Energy pricing: briefing by Department of Energy

Meeting report

Chairperson’s opening remarks
The Chairperson said the issue of energy pricing, particularly that of Liquid Petroleum Gas (LPG), was one which was felt intensely by industrial and commercial sectors. Ordinary residents felt the price hikes as well. A discussion about the impact of electricity prices on the country’s economy, especially on manufacturing, was therefore necessary. The National Treasury had recently introduced a draft policy on carbon tax which would also have an impact on energy pricing. It was important that people were made aware that the determination of crude oil pricing was not under the control of the country or the Department of Energy (DoE), but was determined by global forces.

Apologies were noted from Mr J Selau (ANC), Mr K Moloto (ANC), and Mr S Radebe (ANC)

Presentation: Department of Energy (DoE), Fuel Prices
Mr Robert Maake, Director: Fuel Pricing: DoE, said his presentation would address the fuel pricing mechanism currently being used in South Africa.  The price of petrol was expected to increase by 32 cents a litre, diesel by 32.9 cents, and paraffin by 25 cents, all at the wholesale level. The price of crude oil was determined mainly by the events which affected oil producing countries. Geopolitics was therefore becoming a bit more challenging.  In Yemen, there had been sabotage of the pipelines. In Libya there were also challenges which would evidently impact on crude oil supply. Libya was also one of the custodians of the Suez Canal, and should the canal be closed, the delivery of oil to countries such as South Africa would be negatively affected. The crisis in Egypt also had serious impacts on crude oil and pricing. The conflict between Sudan and South-Sudan had resulted in a rise in fuel prices, as well as a major rail accident in Canada which had forced the Canadian government to reconsider railroads as one of the major modes of oil transportation.  It was also the hurricane season in North America, and that too would have an impact on the pricing of products. The tightening of sanctions on Iran by the United States had contributed significantly to the rising price of crude oil.

Mr Maake explained that there were three basic forms of fuel pricing globally:
• Ad hoc pricing, which set prices irregularly, with no transparency between countries.
• Formula based/ automatic price adjustments --which was used in South Africa -- which meant that prices were published, as well as the pricing formula.
• The liberalised pricing system, which meant that the market set the prices.  The prices were depoliticised, and there was a formula.
On the policy position, he said in South Africa the price of petrol was regulated, while the price of diesel was not regulated.  For illuminating paraffin, the single maximum retail price was regulated, but the wholesale price was not regulated, and this was the cause of some of the main disputes in the industry about liquid fuels regulation. In addition, South Africa used the Import Parity Principle (IPP) for pricing determination. IPP was defined as the price an importer had to pay to purchase a product in the world market and have it delivered for domestic sale. The following pieces of legislation were cited as some of the regulatory/ policy instruments:

• Energy White Paper on Energy Policy of November 1998
• Petroleum Products Act 1977
• National Energy Regulator Act 2004
• Central Energy Fund Act 1977

Basic Fuel Price (BFP)
Mr Maake explained that the BFP was based on the import parity pricing principle, which determined what it would cost a South African importer of petrol to buy the petrol from an international refinery, transport the product from that refinery, insure the product against losses at sea and land the product on South African shores. The Central Energy Fund (CEF) had been appointed by Cabinet in 1994 to be an impartial body which would determine the BFP. The BFP made provision for all grades of petrol, diesel and illuminated paraffin. Elements of the BFP were free-on-board (FOB) value, freight and average freight rate assessment, insurance, ocean loss, demurrage, cargo dues and stock financing costs.

For establishing benchmark FOB values, Platts was the pricing agency of choice in South Africa.  Other agencies included Argus and Bloomberg.  South Africa imported 50% of its petrol from the Mediterranean region and 50% from Singapore, while 50% of our diesel was imported from the Mediterranean while the other 50% was from the Arab Gulf.   Half of the country’s illuminated paraffin was imported from the Mediterranean, while the other 50% was imported from Singapore.

The costs of freight were determined by the London Tanker Brokers Panel.   In addition to the costs, there was a 15% premium which was added to supply oil to South Africa.   There was a 0.15% insurance charge to insure all products to South Africa, and 0.3% was charged for ocean loss, as the products being transported were liquid and evaporated at sea. The tariff for cargo dues were set by the National Port Authorities in various countries. Demurrage was payable for the time a vessel spent in a harbour to load and discharge a cargo, even when the vessel was not operating. A vessel was allowed to stay in a harbour a maximum of three days. On stock financing costs, South Africa used Standard Bank’s prime interest rate, less 2%.

