and below.

Skills and entrepreneurship development
Contractors were committed to training 2128 skills development candidates. The objective was that these people could be employed either on-site or in the Lephalale municipal and traditional authority areas.

Infrastructure development
Eskom had invested more than R40 million in sewage and electrical distribution systems in Lephalale. Eskom was also building and renovating seven rural clinics, and had funded six mobile schools as well as teachers and equipment. About R2.3 billion had been spent on housing in Lephalale since 2007.

With regard to the Kusile Project, the execution team had a synchronisation target of December 2014. These four areas would be potentially affected by the construction:
▪ Boiler erection
▪ Civil work delays
▪ Labour stability
▪ Permitting challenges.

There were however multiple recovery interventions. As with Medupi, Eskom had entered into new labour partnerships to deal with labour discipline and stability. Eskom was also working very closely with the boiler manufacturer to implement recovery plans that bolster production, weekly integration meetings were scheduled with all contractors to address civil delays, and Eskom was working closely with Department of Water Affairs (DWA) and Department of Energy Affairs (DEA) to provide all the information required for permits to be granted.

As for the Ingula Project, the execution team had set a synchronisation target for August 2014. The Ingula Project was the 19th largest pumped storage scheme in the world. It was also the largest underground cavern in the world with four power generating units of 330 MW each. Some of the key risks affecting the commercial operation date were:
▪ Construction interferences
▪ Completing certain design activities
▪ Power outages
▪ Labour action.

Eskom Update on the State of the Power System
Mr Adam announced that his colleague who was to give this presentation, could not make it to the meeting because the plane could not land in Cape Town; it had been diverted to George. He would make the presentation, and any detailed questions which he could not respond to, would be responded to in writing.

He said this winter would be different because generation maintenance would be done and not deferred. Eskom was committed to maintaining at least nine generation units between April and August to ensure the long-term sustainability of the plant. There was sufficient capacity to meet the demand most of the day.  However, the concern was the peak demand between 5pm and 9pm. If that could be reduced by as much as 2000MW, the security of electricity supply would be adequate. Therefore residential customers, particularly those that use geysers, space heating and pool pumps were encouraged to make the biggest difference by switching off such equipment for four hours, as this would yield more than 2000MW savings. With regard to maintenance, Eskom had completed a five year review of its maintenance requirements to create a sustainable generation fleet. It was committed to doing the maintenance that would ensure a sustainable generation fleet to meet the long term supply requirements of the country. In order to manage the risks of supply and demand, the country needed to continue to focus on additional supply options, energy efficiency and some form of mandatory energy conservation schemes.

Eskom could not tackle the challenges of electricity supply alone, all partners and stakeholders needed to be actively involved in managing demand. For example, power stations were ageing as they were being run hard, therefore sustainable high levels of planned maintenance were needed to ensure reliable performance. The power system had been particularly tight and planned maintenance was impacted during 2013 due to:

Transmission line failure from Mozambique due to flooding. It reduced Cahora Bassa imports by 850 MW
Unplanned outage of Koeberg Unit 1 – 900MW
The need to manage the impact of the strike at Exarro’s coal mines – 1000MW
Volatile power station performance .

Eskom usually reduced maintenance to the minimum in winter so that it could meet higher demand. But as alluded to before, this winter would be different because planned maintenance could not be deferred. Demand during winter evening could rise up to 3000MW in 1 hour, as households switched on lights, heaters and cookers. South Africans were therefore urged to switch off non-essential appliances from 5-9pm. Deferring planned generation maintenance would have severe consequences. The Multi-Year Price Determination 3 (MYPD3) also added to the challenge of managing a tight power system by reducing Eskom’s ability to procure additional demand and supply side levers. Regardless, a generation maintenance strategy would be implemented, the strategy would be based on an 80% availability, 10% planned maintenance and 10% unplanned outages over the next five years. Additional supply and demand side options thus needed to be explored to meet medium term electricity demand. Strikes also had a negative impact on power stations in meeting demand.

Eskom had a supply and demand side initiative in place, but they were concerned about the impact which the NERSA decision could have on Eskom’s ability to finance the demand side measures which were needed to manage a tight system. Eskom however had various initiatives in place to save electricity and reduce pressure on the grid, cutting consumer bills at the same time.  The main initiative was the “Beat the Peak” initiative which was a 4-step campaign targeted at the use of electricity during peak time (5-9pm). The four steps of the campaign were:
- Switch off all geysers and pool pumps
- Switch off all non-essential appliances
- Find alternatives to electrical heaters (eg. Insulate ceilings)
- Respond to the Power Alert messages.