Factors which influenced the size of the BFP were international crude oil prices, international product supply/ demand balances, product inventory levels, geo-politics, the Rand/ US Dollar exchange rate, international refining margins, and weather patterns in the Northern Hemisphere

Fuel Levies
Mr Maake said South Africa was supplying Botswana, Lesotho, Namibia and Swaziland with oil.  However, the pump prices in these countries were significantly lower than those in South Africa. The reason for this was that these countries did not have most of the fuel levies which South Africa had to adhere to, such as the Road Accident Fund (RAF) levy, Customs and Excise Levy, and Demand Side Management Levy.   Subsidies were there to cushion the price of fuel on consumers. However, by themselves, subsides were not sustainable.

Single Maximum National Retail Price for Paraffin
The maximum retail price at which "loose" Illuminating paraffin -- excluding the cost of package/ packaging -- may  be sold at any place in South Africa, was 971 cents per litre, in an "own container" supplied for filling.  The wholesale price of paraffin changed every month.  The DoE had done extensive research throughout the country and has since recommended to the Minister that the retail margin at service stations for paraffin be fixed. This would reduce the price of paraffin by about R2 per litre. However, the issue of compliance would still remain a concern. Another challenge was that the sellers of paraffin, such as spaza shops, were not licensed by the DoE.

Maximum Retail Price for Liquefied Petroleum Gas (LPG)
Mr Maake said the government started regulating the price of LPG in 2010. One of the challenges raised by the industry was that elements of the LPG had not been reviewed, and the wholesale price was not regulated -- only the retail price was regulated. Retailers were complaining about this.

Discussion
The Chairperson thanked Mr Maake for the presentation, and said fuel pricing was very complex. By breaking down the composition of fuel pricing, the DoE had enabled Members to have a more holistic understanding of the fuel pricing process. The changes in the retail margin for gas were also very interesting. Members had paid a visit to the BP Gas Centre in Cape Town the previous week as part of their oversight work, and had gained a lot of insight into the inner workings of the oil industry.

Mr L Greyling (ID) agreed with the DoE that a lot of the factors which contributed to fuel pricing hikes were out of the DoE’s control, and there was not much that could be done to control price increases. The increases in fuel prices were one of the factors which had a significant impact on the country’s economy. He was aware that illuminated paraffin was predominantly used by people in the lowest economic sectors of the country, and for that reason it had been exempted from Value Added Tax (VAT) in order to keep the price as low as possible. There were, however, grave consequences from the use of paraffin, such as shack fires and death upon consumption. Although it was the fuel of choice for most South Africans, there was a need to devise a plan to migrate people from paraffin use to other forms of energy, such as gas. A household energy strategy was therefore necessary to facilitate this transition. In the meantime, strict safety regulations and controls needed to be put in place. On gas, he said what seemed to be a concern was that the DoE was regulating only retail, and not wholesale, prices.  This had since resulted in gas shortages.  The terminals to transport gas, as well as other infrastructure, needed to be looked at because when people migrated from paraffin to gas, there needed to be an adequate supply of gas. A proper strategy to ensure a smooth transition was therefore necessary.

The Chairperson said he was very sceptical about peak oil and asked that the DoE spend a few moments discussing the matter. What impact would peak oil have on the fuel sector as a whole? He disagreed with the liberalised pricing system, and said all oil pricing systems were heavily politicised. It was interesting, however, that the market was allowed to determine its own prices.  Fragmented regulation in liquid fuels needed to be looked into, as the status quo could not remain. With regard to the regulatory and policy instruments, he said the distinction between levies and legislation needed to be explained.  He referred to the Gas Act of 2001 and the Petroleum and Natural Gas Regulatory Board Act of 2006, and asked why there needed to be two Acts which seemingly tackled one aspect. What was the rationale of these different Acts?
He said the BFP working rules had been adopted by the National Economic Development and Labour Council (NEDLAC), and were the product of negotiations.  What was the product and value of these negotiations?  Could the DoE not engage with port authorities to ensure that all loading and off-loading was done on time, as every extra delay meant an extra cost, especially during times of high demand. On the slate levy, he asked how the DoE had arrived at the R250 million figure. Regarding transport costs and zone differential costs, he asked about the cost of transporting fuel to rural areas such as Limpopo, as transportation had major cost implications. On paraffin, he asked what plans and strategies the DoE had in order to cut out the costs of the “middle man”, and what implications would these have on the sector overall?  What would the likely impact of upgrading fuel refineries be?  What would be the likely impact of improving household access to appliances?

Ms N Mathibela (ANC) referred to the coastal storage allowance of 25 days, and asked what would happen when the storage limit was exceeded.

Mr Maake said the Import Parity Pricing (IPP) system did not apply to oil producing countries -- it applied to countries with big refining centres. Singapore was one of the main refining centres in the world.

The Chairperson asked whether the IPP also applied to the rest of the petroleum products that were derived from crude oil.

Mr Maake responded that the Equalisation Fund had been used as a smoothing mechanism for pricing, but it had since been discontinued. A household energy strategy was not currently being considered by the DoE, however. On moving people from the use of paraffin to other forms of fuel, he said the dynamics surrounding paraffin were not simple.  He agreed, however, that the issue of safe paraffin use was a serious concern and this was why the DoE was working with various safety associations to curb this problem. Paraffin was still being sold in unsafe plastic containers. On the matter of paraffin appliances, he said the DoE had piloted the paraffin stove four years ago in four provinces, and around 1 500 stoves had been distributed. According to the study, the stoves had proved to be very safe, but residents did not approve of the recommended retail price. Added to that, the stoves had to be manufactured overseas, and that was an added expense. The actual cost to manufacture the stove was about R800 per unit, while according to the study, consumers were willing to pay only about R200.

The DoE pricing team was busy with a review of the current LPG price, and among other matters, were also discussing whether the price should be regulated or not.  On deregulation, and the role of SASOL, he said SASOL was still contributing a small portion of South Africa’s oil requirements -- the majority of South Africa’s oil was still imported from abroad.  On shale gas, he said improvements in pricing would be seen only when there was a rise in local production. On peak oil, he said at the moment, it did not have a lot of impact on fuel pricing in the country.  On fragmented regulations, and how they impact on the economy, he said this was an area where a lot of independent work was needed. The DoE needed to bring in researchers, preferably Honours and Masters students to assist the DoE in their research. Funding would be made available for such an initiative. The advantage of this was that these researchers did not need to be supervised by the DoE -- they would be supervised by their professors. On the Levies Act, and the separation from the main Act, he said that was how levies were collected, according to the Pipelines Levies Act.

The Chairperson said efficiency in any sector was important, and asked whether it would not create problems to have the Levy Act on one side and another Act on the other side. He said all inefficiencies needed to be ironed out.

Mr Maake said the DoE would check with its legal department to see whether these different Acts resulted in any inefficiency, and would communicate the response to the Committee.  When it came to addressing the pricing lag in margin adjustments, the DoE had put together a team to address this concern, and was looking to adjust the margins annually. On the question of why the BFP was a NEDLAC process, he said any changes in the working rules needed to be approved by NEDLAC. The DoE was, however, part of the negotiations with NEDLAC. Regarding demurrage, he said it was important to distinguish between crude oil and the finished product.  Crude oil was not subject to demurrage -- demurrage was applicable only to finished oil products.  IPP was also applied only to finished products.   There had not been any concerns about crude oil vessels not being able to offload when they arrived at shore.  He agreed that transporting fuel from Gauteng to rural areas was indeed very expensive.  With regard to reducing the impact of the middle man on illuminated paraffin prices, he said the DoE was currently discussing an option to establish energy shops closer to where paraffin was predominantly being used. On coastal storage, he said vessels were compensated for storage only for the 25 days, but added that luckily none of the vessels would exceed the 25-day storage limit.

Mr Hein Barn, Fuel Pricing Specialist: DoE, said the DoE and National Treasury had conducted a study in 1998-99 on price smoothing, but as a result of the study, the DoE had not gone ahead with it. On the peak oil question, the problem was not how much crude was available, but rather the quality and the type of the available crude oil. Refineries used only specific types of fuels; most of the refineries in South Africa operated under an Arabian licence. Another problem with peak oil concerned extraction costs, which were too high -- it was becoming more difficult to tap oil from the gas.

On the Nedlac process, he said that in 1994 the Cabinet had decided that the entire regulatory framework within the industry would be taken to Nedlac. The synthetic fuels industry had been subsidised and received tariff protection. However, there had been a lot of disgruntlement among members in the industry, and the DoE had been advised to consult with Nedlac to try and resolve some of the growing concerns. It had then been decided that price subsidisation within the synthetic fuels industry would be removed. It was therefore important that the DoE continued to consult with Nedlac on regulatory matters.
On the crude oil margin system, he said there was a deemed import tariff price. This price also enabled the country to compete well with major international refineries, such as those in Singapore and the Arab Gulf.  Regarding the R 250 million state levies, he said in 1998 the DoE had implemented the Self-Adjusting Slate Levy Rules; and the oil companies were willing to carry the R250 million negative balance -- the R 250 million was therefore an agreed upon levy by the DoE and the oil companies.