Consumers were therefore encouraged to switch to energy efficient technologies by taking advantage of solar water heating rebates and the residential mass rollout programme, which provided a range of free products.

Mr Adam concluded that the power system had been very tight during summer because of reduced imports and high levels of unplanned outages, including Koeberg Unit 1, and this meant less space to do the maintenance work Eskom had planned. All customers were urged to reduce demand, particularly the peak evenings. A comprehensive review of the five year maintenance plan had been conducted; this was required to ensure power stations could deliver more sustainable performance. Eskom was determined to keep the lights on in South Africa, but Eskom could not do this alone.

Discussion
Mr L Greyling (ID) said the three presentations generated a lot of questions. His concern with the NERSA tariff was that the possibility of keeping the lights on had deteriorated. The Committee needed to assume some kind of responsibility in managing demand. He asked if Eskom had programmes in place to involve other government departments in managing demand. During the MYDP3 application, as a motivation for their proposed pricing, they wanted to increase their credit rating in order to be able to secure international funding. He asked if Eskom had now taking into account the impact that NERSA’s decision had had on their credit rating. How would Eskom deal with that going forward? What financial costs did the delays at Medupi and Kusile have on Eskom as a whole? With regard to the new build, he asked if the 20% yearly increases were still a realistic expectation, keeping in mind NERSA’s decision. He argued that the 20% yearly increases for the build programme would probably have to be revisited. As for the issues around the boilers in both Medupi and Kusile, during site visits the explanation was that contracts for these were awarded to a variety of contractors and this caused problems and delays. What kind of actions would be taken for complete negligence by contractors?

Mr D Ross (DA) thanked Mr Adams and the Eskom team for a very good presentation. How was Eskom and NERSA trying to find a balance in bridging the differences they had? The difference of R225 billion was a huge amount and NERSA’s decision had a huge impact on the operations of Eskom. The formula used by Eskom to calculate its pricing needs was very flawed, specifically on its decision to increase its asset base. He said Eskom figures were highly inflated. Was Eskom still using the correct methodology to calculate depreciation? International standards indicated the best practice for return on investment. What impact did Eskom’s inflation figures have on the economy? He asked why Eskom did not make mention of its nuclear programme during the presentation. Funding for Eskom’s build programme seemed to be very bleak. What pressure did the MYDP3 reduction have on funding for the build programme? What were the options for alternative funding?

Ms N Mathibela (ANC) asked about Eskom’s maintenance; how was generation maintenance going to affect the country, seeing that there were very high electricity demands during winter. During the day, industries were the main consumers of electricity, while residents were the highest consumers during the evenings; how did these balance out electricity demand and use for Eskom? Eskom was responsible for connecting electricity in rural areas; however municipalities argued that Eskom was very slow in connecting rural communities to electricity. What mechanisms did Eskom have in place to address such grievances?

Mr K Moloto (ANC) said one consistent concern was raised during the public submission processes; it related to the divergence of statements by the Department of Public Enterprises and those by NERSA. The view which was expressed was that Eskom’s targets stipulated in its Annual Performance Plan were not communicated to NERSA during the MYDP3 applications. This reflected inconsistency on Eskom’s side. Other concerns related to the operating expenditure. There was a significant amount put in as ‘Other’ costs; why were these costs not qualified? Eskom’s transparency as a result seemed to be questionable. What were the benchmarks which Eskom and NERSA had agreed upon? With regard to primary energy costs, he asked if NERSA actually interacted with coal producers to establish the price trajectory. The approved regulatory asset base applied for was R912 billion. NERSA adjusted the amount by about R122 billion. What was the reason for the adjustment? On the matter of guarantees, Eskom had secured about 80% of its funding from guarantees. How much of the guarantees had already been used, and how much was still remaining?

The Chairperson said it was admirable to see that various agencies of government were willing to work together to improve. South Africa had a huge infrastructure build in front of it and coordination was necessary. He wondered however why there were such vast differences in approach between Eskom and NERSA. Consensus needed to be reached between these parties. What were the differences in processes and content between MYPD2 and MYPD3? It seemed as though the MYPD3 was more elaborate and challenging. It was a key fact to note that coal needed to be declared as a valuable and scarce resource. Therefore the Portfolio Committee on Mineral Resources needed to be engaged. Energy efficiency needed to be localized. By so doing, the impact would be stronger. Local community radio stations for example were one area which Eskom was not fully utilising.