Mr Maake commented on the question about price smoothing mechanisms, and said that at present the DoE did not have the funds to implement such mechanisms.

Ms Mathibela raised concern that the DoE was embarking on solar heating systems, but there was no local manufacturer in the country to undertake the job. The skills would have to be imported. She asked why the DoE did not rather invest in research and training people to undertake such projects. Reference was made to the paraffin stoves pilot project.

Mr Maake replied that the paraffin stoves project had been funded by the Central Energy Fund (CEF). The initial idea was that the stoves would be manufactured locally, therefore creating more jobs, but this had not been the case, and was why the project had been dropped.

Mr Greyling argued that it was evident there was a need for a central energy strategy, and it was unacceptable that the DoE had not come up with one yet.

The Chairperson agreed with Members that localisation and efficiency needed to be prioritised, and one way to go about that was to draft and implement a central energy strategy. It would provide guidance to the DoE as a whole.  The value chain needed to be cleaned up, whether through policy or any other aspects, to improve efficiency and accessibility.
He thanked Mr Maake for the presentation and said that the DoE’s pricing mechanisms needed to be improved, and the current pricing formula also needed to be scrutinized.

DoE on Energy Pricing
Mr Thabang Audat, Acting Chief Director: Electricity, DoE, said the presentation would deal with the electricity element of energy pricing.  The presentation would focus on the DoE’s policy position, its electricity pricing methodology and Eskom’s asset re-evaluation.

The Electricity Pricing Policy of 2008 had set out the following principles  for setting electricity tariffs:
revenue requirement, cost reflectivity, transparency and unbundling costs (customer bill), non-discrimination, access to and use of networks, and the long-term price outlook

The DoE’s electricity pricing policy received its mandate from the Electricity Regulation Act of 2006, which conferred upon the National Energy Regulator of South Africa (NERSA) powers and duties to regulate electricity prices and tariffs.

Policy Position
Mr Audat said the generating pricing structures needed to reflect the efficient cost of supply of the generator or the alternatively approved Power Purchase Agreement. The tariff structure could consist of capacity charges, energy charges and ancillary services. In addition, the revenue requirements for a regulated licensee needed to be set at a level which would cover the full regulated business cost. The regulatory methodology therefore needed to anticipate investment cycles and other cost trends, in order to prevent unreasonable price volatility and shocks (price spikes) while ensuring financial viability, continuity, fundability and stability over the short, medium and long term, assuming an efficient and prudent operator.

On generator pricing, he said electricity pricing structures needed to reflect the cost of supply of the generator or any approved Power Purchase Agreement (PPA). Additional economic implications, following the introduction of a renewable energy support mechanism, would be factored into the price of electricity in accordance with prevailing policy. Wholesale energy prices needed to encourage the efficient use of electricity at all times and should reflect the Time of Use (ToU) structure differentiated cost of supply.  The wholesale energy price structure would be periodically reviewed and updated by the wholesaler.  Prices needed to cover the costs of wholesale energy and purchases. NERSA would determine the qualification criteria for Wholesale Electricity Pricing System (WEPS) customers and implementation, subject to cross subsidy stipulations in this Electricity Pricing Policy (EPP) document.

Electricity Pricing Methodology
Mr Audat explained that the price of electricity was determined through the electricity pricing formulation -- the Multi-Year Price Determination (MYPD). The MYPD incorporated the principles of Rate of Return (RoR) and incentive, based on the transmission and distribution service incentive scheme. The main drivers of electricity generation costs were the acquisition costs of assets, operating and maintenance costs, and fuel costs

Eskom’s asset re-evaluation
Mr Audat said the DoE needed to develop a long-term electricity path which would be integrated with the Integrated Resource Plan (IRP), which was revised from time to time.  The electricity demand in the country was not being met by the available sources of power, therefore more power stations needed to be built to facilitate the country’s economic growth.  The tariff would increase because more capital was needed to build these new power stations. It did not matter whether the IPP approach or the utility approach was used in the building of new power stations. The difference between the two was that the IPP approach raised capital on its own -- it did not need revenue from tariffs. With the utility/demand approach, the utility was allowed to raise its own capital through demand.  However, regardless of which approach was used, tariff prices would be increased. He said the DoE had been criticised for the rate at which it introduced non-utility generators.  On an annual basis, the DoE was introducing very small renewable energy megawatts.  The reason was that the cost to manufacture was declining internationally, so South Africa was buying international technology to encourage local manufacturing.