Mr Adam responded and said the commitment from the Members was clear with regard to achieving energy efficiency. About Eskom’s application and the stand alone credit rating, there were various funding options available to Eskom. The bottom line however was that it had to be paid for. The most efficient way to meet its energy targets was to harness the strength of government as well as that of state owned companies to give Eskom more funding. He agreed that the availability of adequate funding would affect the credit ratings. In its application, Eskom developed a mechanism which would generate sustainable funding. Added to that, Eskom needed to be attracting and financially viable on its own, and this required that Eskom strengthen its balance sheet. On the details around the numbers which Eskom was asking for, NERSA’s target was 8.6%, and now their target was reduced to 7.85%. Financing was an issue during the MYPD2 application; and the main concerns were around funding infrastructure and providing a service to the country as a whole. The optimum way to fund was to accept that there was a migration path, and the poor needed to be protected. It was therefore fundamental to understand what the adequate return rate was for a state owned company.

With regard to policy issues, he said depending on the Minister’s determinations, and depending on the variety of funding options available, Eskom’s pricing may or may not be impacted. He referred to the regulatory clearing account (RCA) and said there was a particular assumption about how much the Independent Power Producers contributed to the account. Eskom employees were ambassadors for energy efficiency, and this had a positive impact on Eskom’s efficiency as a whole. The two most prominent campaigns in Eskom were around safety and energy efficiency. As for the questions on the impact of NERSA’s decision on Eskom’s credit rating, it would be premature to have an answer at the moment, seeing that the matter was still being discussed by the rating agency. On the actions and penalties for contractors, Eskom was using the full might of the law to address negligence and non-performance.

With regard to the question of costs of assets and depreciation, during the MYPD3 application, Eskom indicated that replacement costs were better for the economy, than historical costs. The debate around the best methodology was very heavy, however what was important was to recover the full costs of the assets. On the matter of inflation-linked tariffs, as a country it would be great to reach that level, but it was a matter which depended on costs and cost drivers. However, there were a few items which moved away from Eskom, the first was coal costs, the second were the extraordinary measures which Eskom had to take to ensure security of supply, and the last was the cost of electricity over long periods. Cash needed to be paid upfront to get to appropriate tariffs. With regard to maintenance, Eskom’s intentions were to avoid doing maintenance in winter, however unforeseen circumstances with the system meant that maintenance could not be delayed any longer.

The factories and other industries shutting down during the evening did not compensate for the high electricity demands during peak evening times. On areas where Eskom was delaying in bringing electricity connections, it would be difficult to answer the question without any specific information. Generally, the rate at which Eskom could connect electricity depended on infrastructure and the availability of power lines in the area, for example. On the question on divergence, there was a general alignment with its shareholder mandate and the requirements by NERSA. However, on a general basis, Eskom’s corporate plan informed all its decisions and there was no misalignment. On the difference between Eskom and NERSA’s benchmarks, credible international benchmarks needed to be found and agreed upon. Eskom and NERSA were working closely to reach common ground. However it needed to be accepted that there would be differences and disagreements regardless, however the issue was that they could not be R225 billion worth.

Mr Govender replied on the question of welding at Medupi, saying it would be naïve of Eskom to think they were the only people in the world who built infrastructure of such a nature.  So Eskom put in place an excellence and security forum of international companies building similar infrastructure. Solutions to similar issues were then found. One key lesson was that additional monitoring needed to be put in place at sub-contracting levels. Over and above the contract issues, it was important to balance that with the need to get the plants completed on time. As for nuclear energy, it was a very important component for the entire country. Power plants therefore could not be built on a just-in-time approach. Eskom was therefore engaging the the Department of Public Enterprises and other stakeholders to ensure Eskom’s role in the future of these projects.

South African Local Government Association (SALGA) on impact of MYPD3 on municipalities
Mr Sandile Maphumulo, Head: Electricity, Ethekwini Municipality, said the discussion points for his presentation stemmed from the 16% electricity tariff increase proposed by Eskom. Subsequently, Eskom was allowed a tariff increase of only 8%. This resulted in much of the arguments previously raised being automatically addressed by way of the reduced increase. However, SALGA would like to use this opportunity to brief the committee on further issues pertaining to electricity tariffs as well as provide feedback on previously discussed matters.

Reduced electricity tariff increase
With only 8% of Eskom’s requested tariff increase of 16% approved by NERSA, the concern was the ability of Eskom to operate a sustainable network with the reduced increase. NERSA/Eskom needed to quantify the direct and indirect consequences to the Eskom business as a result of the reduced increase. A report on the consequences then needed to be made available to SALGA and other stakeholders, so all associated risks could be understood. The risk of security of supply needed to be understood and addressed.