Discussion
The Chairperson thanked Mr Audat for the presentation, and said some of the matters raised were not new. However the issue of transparency in price determination was still a concern. He thanked the DoE for explaining the calculation for Return on Investment and Return on Capital. The calculation for Return on Capital was still considered to be very controversial, however.

Mr Greyling said there was not enough time for Members to raise all their questions and concerns. However, some of the issues raised by the DoE had been covered during the National Energy Regulator of South Africa (NERSA) hearings. Members had raised some concerns on the present pricing strategy. The problem with the logic presented was that the DoE wanted consumers to pay for the building of new power stations now and to fund future assets which would be built, together with the return on these assets. This would make the price increase utterly unaffordable to consumers. He suggested that the working cost of capital be used as a benchmark for price and asset determination. His concern with the new pricing strategy was that a number of companies were struggling now because they had planned demand side management incubation, but this was no longer funded by Eskom.  What mechanisms did the DoE have in place to address this?  He asked whether the DoE expected municipalities to solely fund the replacement of new meters, or whether there would be some kind of subsidy scheme from government to assist in the process. Municipalities could not afford to replace meters on their own. On the new power stations which had to be built, he said the problem with the present IRP was that pushing up the tariff too much would hold back economic growth and still not deal with the problems of capacity. There was therefore a need to revise the current IRP.

Ms Mathibela thanked the DoE for a wonderful presentation. She asked about Eskom wanting to stand alone financially, and asked whether that meant that Eskom no longer wanted to be a government entity.

The Chairperson said Eskom’s policy management strategy needed to be reviewed and revised frequently, but the pricing policy had been revised only as necessary and not regularly. What was the logic of this?  The Committee had also expected the DoE to brief the Committee on its transformation policy. He asked how municipalities were factored into the electricity pricing process. He reiterated Ms Mathibela’s question about Eskom wanting to be a stand-alone entity, and said Eskom would be engaged on the matter.   The focus on primary energy was very interesting, and he suggested that the DoE should introduce efficiency to improve the primary energy component.  On “wheeling”, he asked how it came into pricing.  Questions on micro generation needed to be directed to Nersa, but he wanted the DoE to comment on the impact it had on pricing.  What mechanisms had been put in place to ensure fair representativity when Eskom was evaluating its asset base?

Mr S Mayathula (ANC) asked when the IRP would be reviewed, and who would be reviewing it. The IRP was supposed to be reviewed every two years, and this had not taken place.

Mr Audat responded to the question on demand side management, and said there were two elements which had not been approached; power buy-backs and solar water heaters.  Power buy-backs were approved, but the issue was that factories were not being productive. National Treasury could therefore not pay manufacturing houses for not working.   Eskom priced electricity at a wholesale level and a certain percentage was allocated to demand side management. In the Gauteng province, the DoE had an understanding with the provincial municipalities that there would be a small metering project piloted in the province. Most municipalities argued that time-of-use metering and smart metering would run in opposite directions. The pilot was therefore there to prove that smart metering could be implemented without negatively affecting municipal revenue collection. On the review of the IRP, he said the process had already started internally.  The DoE was going through a public consultation on the IRP, after which stakeholders would also be consulted.

On the question of Eskom wanting to be a stand-alone entity, Eskom no longer wanted to rely on the government’s limited resources, but wanted instead to be able to approach the market and raise its own funds. The state would still remain the main shareholder, however.
He agreed that the electricity pricing policy had not been formally reviewed.  What the DoE had been doing was to raise its concerns during the MYPD3 price applications. The 2008 Electricity Pricing Policy still needed to be reviewed, however. Municipalities were affected by the outcome of the MYPD3 applications, and it would not make sense for municipalities to want to be stand-alone credit entities. Municipalities provided many other services other than electricity.
Primary energy costs were dominated by coal -- 97% of it was coal. The current approval by the Competition Commission could open a large export base for coal, especially with India.  South Africa could then be exposed to the international costs of coal.  
On tariff increases, he said that the current Electricity Regulation Act and the Nersa Establishment Act did not allow for the regulator to pronounce on the tariff upfront.
He responded to the question on “wheeling,” and said they were charges which were paid by privately-owned generators to Eskom transmission for services to transport power from generation to consumer.  On micro generators, he said they were linked to time-of-use meters and would be implemented at municipal level. However, micro generators did have an impact on municipal revenues.

The Chairperson said there was not enough time to cover all questions.  The DoE was asked to respond to the rest of the questions in writing. He thanked the DoE once again for their presentations. He said it would have been helpful to have Nersa and representation from municipalities present at the meeting.

The meeting was adjourned.