Expected projections on surcharges by municipalities to address possible financial shortfalls
Load shedding reduced sales, and this reduced municipal revenues. Media reports and recent Eskom correspondence raised alarm bells about load shedding. Municipal tariffs were structured to attain revenue recovery by means of electricity sales. Load shedding forced reduced sales volumes for municipalities which impacted the bottom line and in turn reduced the finances available for carrying out municipal functions (that is, repairs, maintenance, and ability to cross subsidise.).

As for introducing rolling contingency reserve within budgets, suitable provision needed to be made via tariff approval processes to allow municipalities to include a rolling contingency tariff within their budgets. This would deal with shortfalls as a result of the reduced sales volumes. Added to that, municipal surcharges needed to be introduced. Surcharges were purely designed to bridge the financial gap between what was budgeted for versus what was received. However the raising of a surcharge may make certain cities more expensive to operate in and could possibly drive away business and industries.

Reasons for substantial electricity pricing variation at municipalities
Electricity prices were based on financial requirements and budgets. Municipalities had different financial needs and this ultimately dictated the prices. The sales profile of a municipality was a major driving factor in determining prices. These were all different among municipalities and the reality was that there would be pricing variation among municipalities. There was great misalignment between Eskom and municipality prices. Municipalities were in most cases trying to align their prices closer to Eskom prices; and this was difficult to achieve. One of the reasons for this mismatch was as a result of municipal customers not being allowed to purchase electricity from Eskom Transmission at the same rate as Eskom Distribution.

Effect this had on municipalities in terms of service delivery
Service delivery and carrying out maintenance was hinged on 2 important criteria:
- Financial Sustainability
The municipality had to be financially sustainable to carry out their service delivery charter. The electricity supply industry was volatile. Ensuring financial sustainability in a municipal environment could be attained should SALGA steer its thinking in line with the introduction of contingency reserves and/or surcharges.
-  Attracting and Retaining Suitable Skills
There had to be suitable skills within a municipal environment to deliver on the service delivery charter. However, attracting technical skills to a municipal environment competed directly with Eskom and private industry.

Infrastructure maintenance and development including skills and capability development
During the long period of uncertainty about future ownership of distribution assets, there had been a significant underinvestment in infrastructure. Municipalities were reluctant to invest in infrastructure in a situation where there was no certainty about the future of such investment. This added to inherited maintenance backlogs that accumulated as a result of the country’s prioritisation of extension of infrastructure to the unserved rather than focusing on maintaining infrastructure that served a minority.

Factoring in of the Approach to Distribution Assets Management (ADAM)
The Electricity Distribution Industry (EDI) developed a significant backlog over the last couple of years in electricity distribution-related asset maintenance, refurbishment and strengthening. SALGA therefore, welcomed and supported the launch of the ADAM project in line with Strategic Integrated Projects (SIPs) 6 and 10 of the Presidential Infrastructure Coordinating Commission’s (PICCs) National Infrastructure Plan. The ADAM pilot project allocated R320 million to seven municipalities for 2013/14 to address infrastructure backlogs.

Issues around non-payment by municipalities to Eskom
On 19 March 2013 SALGA convened an urgent meeting with affected municipalities to explore alternative mechanisms to resolve the non-payment of Eskom’s bulk electricity accounts. The challenges raised by municipalities included: cash flow problems due to declining revenue base, ageing infrastructure, incorrect tariffs and the high interest rates on Eskom accounts. A contributing factor was the amount owed to municipalities by consumers. According to National Treasury figures, the aggregate municipal consumer debts were R83.7 billion as at 31 December 2012.

National Energy Regulator of South Africa (NERSA) on Municipal Tariff Determination Process
Mr Charles Hlebela, Head of Communications: NERSA, briefed the Committee on the purpose and mandate of NERSA, the tariff approval process and information requirements, municipal tariff guidelines and financial considerations. NERSA’s tariff approval process began with the assessment of Eskom’s revenues through the MYPD application process, from which Eskom’s standard tariffs were assessed, these tariffs were then implemented to Eskom’s direct customers as well as to municipal and private distributors. From there tariffs were implemented to private customers. In summary, NERSA approved the following tariffs for the 2013/14 financial year: Local Authority Tariffs were approved 7.3%, Non Local Authority Tariffs were approved 8.4%, Urban tariffs were 9.6%, Rural tariffs 9.3% and Residential tariffs got an approved tariff of 5.0%. In total the MYPD3 approved tariff was 8.0%.

Currently municipal tariffs were approved on an annual basis, and the process involved about 190 municipalities, Eskom as well as private distributors. The entire process needed to be finalised by 15 March of every year prior to the implementation of the tariff on 1 July. The process was dependent on the approved Eskom prices under the MYPD process. NERSA approved the Eskom prices/revenues and this determined the average increase to municipalities and other customers but may be different for each customer/municipality. NERSA determined the municipal tariff increase guideline and benchmarks (based on generic assumptions). Licensees then applied to NERSA for approval of their tariffs, supported by information pertinent to the individual municipality and NERSA reviewed the applications and made a determination on each application. Municipal tariff increase guideline and benchmarks were therefore determined based on the Eskom approved prices and revenues together with expectations of other economic indicators (inflation, salary increases etc).

The following assumptions were made by NERSA on the approval of the municipal guidelines:
▪ Bulk purchases increased by 7.3% in line with Eskom’s  tariff increase to municipalities
▪ CPI of 5.5% (as quoted in the Medium Term Budget Policy Statement 2012)
▪ Salary & Wages CPI + 1.25 % (as indicated in Circular No 6/2012: Salary and Wage Collective Agreement)
▪ Repairs and Maintenance, capital charges and other costs of CPI of 5.5% (as per inflation)

Eskom requested R13bn and was allowed R5bn. This was because Eskom’s requested costs were adjusted based on MYPD2 historical performance and then escalated by inflation. Solar Water Heaters (SWH) were disallowed as the MYPD2 M&V history proved that these programmes achieved little demand savings at high cost. According to the IRP 2010, beyond 2016 there would be enough capacity due to the introduction of Medupi and Kusile power stations on the national grid. Therefore it was necessary to adjust the DMP and power buy-back programmes accordingly. The power buy-backs programme was disallowed as the initiative was covered by the DMP.

Mr Maphumulo concluded that NERSA through its mandate of tariff pricing had a critical role to manage the price paths migration during this period of necessary high capital investment in South Africa. However NERSA would continue to conduct its business in a fair and transparent manner, within government policy and legislation.

Discussion
The Chairperson thanked NERSA for the presentation and said the closing remarks were very encouraging. The affordability of electricity, especially to the poor was fundamental. Another fundamental thing was that of transparency, and the impact it would have on price determination. NERSA’s tariff decision seemed to impact the viability of the economy as a whole. He urged all municipalities to roll-out local development programmes, as this did not receive the attention it deserved. The misalignments between Eskom and SALGA needed to be addressed as a matter of urgency. The Department of Energy needed to explain how ADAM linked up with SALGA; the pilot project had only been rolled out to seven municipalities. How long did the other municipalities have to wait for the roll-out? Time had run out so Members must limit their questions.

Mr J Selau (ANC) said what he got from NERSA’s presentation was that renewable energy was a futile exercise, and it was expensive. He asked NERSA to explain what it actually wanted to communicate on renewable energy. A concern was raised about security of supply. Was the current building of power stations a sustainable solution in the long run?

Ms Mathibela said the presentation should have started with SALGA as there were a lot of questions directed to them. Her main concern was about free basic electricity and free basic alternative energy; SALGA was awarding electricity to people who could afford electricity; instead the poor people who could not afford electricity were suffering with the shortages. He asked if spending on prepaid meters was not better than having billions owed to them by consumers.

Mr Greyling said what SALGA should be looking at grouping municipalities together to have a centralised electricity system. A sustainable solution needed to be looked into. Migration of demand side management from Eskom to government was a concern. The Committee therefore needed to ensure that government was pulling its weight on the matter to ensure security of supply. What incentive systems did Eskom have in place to encourage the private sector to be involved?

Mr Maphumulo thanked the Members for their questions and the strong messages which were directed at SALGA about dealing with the challenges faced by municipalities. On the question of prepaid meters, most of Eskom’s customers were prepaid customers. The biggest problem was with illegal connections and energy theft at vendor municipalities. With regard to capacity constraints and incentives, as long as there were packages between Eskom, municipalities and the private sector, there would always be problems. However Eskom was trying to address these issues. As for network constraints, the rate of development was growing very fast; therefore the expansion programmes were impacted. SALGA was dedicated to look at the Integrated Development Plans (IDPs) at all municipalities and assist where necessary.

Mr Selau suggested to SALGA that it meet with the Department of Public Administration to discuss the IDPs at municipalities.

The Chairperson extended a warm thank you for all the presentations, and thanked the Members as well for their contributions.

The meeting was adjourned.

Apologies: Mr S Radebe (ANC), Prof S Mayathula (ANC), Ms B Tinto (ANC), Mr J Smalle (DA), Ms B Ferguson (COPE)

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